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Japan’s Slow-Motion Crisis
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If you listen to American, European, or even Chinese leaders, Japan is the economic future no one wants. In selling massive bailouts, western leaders told their people, “We must do this or we will end up like Japan; mired in recession and deflation for a decade or more.” Chinese leaders love pointing to Japan as the reason for not allowing any significant appreciation of their conspicuously undervalued currency. “Western leaders forced Japan to let its currency rise in the second half of the 1980s, and look at the disaster that followed.”
Yes, nobody wants to be Japan, the fallen angel that went from one of the fastest growing economies in the world for more than three decades to one that has slowed to a crawl for the past 18 years. No one wants to live with the trauma of the deflation that Japan has repeatedly experienced. No one wants to navigate the precarious government debt that Japan faces, with debt levels far above 100 per cent of GDP. No one wants to be a poster child for economic stagnation.
Yet, visitors to Tokyo see prosperity everywhere. The shops and offices are bustling with activity. Restaurants are packed with people dressed in better clothing that one sees in New York or Paris. Even after two decades of “recession”, per capita income in Japan is more than $40,000. Japan is still the world’s third-largest economy after the US and China. Its unemployment rate remained low during most of its “lost decade”, and, although it has shot up more recently, it is still only 5 per cent.
So what gives? First, things look a lot grimmer when one gets two hours outside of Tokyo to places such as Hokkaido. These poor regions are dependent on public projects for jobs. As the government’s fiscal position has weakened, the jobs have become scarce. True, there are beautiful roads, but they go nowhere. Old people have retreated to villages, many growing their own food, with their children living in cities.
Even in Tokyo, the air of normalcy is misleading. Two decades ago, Japanese workers could receive huge bonuses; typically one-third of the salary or more. Now, these have shrunk to nothing. Thanks to falling prices, the purchasing power of workers’ remaining income has held up, but it is still down by 10 per cent. There is more job insecurity than ever before as firms increasingly offer temporary jobs.
Although hardly in crisis yet, Japan’s fiscal situation grows more alarming by the day. Until now, the government has been able to finance its vast debts locally, despite paying paltry interest rates even on longer-term borrowings. Remarkably, Japanese savers soak up some 95 per cent of their government’s debt. Perhaps, burned by the way stock prices and real estate collapsed in the 1980’s bubble burst, savers would rather go for safe bonds, especially as gently falling prices make the
returns go farther than would be the case in a more normal inflation environment.
Unfortunately, as well as Japan has held up until now, it still faces profound challenges. First and foremost, there is its ever-falling labour supply, owing to low birth rates and deep-seated resistance to foreign immigration. The country also needs to find ways to enhance the productivity of its workers.
Inefficiency in agriculture, retail, and government are legendary. Even at Japan’s world-beating export firms, reluctance to confront the ingrained interests of the old-boy network has made it difficult to prune less profitable product lines — and the workers who make them. As the population ages and shrinks, more people will retire and start selling the government bonds they are now lapping up. At some point, Japan will face its own Greek tragedy as the market charges sharply higher interest rates.
The government will be forced to consider raising revenues sharply. The best guess is Japan will raise its value-added tax, now only 5 per cent, far below European levels. But is it plausible to raise taxes in the face of such sustained low growth?
Investors who have bet against Japan in the past have been badly burned, underestimating the Japanese people’s remarkable resilience. But the fiscal road ahead looks perilous, with political consensus fraying badly in recent years.
In the end, are foreign leaders right to scare their people with tales of Japan? Certainly, the hyperbole is overblown. However, apologists for deficits should not point to Japan as reason to be calm about outsized stimulus packages. Japan’s ability to trudge on in the face of huge adversity is admirable, but the risks of crisis ahead are greater than bond markets seem to recognise.
The writer is professor of economics and public policy at Harvard University, and was formerly chief economist at the IMF. Copyright: Project Syndicate, 2010
(This story was published in Businessworld Issue Dated 29-03-2010)