Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Everyone is lining up to be the next Japan – the lost decade or two version that is. It has been taken for granted that Japan collapsed in the early 1990s after a spectacular property boom burst and has not really recovered since. The conservatives also claim that Japan shows that fiscal policy is ineffective because given its on-going budget deficits and record public debt to GDP ratios the place is still in shambles. I take a different view of things as you might expect and while Japan has problems it demonstrates that a fiat monetary system is stable and we should be careful comparing Ireland, the US or the UK to the experiences that unfolded in Japan in the 1990s and beyond.
An article in the UK Guardian yesterday (April 11, 2011) – Is Ireland heading for a Japanese lost decade? – by Irish academic economist Stephen Kinsella claims that the when making a comparison between Ireland and Japan:
There are more similarities than differences in this story.
Kinsella says he is a “student of economic history” and has been reviewing “Japan’s lost decade” which led him to that conclusion. He acknowledges without explanation that “Of course the economies are different. Of course Japan had its own currency. Of course Ireland’s fiscal and political problems would be there regardless of Ireland’s banking disaster”.
I thought that was an interesting juxtaposition. Japan’s monopoly over its own currency issuance is a defining difference rather than one difference that can be easily compared to the similarities.
Further, Ireland would not have any fiscal problems if it had its own currency. It might has some real economic problems, as has Japan but they would be of an entirely different scale to those faced today by Ireland. Further, one might speculate that its political problems should be less acute had it stayed out of the Eurozone (that is, kept its own currency).
Japan’s lost decade has been vilified by the mainstream for years. The New York Times ran a special series last year – The Great Deflation – which purported to examine “the effects on Japanese society of two decades of economic stagnation and declining prices”. It was an interesting series but missed several key points.
Consider this Huffpost article (November 19, 2010) – Reconsidering Japan – from political analyst Steven Hill which addressed some of the “myths” about Japan that motivate economic policy debate in the advanced nations (such as the US).
In relation to the NYT series, Hill says:
Reading the series is about as cheery a task as rubbernecking at a car wreck on I-95. But unfortunately the Times series simply repeats the “conventional wisdom” about Japan put out by the same economic experts who missed an $8 trillion housing bubble in the United States, and in fact have been wrong on most of the big economic issues over the past two decades.
Look at it this way: In the midst of the Great Recession, the United States is suffering through nearly 10% unemployment and 50 million people without health insurance. A new report has found over 14% of Americans living below the poverty line, including 20% of children and 23% of seniors, the highest since President Lyndon Johnson’s War on Poverty. That’s in addition to declining prospects for the middle class, and a general increase in economic insecurity.
How, then, should we regard a country that has 5% unemployment, healthcare for all its people, the lowest income inequality and is one of the world’s leading exporters? This country also scores high on life expectancy, low on infant mortality, is at the top in literacy, and is low on crime, incarceration, homicides, mental illness and drug abuse. It also has a low rate of carbon emissions, doing its part to reduce global warming. In all these categories, this particular country beats both the U.S. and China by a country mile.
Doesn’t that sound like a country from which Americans might learn a thing or two about how to get out of the mud hole in which we are stuck?
The article is insightful and documents why the “you don’t want to end up like Japan” syndrome is appealing to conservatives but missed the point entirely.
According to Hill, during the lost decade, Japan maintained:
- An unemployment rate was about three percent and about half the US unemployment rate over the same period.
- Universal healthcare.
- Less income inequality than the US.
- The highest life expectancy among the advanced nations.
- Very low rates of infant mortality, crime and incarceration.
The obvious conclusion is that “Americans should be so lucky as to experience a Japanese-style lost decade”.
Hill attacks Paul Krugman who he says has regularly paraded the “lost decade myth” but misses the point that “Americans are the only ones who seem to think they need three refrigerators, four televisions and a car for everyone in the household” should be the norm to aim for and the benchmark upon which to judge economic success.
The Japanese are more collectivist in this regard as the metrics above suggest.
Krugman did write a column (March 9, 2009) in the New York Times – Japan reconsidered – which altered his usual “attack the dithering Japanese line”. Given the timing of that article and what has since transpired it is interesting to reconsider it.
