Issue 227 of SOCIALIST REVIEW Published February 1999 Copyright © Socialist Review
'Japan is in a depression, not a recession or a cyclical slowdown... In a depression goods are in excess supply so prices fall. Tax cuts will not boost demand because frightened consumers just save the money. Lower interest rates--even zero rates--will also not lift demand because consumers and companies refuse to borrow.'
This was not written by a Marxist but by John Makin, an economist with the ultra-free market American Enterprise Institute, in the Sunday Times on 29 November 1998. It is an indication of ruling class desperation as it contemplates the world's second largest economy's worst economic crisis since the 1950s, and possibly since the Great Depression of the 1930s. Figures for October 1998 showed that Japanese industrial production had fallen by 8 percent year on year, retail sales fell 5.5 percent and the core retail price index fell 0.2 percent. How has the Japanese economy reached this disastrous state?
In the 1980s Japanese growth was sustained by Reagan's military Keynesianism--tax cuts for the rich, increased arms spending and huge government budget deficits which made the US the 'importer of last resort'. Japanese imports began to flood into the US at the expense of US industry and tensions rose. This culminated in the Plaza Accord of 1985 when the Japanese and US governments and central banks agreed to push down the value of the dollar and push up the value of the yen, thereby attempting to choke off the flood of Japanese imports by making them much more expensive.
The Japanese government tried to counteract the effects of the rising value of the yen and to reorient Japanese export industries to the domestic Japanese market in order to ease the trade and political tensions with the US. It did this by pushing interest rates down to very low levels. Japanese export industries took advantage of this easy money policy by raising investment to very high levels in order to improve productivity and cut costs. Between 1986 and 1991 net new investment in Japan amounted to a staggering $3.5 trillion. By the end of 1991 capital spending in Japan represented 23 percent of Japan's annual production, more than twice as high as British investment rates.
An intentional byproduct of the low interest rate policy was a dramatic rise in the value of the Japanese stock exchange and property prices, asset price inflation on a huge scale. The Japanese government hoped this would trigger a growth in domestic consumer spending as a result of the 'wealth effect' of higher share and property prices. Their strategy, however, ended in abject failure.
In 1990, in the face of rising fears of inflation, Japanese interest rates were raised from 2.5 percent to 6 percent and the 'bubble economy' began to deflate dramatically. The Nikkei index of share prices now stands at around one third of its peak value in 1990.
The bursting of the bubble left the Japanese banking sector with loans that could not be repaid, backed by assets in the form of property and shares which were a fraction of the original value of the loans. Some estimates put the value of bad loans in the banking system as high as $1 trillion.
The response of Japanese industry to the deflation of the economy and continued competitive pressures from a high exchange rate was to cut investment. Between 1991 and 1995 Japanese industry also increased annual investment in the Tigers and Tiger cubs, from $2.9 billion to $8.1 billion. Japanese bank lending into the region also grew significantly.
The Tigers had two great advantages: their labour costs were cheaper and they had pegged their currencies to the value of the dollar and therefore were not subject to the same squeeze that domestic Japanese industry had suffered as a result of the rise of the yen.
With increased investment came an increased export dependency on south and east Asia with the share of Japanese exports going to the Tigers and the cubs rising from just over 30 percent in 1990 to 44 percent in 1995. Therefore, when the Tigers collapsed in the second half of 1997, the Japanese economy, which had been all but stagnant since the bursting of the bubble in 1990, was hit by a triple whammy--falling profits on its Tiger investments, more bad loans for Japanese banks and a dramatic decline in what had become Japan's major export market. This is the trigger that has turned stagnation into recession and even depression.
The Japanese government has made a number of attempts to revive the economy since the early 1990s. It has tried to stimulate the economy by the Keynesian policy of fiscal reflation, cutting taxes and boosting government spending. Up until the latest package announced by the Obuchi government, the Japanese government had pumped what it claims is close to 80 trillion yen ($600 billion) into the economy since the bubble burst in 1991. In addition the central bank has cut interest rates to almost zero. These measures have almost certainly had the effect of preventing the downturn in the Japanese economy getting even worse, but they have not lifted the economy out of its decline.
Now the government has announced a new package of measures. There is to be a further 24 trillion yen ($198 billion) boost to the economy, the biggest ever, from increased public spending, tax cuts and government loans. In addition the government has nationalised the Long Term Credit Bank and announced a rescue fund of up to 60 trillion yen from which the government hopes that the top 18 big banks will take some 25 trillion yen to recapitalise themselves, thereby enabling them to address their enormous bad loan problem. It may be that this latest bail out of the Japanese economy will finally lift it into some sort of limited recovery but the risks are all on the 'downside'.
