Japan's Economic Puzzle

With global stock markets gyrating, and growing fears of an economic crash, the state of health of Japan’s economy becomes more important than ever. Still Asia’s economic giant and the world’s second largest economy, Japan, though, is simply muddling its way since its bubble burst a decade ago. The economic meltdown of some of the regional economies made things even worse. This led Tokyo to encourage some economic restructuring at home. The banks, for instance, were given funds to reduce bad debts, subject to some transparency requirements. Even tentative and tardy economic restructuring has contributed to large-scale bankruptcies, and rising unemployment. The result is a paralysis of confidence among many people. They are no longer sure of the future direction of their lives. With a sub-standard social security system, and bleak economic prospects, people are simply not spending more than what is necessary. With an estimated 60 per cent of Japan’s gross domestic product (GDP) dependent on consumer spending (which is virtually stagnant), the economy simply is at a standstill. There are mixed signals now and then about some turn-around, but without sustained trends. Japan, therefore, looks like going in circles without making a real breakthrough. The stockmarket does sometimes appear to be taking off with foreign interest in its technology stocks. But its volatility precludes any firm conclusions. What exactly is the Japanese government doing about the country’s sluggish economy? Apart from some half-hearted encouragement of restructuring, its main approach is to kick-start the economy through public spending on infrastructure projects, mainly in the construction sector. But this has reached a ludicrous stage where there are now multiple roads serving similar needs. Though such spending does provide short-term employment for some people, these projects are not always productive. Hence, their contribution to the economy is increasingly dubious. Indeed, the government’s pump-priming exercise is mortgaging the country’s future to a growing public debt to finance government spending. In other words, Japan’s future generations will have to pay the price. For instance, the country’s accumulated public debt is now way over its GDP at 130 per cent. And it is rising. Japan’s ageing population will further compound the problem, because of the pressure on an already over-stretched system. There are two ways to deal with this situation: to raise taxes and/or to reduce spending. Both are considered inappropriate at the present time. The first will further depress consumer spending, and the second will only deepen recession. Therefore, Japan is in a real bind. It doesn’t mean, though, that Japan is likely to turn into a ‘banana republic’, a colourful term used by Australia’s then treasurer, Paul Keating, in mid-eighties to jolt his country out of its economic stupor. This is so for a number of reasons. First, Japan continues to enjoy a healthy trade surplus, and is not vulnerable to foreign debt. (The Asian meltdown in 1997 was primarily due to unhealthy exposure of affected regional economies to foreign debts, particularly of short-term duration. When the panic started, these creditors were the first to quit.) But any appreciation of the yen might start to affect its trade surplus. In any case,even a growing export sector is unlikely to pull Japan out of its long economic stagnation. As noted earlier, 60 per cent of Japan’s GDP is generated through consumer spending. Exports account for a small, but crucial, part of Japan’s economy – particularly at this time when domestic demand is sluggish. Second, and more importantly, Japan has huge domestic savings, much of it in postal saving accounts and other state-controlled schemes. And these incur virtually no interest payments, thus constituting a huge cushioning for the state. According to recent press reports, an estimated 106 trillion yen in postal accounts will mature over the next two years. And most are likely to be reinvested with the post offices. For most part, Japanese people feel safe with government guaranteed savings. They are not into chasing higher interest rates with private schemes and funds. For the Japanese government, though, it is a bonanza to fund public spending. The same may not, however, be true for the country’s economy. Because of the pork-barrelling nature of such spending, it is not always economically prudent. There is, therefore, a political element in it to nurture the ruling Liberal Democratic Party’s rural constituency and other special interest groups. Hence, the country’s economy tends to languish due to mis-allocation of resources. Japan is facing this problem all the time. There is, undoubtedly, an element of economic reasoning too behind increased public spending. It is feared that without this the economy might go into a deflationary spiral with disastrous consequences all round. On the other hand, if and when the economy does pick up with the help of periodic spending packages, the additional revenue thus generated will help to progressively reduce the public debt level. At that stage, the government might even be able to raise taxes to speed up the process of debt reduction. Therefore, Japan is opting for a long-term strategy combining public spending with an element of luck. This is obviously a case of pious hope over policy, considering that it hasn’t worked over the last decade. The alternative, though, of large-scale economic restructuring (including opening up Japan substantially to foreign goods, services and investments) is not regarded with equanimity as involving intense social and economic pain. If anything, the government appears to be slowing the process of economic restructuring. For instance, according to Samuel Wilkin in the Far Eastern Economic Review, “Recently, it [the government] announced a delay in plans to remove state guarantees of bank deposits... The initial schedule of April 2001 served as a looming deadline – banks would need to sort out their problems by then or face runs at the hands of worried depositors...” This is precisely Japan’s problem. It is feared that any bold and radical economic surgery (however overdue) will undermine the country’s carefully nurtured social cohesion and harmony. Therefore, why not stick with slow, but incremental reform, combined with additional public spending. Who knows, this might do the trick. But will it? The experience of the last decade doesn’t bear it out. In the meantime, Japan continues to increase its public debt. Even for a country like Japan, with its mountain of people’s savings, the need will arise at some time in the future for squaring its national accounts.