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Japanese Phoenix: The Long Road to Economic Revival

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Summary:
The author provides excellent insights why the Japanese economy faltered. The economic miracle of the eighties did not grow much after 1989. He suggests economic reforms that would restore sustainable economic growth. But, he indicates such reforms are unlikely until Japan reforms its political system first. This means splitting the powerful LDP into two parties. This will not happen shortly. But, the building pressure for political reform as a result of the ongoing faltering economy is immense. Thus, Mr. Katz is confident it will happen.

Abstract: Japan has gone from experiencing the "Japanese miracle" in the eighties to being in the economic doghouse since 1989. During the eighties, Japan economy grew at 4% per year with little inflation and unemployment. During the nineties, Japan experienced no economic growth, suffered deflation due to weak consumer demand; and. its share of World GDP and World exports shrunk. Japan sustainable growth rate has decreased from 4% in the eighties to only 1% in 2000, on its way to only 0.5% by 2010. Japan?s GDP grew by only 0.3% per annum since 1997. Why did this economic decline occurr? There are really two Japanese economies. One consists of the super efficient exporting industries, including automobiles and consumer electronics. The other consists of the much larger domestic sector which employs 80% of labor force. The domestic sector is protected from competition by an anticompetitive regulatory environment that allows price collusion and restricts all imports. This sector includes food processing, retailing, wholesaling , finance, farming, and other services. Within these domestic industries, Japan?s productivity is between 50% to 66% lower than in the U.S.

During the eighties the productive exporting sector was carrying the inefficient domestic sector. But, in the nineties, the exporting sector progressively outsourced manufacturing overseas to lower its costs and remain competitive. As a result, the lagging domestic sector employing a rising percentage of the labor force caused a decline in Japanese productivity.

Japan suffers many structural problems. Its companies are overleveraged, and have over invested in nonproductive investments. This has caused Japan chronic nonperforming loans (NPLs) problem. These NPLs represent a staggering 20% of GDP. The banking system generates these NPLs faster than it can charge them off. This crisis has been going on since 1989. Both the government and the banking industry have refused to make the tough decisions to resolve these NPLs. The allocation of credit is fraught with conflict of interests. Risk management is lackluster. The banking industry is the weakest among industrialized nations.

Why are current monetary and fiscal stimuli not working? The Japanese central bank has maintained short term interest rates close to 0% for most of the past decade. The government has run large budget deficits (around 6% of GDP) for several years. But, despite these measures, economic growth has remained flat. The reason is industry suffers from excess capacity. As a result, loan demand is close to zero and so is the resulting economic growth.

Is the U.S. likely to experience the same fate? Some believe that the U.S. economy is experiencing a decade later the same economic ills as Japan. Mr. Katz makes a convincing case that the U.S. and Japan are on different economic paths. As mentioned, Japan economy is plagued by NPLs representing 20% of GDP. Japan?s banking sector is weak. Also, its long term sustainable economic growth rate is only 1%. Meanwhile, the U.S. has no NPLs problem, as NPLs represent only 2.4% of GDP. It has a well capitalized banking system. Also, its long term sustainable growth rate remains robust at 4%. Contrary to Japan, the U.S. has the most competitive domestic markets. All sectors are fully exposed to invigorating price competition from both domestic and international competitors.

What will it take for Japan to redress their situation? Mr. Katz suggests the following economic reform:

1) Resolve the NPLs by making a large capital infusion into the banking system. This capital infusion would come with the implementation of tough banking regulations including: implementing better accounting disclosure and rigorous classification of bad assets. These measures would instill a sound credit culture within the banking industry.

2) Cut individual income taxes to boost consumer demand.

3) Boost unemployment compensation to allow for the necessary rise in unemployment resulting from the elimination of excess capacity.

4) Promote forces of globalization to enhance competition within domestic economy. Deregulate domestic industries. Eliminate price collusion. This would increase the supply side efficiency and also increase real purchasing power of consumers by lowering monopolistic pricing.

How likely are the above reforms to occur? Mr. Katz mentions that some of these reforms have been attempted. But, any progressive regulatory step has been associated with two steps backward. The deregulation of the financial sector in 1999 was too timid. Since 1999, there has been a rise in ?financial socialism? as government bodies mediate 45% of deposits and 35% of loans. Thus, competition within the financial sector has actually weakened since 1999.

