| |
A prescription for the Japanese
economy
Balance Sheet
Recession by Richard C Koo
Reviewed
by Gary LaMoshi
 Cataloguing Japanese economic miracles, you'd
likely skip the years since 1989 featuring sluggish
growth or outright recessions, deflation and stock
prices riding at 20 year lows and still falling. But
Nomura Securities chief economist Richard Koo credits
Japan with an unprecedented achievement during these
years.
Since the property bubble burst, fallen
asset prices have reduced Japan's national wealth by 41
percent, equivalent to 2.7 times its annual gross
domestic product. The last comparable asset-price
collapse led to the Great Depression of the 1930s, when
the United States sustained wealth losses of 25 percent,
roughly equal to its GDP at the time. Despite its far
greater losses, Japan's economy has not collapsed into
depression.
Koo attributes this miracle to the
140 trillion yen (US$1.2 trillion) in fiscal stimulus
over the past decade under a string of Liberal
Democratic Party (LDP) prime ministers that Koo advised.
That spending guided Japan safely through uncharted
economic terrain and kept it from spinning into the
vicious cycle of acute deflation and collapse.
By contrast, the "no recovery without
restructuring" medicine administered now by Prime
Minister Junichiro Koizumi and his economics czar Heizo
Takanaka seems to Koo frighteningly similar to the
policies of US president Herbert Hoover and his treasury
secretary Andrew Mellon that turned the 1929
stock-market crash into the Great Depression (see Fighting over a cure for Japan's
economy). While stimulus has yet to produce
sustainable recovery, Japan's performance since the
bubble burst is far superior to the Great Depression's
20 percent unemployment, 90 percent fall in stock prices
and 50 percent reduction in GDP.
Koo's new book
Balance Sheet Recession either bravely ignores
conventional wisdom to map Japan's path to renewed
prosperity or cleverly justifies a dozen years of failed
fiscal policy that Koo helped create.
Japan's
economy suffers from two diseases, Koo explains,
pneumonia and diabetes. The stagnant economy is the
pneumonia, potentially fatal; structural diabetes can
wait until the acute condition is cured. On reform, Koo
advocates greater deregulation of the economy,
especially land use, and a government policy to extend
Japanese vacations. But first the pneumonia must be
cured.
Japan's long-running economic sickness is
different from a cyclical downturn, according to Koo,
and this particular condition is not discussed in any
economics textbook. A balance-sheet recession (the US
Federal Reserve coined the term in 1991) occurs after a
sharp drop in asset prices that leads prudent companies
to pay down debt, temporarily eschewing business
expansion and profit maximization to protect long term
survival, while thrifty households continue to save.
The result is a severe economic contraction.
Deflation and non-performing loans are symptoms of
balance sheet recessions, not the cause of the economy's
problems, Koo contends, so they shouldn't be the focus
of policy prescriptions. Similarly, Japan's structural
problems, serious as they may be, existed during the
boom years when Japan's economy was the envy of the
world. (Koo convincingly makes this same point about the
irrelevance of structural problem while other factors
are favorable when discussing the Asian economic crisis,
which he connects to the fall of the yen while other
Asian currencies' values remained linked to the US
dollar.)
"This view has never been expressed in
economic literature," Koo stated in an interview with
Asia Times Online. "Economics assumes that corporations
seek to maximize profits and households maximize
utility. When that's not happening, you need a different
theory." Starting with the Japanese version of
Balance Sheet Recession published in 2001, Koo
has stepped in where monetarist and Keynesian theory
fail.
Koo credits John Maynard Keynes as coming
close to understanding balance sheet recessions with his
theoretical "liquidity trap" though Keynes' missed the
role of debt - "perhaps Keynes was too rich to
understand debt," Koo joked. However, Keynesian
prescriptions, aimed at preventing another Great
Depression, are the right ones for Japan's situation
(and, Koo says, fell into disrepute through abuse by
policymakers that attempted to coax healthy economies
into defying the business cycle during the 1950s and
'60s). In Japan today, monetary policy has proven
useless, as it did during the 1930s. Despite interest
rates near zero, there is little corporate demand for
loans and a persistent preference for paying down debt.
