The Japanese Disease

By Jeff Harding

President-elect Obama says that he will spend upwards of a trillion dollars the kick-start the economy. President Bush fully supports Hank Paulson and Ben Bernanke in their efforts to spend our way out of a serious recession-depression. Almost all economists, liberal and conservative, agree that the government will have to spend hugely to get things back to normal, though they disagree on the specific implementation of the cure.

If I tell you they are wrong you may think I’m either delusional or ignorant for rejecting the mainstream conventional wisdom. However, there is another economic theory which has been proven right in the past, namely Austrian theory economics. I am a student and advocate of Austrian School economics which is almost diametrically opposed to Keynesian theory which most economists follow.

I think the Keynesian cures for our shattered economy will make things worse. Much worse.

Who’s right?

By looking at Japan in the 1990′s and early 2000′s we can see the results of a Keynesian solution to a set of facts almost identical to our present situation. The “solution” caused an almost 15-year (1990–2005) stagnation of the Japanese economy.

It’s not as if mainstream economists are unaware of the parallels to Japan and its failures. But the universal response of Keynesians, instead of an admission of failure of their theory, is that the Bank of Japan didn’t act soon enough and were not aggressive enough in their application of “corrective” Keynesian programs.

Here’s the Japanese experience which is startlingly similar to our present situation.

They started with a huge credit expansion. Their discount rate was cut from 4.4% to 2.5% in 1986-1987.

1. Real estate and equity prices soared.
2. To counter the speculative boom, the discount rate was raised in 1989-1990 from 2.5% to 6% and their markets crashed.
3. The Nikkei went from 40,000 in 1989 to 11,000 in 2005. Real estate values plummeted 80%.
4. GDP grew at only 1.17% from 1992 to 2003.
5. Unemployment went from 2.1% in 1991 to 4.7% by 2004 (a very high rate in Japan).
6. Consumption and investment fell dramatically.
7. Banks were not lending.

What was the response of the government to this crisis?

1. In order to kick-start the economy, the government went on an infrastructure spending binge and cut taxes.
2. From 1992 to 1995 they spent ¥65.5 trillion on projects and cut taxes.
3. In 1998 they cut taxes ¥2 trillion.
4. In 1998 they spent another ¥40.6 trillion on spending stimulus.
5. In 1999 they spent another ¥18 trillion in fiscal stimulus.
6. In 2000 they tried another ¥11 trillion spending package.
7. They set up a ¥20 trillion fund to lend directly to businesses (the Financial Investment and Loan Program [FILP]).
8. To try and push money into the system the Bank of Japan and Ministry of Finance bought more than half of existing government bonds from the private market at a cost of ¥2.22 trillion.
9. Trying monetary policy, they lowered the discount rate from 4.5% in 1991, 3.5% in 1992, 1.75% 1993-1994, to 0.5% 1995-2003.
10. They set up a $524 billion bailout fund in 1998 to buy stock in failing banks or nationalize them.

It is estimated that the Japanese spent about $1 trillion about (¥135 trillion) to cure their financial problems. But the problems lingered, banks remained weak, lending and investment was severely reduced, unemployment was high, government debt went to more than 150% of GDP, and the yen devalued. Nothing seemed to work.

In a January 2008 article in USA Today on the lessons learned from the Japanese “disease,” several prominent economists were quoted as saying the lessons of Japan have been learned and if there is a problem we’ll jump on it immediately.

Robert Rubin said, “If you look back at Japan, and you think to yourself what was their monetary policy like and why did that happen, I don’t think this is an analogous situation.” Ken Rogoff of Harvard said of the parallels, “If the U.S. escapes with just a mild recession, we’ll be lucky,” says Rogoff. “There’s a chance we’ll have no recession, but there’s at least an equal chance of a deep and long recession with high direct and indirect costs.” Rogoff predicted a $450 billion price tag.

It appears we are following the Japanese experience almost to the letter. To date we have done many of the same things that the Japanese tried yet these remedies have failed to rescue the economy. While there are substantial differences in our respective economies, the parallels to our banking crisis are more similar than not. The same Keynesian remedies being implemented in the US now were tried in Japan with disastrous results. Surely there’s a better way.

Tags: financial crisis, Keynesian economics, fiscal stimulation, Japanese disease