Mr. Katz indicates that political reform has to occur before successful economic reform can take place. This entails that the LDP will have to split into two parties. Japan is the only democracy that has been ruled by a single party since 1945. You need political competition before you can stimulate economic competition. Mr. Katz believe the LDP will inevitably split up because the LDP can not survive flat economic growth for another decade.

Books on the Japanese economy should follow a reasonably simple format. Having first explained the conflicting objectives of Japan's policy makers, they should then outline the constraints the policy makers face in meeting those objectives and, finally, they should discuss the monetary and fiscal options available to Japan's policy makers in trying to reach their objectives. That basic framework should serve as the scaffolding around which authors propound their various prognoses for the Japanese economy.

Richard Katz, Senior Editor of The Oriental Economist Report, a monthly newsletter on Japan, takes a different approach in Japanese Phoenix: The Long Road to Economic Revival, his recently published book. Instead of approaching the Japanese economy in this systematic way, he seems to have merely gathered together several dozen of his articles from The Oriental Economist and collated them into a book. The result is a very uneven, disjointed and disappointing work that has little of substance to offer the reader.

His rosary of disjointed articles put too much weight on the reforming zeal of recent prime ministers such as Junichiro Koizumi and the late Keizo Obuchi. He believes that Koizumi, like some hero in a manga comic, can single handedly turn the economy around and restore Japan's former growth rates. The reality is much more prosaic. Because Koizumi, like so many of his predecessors, is a prisoner of the outmoded structure of the Japanese economy, he is no more likely to effect fundamental change than they were.

The Japanese economy is geared to exporting cars, video games, precision instruments and other high valued added products and using the trade surpluses those exports garner to pay both for its imports and to subsidize its very large sheltered sector: the farmers, distributors, construction workers and other inefficient sections of the Japanese workforce. Although Katz believes that these ailing sectors will become internationally competitive, he does not offer any compelling reasons or arguments to support his radical belief. Japan has gone from being a country with excess pools of labor to being a nation where young workers are at a premium. That being so, Japan must concentrate on high value added industries whilst also being cognizant of the considerable financial problems its graying demographics portend. Japan therefore runs the risks of concentrating on too narrow a range of exports and prematurely relaxing its immigration policies to make up its labor shortfall. Although these problems are easy to propound, they are not so easy to solve. New international markets are not easily won and a major influx of immigrants would lead to radical social upheavals, at least in the short term. Japan's political leaders, wisely enough perhaps, given the political constraints they labor under, prefer to postpone the inevitable day of reckoning.

The Japanese problem is, in many ways, analogous to India's. Though we may criticize India's caste system, yet we cannot propound any way of effecting change without incurring very major short term upheavals. Japan's leader know very well what Japan's economic problems are: their dilemma lies in redressing them, not in identifying them and Katz certainly does not provide them with any useful policy insights.

Contrary to what Katz may believe, Japan's problems will not be solved by whatever edicts Koizumi might pass. Rather, they will be solved by Japan's business community working in consort with the government and gradually achieving the necessary structural reforms.

Because monetary policy will undoubtedly play a part in this just as it has in stimulating demand in America during the 1990s, Katz is therefore wrong to berate those who favor monetary action as a partial palliative for Japan's ills. He is also wrong to castigate the so-called revisionists, those who argue that the Japanese economic model is radically different from Western models. The reality is that every country is different from the standard text book model: the German growth model, for example, is markedly different from the British and Dutch models, which in turn have very little in common with the rent seeking Spanish type. American capitalism is very different again, simply because the United States faced a different matrix of objectives and constraints that did any of those European countries. Japan, which depends so much on exports to fund its huge protected area, marches to yet a different drum. Contrary to what Katz believes, Japan's problems are not "eminently solvable". They are as deep, as entrenched and as resistant to change as are those of India, the United States, Germany or any other country. Although Japan's political and business leaders will, in time, find partial solutions to Japan's economic woes, those solutions will not be found within the pages of this badly edited book.

The author seems very knowlegeabl on Japan, how it got to be an economic superpower and the recent decade of stagnation. Gives you a quick overview of both. It seems sad that such creative people are mired in a horrible slump out of which they can not come out unless they change the way the think. A must book for anyone who wants to know why Japan is in such a sad state.