Companies' reducing debt, rather than seeking
higher profits, drives the economy in the wrong
direction. Japan's corporate sector currently is a net
supplier of 20 trillion yen to the banking sector,
equivalent to 4 percent of GDP; in 1990 bank loans to
corporations were equivalent to 10 percent of GDP, a
negative swing of 14 percent. Meanwhile households, at
least through 1999, continued to save about 7 percent of
GDP, deepening the deflationary gap in the economy.
Economists call this behavior "fallacy of
composition". Corporations seeking to bolster their
balance sheets through debt reduction are acting
responsibly. Households that continue saving in the face
of rising uncertainty about jobs and retirement funds
are also acting responsibly. The overall impact on the
economy of this collective virtuousness, however, is
devastating.
Understanding the situation in
these terms leads Koo to the conclusion that the
government must fill the deflationary gap with public
spending. Advisor to 1990s LDP prime ministers through
Yoshiro Mori, Koo contends their fiscal stimulus
policies didn't steal money form future generations and
waste it in a futile effort to evade reform; that
spending, he says, was all that kept Japan from complete
economic collapse.
"As a result," Koo writes,
"the Japanese public were unaware of how close they were
to economic catastrophe during that period. Furthermore,
after 10 years of crisis prevention, people began to
take the situation for granted." And under Prime
Minister Koizumi, one of the few LDP leaders who hasn't
welcomed Koo's advice, they're seeking the wrong
solutions: "The problem is that Mr Koizumi does
not have an advisor who understands economics."
Economics guru Takenaka is a microeconomics expert
facing what Koo characterizes as a macroeconomic crisis.
Koo cites the Latin American debt crisis of 1982
as a model for Japan today. During that period, Koo
worked at the US Federal Reserve (Koo is a US citizen
born in Japan with roots in Taiwan) and saw first-hand
how the Fed chairman Paul Volcker set aside
microeconomic orthodoxy to combat the macroeconomic
emergency caused by bad loans to South American
borrowers that endangered the entire US banking system.
That crisis was overcome through patience over a
dozen years at virtually no cost to US taxpayers.
Volcker twisted arms to prevent banks from declaring
borrowers in default and keep credit lifelines open. In
contrast, the US Savings and Loan crisis of 1989 - with
its quick disposal of non-performing loans at a cost of
$160 billion to US taxpayers - is the wrong model for
solving Japan's banking problems, Koo argues. S&Ls
represented just 5 percent of banking system whereas
Japan's current bad-loan situation, like the Latin
American crisis, threatens the entire Japanese banking
system.
Koo provides a more recent precedent to
support his theory that the government has to continue
fiscal stimulus. In 1997, prime minister Ryutaro
Hashimoto took Western advice (and ignored Koo's),
raising taxes and cutting spending to narrow the budget
gap. Five quarters of economic contraction followed,
government debt grew, and asset prices fell further. The
recession set back corporate balance sheet repair, and
the economy required greater fiscal stimulus to climb
out of its tailspin than it would have needed to remain
on its previous no growth plateau.
If you look
at Japan's struggles as a journey out of a slow growth
jungle, Hashimoto's policy veered off the path toward
the clearing and back toward the heart of darkness,
leaving the economy further from escape. Koo sees
Koizumi's policies as having the same impact, on an
economy he estimates was perhaps two years away from
balance sheet repair and resumed corporate demand for
funds when he took office.
Koo's book sensibly
explains the elements of Japan's economic malaise since
the stock-market and property bubbles burst, presenting
a strong case for further government fiscal stimulus.
Trendy ideas such as quick disposal of non-performing
loans, restructuring and deregulation don't solve the
problem at the center of Koo's analysis: no corporate
demand for loans. Only economic recovery, the book
insists, will restore that missing link in the economic
cycle and lead to lasting recovery. It is a convincing
point, eloquently argued by someone who understands
banking and banking crises.
Balance Sheet
Recession deserves to be called a groundbreaking
work. Groundbreaking generally results in either a new
edifice getting built, or something getting buried. It's
up to Japan's policymakers to decide which fate awaits
Koo's contrarian prescriptions and the national economy.
Balance Sheet
Recession by Richard C
Koo,
John Wiley & Sons (Asia), 2003, Singapore.
ISBN: 0-470-82116-7. Price: US$29.95, 284 pages.
(©2003 Asia Times Online Co, Ltd. All rights
reserved. Please contact content@atimes.com for
information on our sales and syndication policies.)
|
| |
|
|
 |
|