For a decade or so Japan’s lost decade has been the great bugaboo of modern macroeconomics. Economists constantly warned that you mustn’t do X or you must do Y, because otherwise we’ll turn into Japan. And policymakers congratulated themselves in advance for not being like their Japanese counterparts, who dithered and drifted, refusing to make hard decisions.
Well, I’m sure I’m not the only person to notice this: Japan doesn’t look so bad these days.
Which is one of the points I am making in this blog. On a number of indicators Japan held up in the face of a major collapse in private spending much better than other nations.
Krugman concluded that:
And given what the next couple of years are likely to look like, Japan’s lost decade – yes, growth was slow, but there wasn’t mass unemployment or mass suffering – is actually starting to look pretty good. We may or may not be about to face our own lost decade, but the sheer misery millions of Americans will face in the near future probably exceeds anything that happened in Japan during the 90s.
Which was a prescient look into the present!
But for Kinsella he still proposes to that the Irish government might learn from the Japanese experience to avoid a lost decade. Well if the Irish could replicate the Japanese response to economic crisis it would be far better shape than it is and will be for many years to come.
I thought some comparisons might put Kinsella’s mind at rest that Ireland is a lost cause while it remains in the EMU whereas Japan will always be able to avoid the dramatic decline in fortune that Ireland is undergoing because it issues its own currency (conservative central bank policy or not).
When comparing nations I usually begin with the real sector and focus on the events that affect people the most and nothing is more pervasive in that regard than unemployment. The following graph is taken from the OECD Main Economic Indicators and compares Japan to Ireland, the UK and the US from January 1982 to September 2010.
The two vertical lines note the beginning of the 1990s when the Japanese economy was seriously disrupted by the property collapse and 1997 when the neo-liberals badgered the national government into raising taxes because they claimed the budget deficit was dangerously high and the country was going bankrupt.
As we will see this sent the Japanese economy back into recession. But the scale of things is what matters. When Japan has a major real economic meltdown (pun not intended) the unemployment rate moves up – slightly. When Ireland encounters disturbed economic waters its unemployment rate soars.
Note the UK unemployment rate after fiscal austerity was announced courtesy of the national election result last year.
The point is that Japan’s lost decade was not that bad in terms of unemployment, which is an important measure of a nation’s progress.
The next graph shows annual employment growth from 1982 (Ireland’s MEI database is shorter). The vertical lines indicate the start of the “lost decade” and then the start of the 1997 austerity madness. Japan struggled to add net jobs in the early part of the 1990s. After several years of fiscal support, however, employment growth started to pickup again in the second half of 1996 and into 1997 it gathered pace.
Then it collapsed again as the fiscal austerity was imposed on a fragile economy. From March quarter 1998 to September quarter 2000 the employment growth rate was negative as the economy struggled as a result of the fiscal vandalism. It was only after a concerted renewed fiscal stimulus was introduced that growth slowly returned.
But even though the Japanese economy was in very serious trouble during the post-property collapse period in the early 1990s, annual employment growth was still mostly positive and in the four-quarters that it was negative the average annual growth was – 0.2 per cent – a very modest decline indeed.
Compare that to Ireland in the current crisis. From June 2008 to June 2010, the average annual employment growth in Ireland has been -5.5 per cent compared to Japan -1.1 per cent.
The reason lies in the inability of the Irish government to provide necessary fiscal support. Being a currency issuer really matters.
The following graph shows the contributions to annual real GDP growth by the major National Accounting expenditure components from March 1991 to March 2000 the period which saw growth stagnate in Japan. The data is available from Official Japanese statistics.
To compute the contributions to growth you use the formula Contribution = 100*(A(t) – A(t-1))/GDP(t-1), where A is the series you are interested in (for example, household consumption), t is now and t-1 is the time period in the past that you want to define the span of the growth by, and GDP is real GDP at the base period (t-1).
So for Japan, in March 1991, real GDP was 458,247.80 billion yen and household consumption (C) was 246,146.70 billion yen. In March 1992, the respective volumes were 466,052.40 and 255,489.60. So the contribution of to real GDP growth over that year from household consumption was 100*(246,146.70 – 255,489.60)/466,052.40 = 2 per cent. The fact that real GDP growth was only 1.7 per cent was the result of negative contributions from private investment (I) of 2.1 per cent; positive contributions from government spending (G) of 1.1 per cent; and positive contributions from net exports (NX) of 0.3 per cent. The contributions do not usually exactly add up to the GDP growth figure because of statistical discrepancies inherent in the National Accounts.