Much of the public spending announced requires the cooperation of Japanese local government. Yet local government is itself struggling with a huge debt burden. Revenue from corporate taxes on profits, which provided one third of local government income, has slumped as profit rates have fallen. Local government is therefore much more likely to use central government handouts to repay debt rather than launch new spending projects. Moreover the scale of new government borrowing to finance the boost to public spending has caused interest rates on government bonds to more than double to attract increasingly reluctant investors. The rise will increase the cost of the burgeoning public sector debt. More importantly, these interest rates establish a benchmark for long term bank lending, thus increasing the burden on the beleaguered private sector. The rise in interest rates on government bonds has also contributed to a rise in the yen against the dollar further squeezing Japanese exports.
In addition, Japanese consumers are unlikely to be persuaded to lift their spending through tax cuts. Workers are feeling much more insecure as the unemployment rate has doubled since 1990. Overtime, a significant addition to the income of many workers, has been slashed. Many workers will also be concerned that tax cuts will in reality only be temporary as the combined central and local government debt now exceeds ten percent of GDP, more than three times the maximum, permissible level for European governments under the Maastricht convergence criteria for European Monetary Union. And workers may also be holding off from unnecessary spending in the expectation that prices will continue to fall. In the face of this the government has resorted to the extraordinary measure of handing out spending vouchers to Japanese consumers to try to force them into spending more in the shops!
The banks are also reluctant to sort out their bad debt problem. To call in the loans would cause the collapse of many companies and reveal just how little of those loans the banks will be able to recoup. A taste of what could come was felt last year in Hokkaido when the Hokkaido Takushoku bank collapsed, devastating the regional economy. The scale of the bad debt problem means that any workout is going to take a long time anyway. In the early 1990s the US suffered a recession, a significant aspect of which was a $250 billion bad debt problem in the financial system. It took the much larger US economy some two to three years to work that problem out of the system. The Japanese debt problem could be some four times larger in a smaller economy, and there is an understandable desire to put off the day of reckoning. Yet unless the bad debt problem is sorted out the banks will be both unwilling and unable to make new loans to stimulate economic growth. As the Economist put it:
Most fundamentally, however, the productive sector is suffering from acute overcapacity in key areas of production. The very high rates of investment in the late 1980s and the lower but still high rates in the early 1990s contributed to a crisis of overproduction across the world which in turn triggered the Tigers' collapse in late 1997. Between 1988 and 1995 the rate of profit of non-financial corporations fell by 37 percent and there have been further significant falls since, with Hitachi, for example, reporting this year its first losses in 50 years.
Unless there is some unforeseen miraculous recovery of the world economy and of Japan's major export markets in particular, this overcapacity is going to keep profit rates depressed, which in turn will ensure that new investment to boost the economy will not materialise. In fact all the signs are that the Tiger economies will remain mired in depression and that the European and US economies are facing a severe slowdown and possibly recession in 1999.
In the face of these problems the only solution would be the elimination of the overcapacity--the bankruptcy and closure of companies and of productive capacity in Japan and elsewhere. Not surprisingly the Japanese government (along with other governments) is reluctant to allow such wholesale collapse.
There are a number of western economists who are now so scared of the state of the Japanese economy that they are recommending desperate remedies, including wholesale nationalisation of the biggest banks and pumping money into the economy in what would be a declared inflationary policy. It is ironic that these recommendations are coming from those who have warned of the evils of inflation in the past and who have been the most committed advocates of privatisation and the virtues of the free market. There are four principal arguments for an inflationary policy: firstly, persuading Japanese consumers that inflation was in the pipeline would encourage them to bring forward their spending before prices rose; secondly, if it fuelled a rise in asset prices on the stock exchange and in property, it would encourage people to feel wealthier and therefore spend and invest more; thirdly, if prices rose it would ease the debt burden on companies, which has been increasing, despite the very low interest rates, because prices are falling; and finally, a falling value of the yen, which should be a consequence of higher inflation, would stimulate exports.
However, an inflationary policy is fraught with danger. Firstly, with the liberalisation of the financial system in Japan it is easier for Japanese savings to leave the country for better returns elsewhere. Savers would be foolish to leave their savings in Japan if they thought the value of those savings were going to be devalued through inflation. And if they were to be persuaded to retain their savings in Japan this would require much higher interest rates to compensate. But much higher interest rates would have a devastating effect on the government's already shaky finances. Secondly, a dramatic fall in the value of the yen would set off further financial instability across the region, affecting not only the Tigers and their cubs but also the Chinese economy. And trade tensions, already growing would worsen considerably with the rapidly slowing European and US economies.
The fact is there is no obvious and easy solution for the ruling class to the very deep crisis in the Japanese economy. And as long as that crisis continues in Japan, it remains a threat not only to any sustained recovery in east Asia but also to the rest of the world economy.