Asia Times: ASIAN CRISIS DIARY, VOL II : Japan: Krugman v. Koizumi


	May 5, 2001	atimes.com

Editorials

ASIAN CRISIS DIARY, Vol II
Japan: Krugman v. Koizumi
By Uwe Parpart, Editor

New Prime Minister Junichiro Koizumi enjoys the highest public approval rating - over 80 percent - of any Japanese leader in recent memory. Hopes are running high, and not just in Japan, that he will liberate Japan from a decade of stagnation and misery. Appointment of a reform-minded cabinet, including five high-profile private-sector representatives, underlines Koizumi's commitment.

Princeton University professor Paul Krugman (who recently moved from MIT), the man who predicted the Asian crisis three years before it happened (for most of the wrong reasons in our opinion) doesn't doubt Koizumi's reform zeal, but thinks his platform will more likely make him Japan's Herbert Hoover than its Franklin Roosevelt. In his New York Times column last week he quotes Koizumi: "There will be companies going bankrupt and increased unemployment ... But if we are fearful of unemployment, we will never see the recovery of the Japanese economy." That, says Krugman, is reminiscent of the disastrous advice given by Andrew Mellon, Hoover's Treasury secretary: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate ... It will purge the rottenness out of the system ... Values will be adjusted, and enterprising people will pick up the wrecks," adding that what was wrong with that advice, aside from its callousness, was that it confused supply with demand.

Krugman's argument in a nutshell: "When an economy's production is limited by its capacity to produce - the normal state of affairs - it is important to make sure that scarce resources like capital are used efficiently ... So if Japan's production were limited by its capacity, Mr Koizumi's proposals to privatize postal savings and force banks to write off bad loans would be right on target ... But Japan isn't limited by its capacity. It is plagued by chronic insufficiency of demand - that is, consumers and businesses are unwilling to buy as much as the economy is already capable of producing. And in such an economy, attempts to increase efficiency often do more harm than good. Freeing capital by reducing the budget deficit and closing down unprofitable businesses sounds great - but if that freed capital is simply put under the mattress (or stored in a bank vault), the result is not faster growth but a deeper slump ... The actions Mr Koizumi has proposed could tip Japan into full-blown depression."

Krugman's answer to Koizumi's problem? Unconventional monetary expansion, with the Bank of Japan buying dollars, euros and long-term government bonds; accepting and indeed promoting mild inflation and a weak yen. But he doesn't think that's about to happen and concludes: "Poor Japan. It is the victim of those who refuse to learn from the past, and thereby condemn others to repeat it."

With all due respect to Krugman's Keynesian wisdom, OUR only worry is that Koizumi will NOT go through with his reform proposals and will be tempted to rely on the Bank of Japan's already instituted quantitative easing and further steps in that direction to carry the day.

What's mainly wrong with Krugman's argument is that it treats supply and demand as, in effect, independent macroeconomic variables and in the process - true to Keynes - studiously ignores Say's Law (after the original supply-side French economist Jean-Baptiste Say (1767-1832)) that "supply creates its own demand", that production is the source of demand, that one's ability to demand goods and services from others derives from the income produced by one's own acts of production, that WEALTH IS CREATED BY PRODUCTION NOT BY CONSUMPTION, and that one's ability to demand anything derives from the productivity of one's labor or non-labor assets. From this perspective, Say's Law has nothing to do with an equilibrium between aggregate supply and aggregate demand (as Keynes wrongly interprets it), but rather it describes the process by which supply in general is turned into demand in general.

The issue in Japan - and the gist of Koizumi's proposed reforms - is not, as Krugman has it, "attempts to increase efficiency" of existing businesses, but liberating the supply side from crippling restrictions (including restrictions imposed by bad-loan saddled banks on new lending), allowing new market entrants, new competitors, and greater access by wider population segments to entrepreneurial activity and wealth creation. Employee-consumers, especially those increasing numbers of Japanese consumers on fixed incomes, are risk averse; only self-reliant, self-employed consumers are ready to spend what they know they can create and re-create. And, of course, new wealth creating producers with new ideas and new products will create new types of demand in a virtuous circle.

As Japan undertakes long, long overdue structural reform, depressive effects will undoubtedly initially ensue. The BOJ's easy money policy is the cushion to mitigate those. But without such reforms, no amount of fiscal stimulus deficit spending or monetary easing - as several years and over a trillion dollars of that have proved - will make a substantial difference. Koizumi and his advisers would be dead wrong listening to Krugman and untested ideas on the efficacy of monetary-policy induced inflation.

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