It is clear that there was a strong positive contribution from the government sector in the early years of the lost decade which attenuated the downward spiral in growth that was being driven by sharp declines in private investment and more modest decline in the contribution of net exports.
It was only when the Japanese government started to withdraw its fiscal support in early 1993 that the economy recorded on quarter of negative annual real GDP growth. Prior to that and after that the public spending supported the economy in the face of a very significant private investment collapse.
That is, until the neo-liberals won the political debate, albeit temporarily, and forced the cuts on the government in 1997. You can see that prior to that private investment was recovering under the wing of the fiscal support. After the austerity began and the contribution of government to growth became negative (from March 1997 but faltering in late 1996), both private investment and private consumption growth collapsed and were negative contributors to real GDP growth. Only net exports contributed positively.
At that point Japan experienced a full-blown recession with negative annual real GDP growth from the December quarter 1997 to March quarter 1999.
Growth returned in late 1999 once there was a strong positive contribution from government spending again.
Now consider the current crisis. The following two graphs juxtaposed with the same vertical axis for comparison show the contributions to annual real GDP growth for Ireland (left-panel) and Japan (right-panel) from March 2007 to December 2010. The Irish data came from the Ireland Central Statistics office.
The comparison is stark. Both nations entered as severe recession brought on by a private spending collapse. In Japan’s case it was worsened by its net exports sector also contributing negatively.
But consider the different way in which government spending behaves. The Japanese government spending started to play an increasingly positive role in stimulating growth and helped turn the economy into positive growth relatively quickly given the scale of the downturn.
The Irish government, one of the first to formally adopt fiscal austerity measures in early 2009 failed to provide the necessary support in the face of a collapse in private investment and consumption. The government contribution to annual real GDP growth became increasingly negative just at the time that sound fiscal management would call for it to make a positive contribution.
But the fiscal vandals argued that all would be well and private spending would fill the gap (and more). Ireland is still waiting and hasn’t come out of the recession yet while Japan has regained some private spending confidence and is growing steadily again.
Be careful in interpreting the net exports contribution to real GDP growth. In the recession, the decline in imports fell more quickly than the decline in exports which meant that net exports improved!
These historical snippets provide a firm warning to the nations now contemplating fiscal austerity. The following graph shows the contributions to annual real GDP growth for the US from 1999 to 2010.
The positive contribution of the US federal Government (Fed G) is clear in the face of collapsing investment and consumption spending. The dramatic cuts in the deficit proposed in the last week or so in the US will undermine real GDP growth. There is no question about that.
I am not suggesting that everything is fine in Japan. But in relative terms despite dramatic collapses in private spending, the Japanese government has shown a willingness to underpin collective outcomes and have kept unemployment from skyrocketing and employment growth from collapsing.
It can do this because it is a sovereign issuer of its own currency. Ireland cannot do this. The bank bailout situation is not the relevant issue even though the way the Irish government has handled that is appalling.
The problem is that those who are saying that the UK and the US are both on a track to be like Japan are, in my view, underestimating the magnitude of the damage the fiscal austerity will bring to those economies.
The relevant period to consider for Japan is between 1997 and 1999. Then the neo-liberals dominated and you can see what happened. In the other periods, there has been fiscal support – significant and necessary.
This public debate in the US and the UK at present is not considering this level of fiscal support. They are chasing Ireland down the path to obscurity by acting as if they have constraints on their currency issuing capacity and believing a bevy of mainstream economists who have told their respective governments that they are approaching insolvency.
Japan proves over and over again that a currency issuing government cannot become insolvent and that the public debt ratio can go to 200 per cent (well above the IMF 80 percent insolvency limit) and beyond without any problems at all. Inflation is low (and falling), interest rates have been low for 2 decades and unemployment remains below that experienced in most advanced nations – lost decade notwithstanding.
The reality for the US and the UK is they are heading Ireland’s way – despite having all the fiscal capacity they need to stimulate growth. If only Ireland could do that. For them, an exit from the EMU is required. For the US and the UK – bashing some sense into some conservatives (on both sides of politics) is all that is required.
That is enough for today!