An Alternative View on Japan's Stagnation

There can be lots of easy comparisons between the economic crisis faced by Japan twenty years ago and the crisis now facing the United States. Both had severe real estate and financial busts which badly affected the real economy.

The literature on financial crises points out that financial crisis induced recessions go for longer than boom-bust business cycle recessions and this appears to be happening currently in the United States where consumers are restricting their spending to deal with the build-up of debt.

The general contention is that Japan failed to deal with its crisis and as a consequence has suffered twenty years of stagnation. Some worry that the United States is facing a long period period of sub-par growth.

Paul Krugman seems to delight in iconoclasm - or what we might call contrariness.

A decade ago, Japan was a byword for failed economic policies: years after its real estate bubble burst, it was still suffering from chronic deflation and slow growth. Then America had its own bubble, bust and crisis. And these days, Japan’s record doesn’t look that bad to an American eye.

Why not? For all its flaws, Japanese policy limited and contained the damage from a financial bust. And the question in America now is whether we’ll do the same — or whether we will take a hard right turn into economic disaster.

In the 1990s, Japan conducted a dress rehearsal for the crisis that struck much of the world in 2008. Runaway banks fueled a bubble in land prices; when the bubble burst, these banks were severely weakened, as were the balance sheets of everyone who had borrowed in the belief that land prices would stay high. The result was protracted economic weakness.

And the policy response was too little, too late. The Bank of Japan cut interest rates and took other steps to pump up spending, but it was always behind the curve and persistent deflation took hold. The government propped up employment with public works programs, but its efforts were never focused enough to start a self-sustaining recovery. Banks were kept afloat, but were slow to face up to bad debts and resume lending. The result of inadequate policy was an economy that remains depressed to this day.

But Krugman argues the black and while view of Japan's 'failure' is too simplistic and although its economy has been depressed it has avoided depression. Unemployment remained at relatively low levels compared to the current US situation partly because of government spending. The verdict is that Japan has avoided disaster. For the US the jury is still out and Krugman worries that the Republicans are stopping any comprehensive solution for a weak economy. 

Like their Japanese counterparts, American policy makers initially responded to a burst bubble and a financial crisis with half-measures. I’ve lamented that fact, but at this point it’s water under the bridge. The question is: What happens now?

Republican obstruction means that the best we can hope for in the near future are palliative measures — modest additional spending like the infrastructure program President Obama proposed this week, aid to state and local governments to help them avoid severe further cutbacks, aid to the unemployed to reduce hardship and maintain spending power.

Even with such measures, we’ll be lucky to do as well as Japan did at limiting the human and economic cost of the economy’s financial woes. But it’s by no means certain that we’ll do even that much. If the Republicans go beyond obstruction to actually setting policy — which they might if they win big in November — we’ll be on our way to economic performance that makes Japan look like the promised land.

It’s hard to overstate how destructive the economic ideas offered earlier this week by John Boehner, the House minority leader, would be if put into practice. Basically, he proposes two things: large tax cuts for the wealthy that would increase the budget deficit while doing little to support the economy, and sharp spending cuts that would depress the economy while doing little to improve budget prospects. Fewer jobs and bigger deficits — the perfect combination.

More broadly, if Republicans regain power, they will surely do what they did during the Bush years: they won’t seriously try to address the economy’s troubles; they’ll just use those troubles as an excuse to push the usual agenda, including Social Security privatization. They’ll also surely try to repeal health reform, which would be another twofer, reducing economic security even as it increases long-term deficits.

So I find myself almost envying the Japanese. Yes, their performance has been disappointing. But things could have been worse. And the case Democrats now need to make — the case the president finally began to make in Cleveland this week — is that if Republicans regain power, things will indeed be worse. Americans, understandably, are disappointed over, frustrated with and angry about the state of the economy; but disappointment is better than disaster.

One can only imagine how strong the United States economy would be if it abandoned its antipathy to certain regulations and supports for society such as education and health reforms.

Remember that the US right and big business is not opposed to regulation - just think about patents, copyrights, licences and the like and the health industry in general - just regulations that help to distribute wealth downwards. Bill Gates has no problems when it comes to government regulation of copyright and attempts to enforce it world wide. Regulations that distribute wealth upwards are fine. Big pharmaceutical companies have no problems with regulations that enable them to make billions on protected medicines whose marginal costs of production are negligible. (for an excellent exposition of these arguments see Dean Baker Taking Economics Seriously.

For those wanting a more traditional take on Japan's stagnation see the excellent series of articles on Japan in the New York Times, called "The Great Deflation"