Abe Listening to Krugman After Tokyo Limo Ride on Abenomics Fate

Nobel Laureate Paul Krugman
Nobel Prize-winning economist Paul Krugman plays down his role, saying the Nov. 6 meeting with Abe "was very straightforward." Photographer: Scott Eells/Bloomberg

When Japanese economist Etsuro Honda heard that Paul Krugman was planning a visit to Tokyo, he saw an opportunity to seize the advantage in Japan’s sales-tax debate.

With a December deadline approaching, Prime Minister Shinzo Abe was considering whether to go ahead with a 2015 boost to the consumption levy. Evidence was mounting that the world’s third-largest economy was struggling to shake off the blow from raising the rate in April, which had triggered Japan’s deepest quarterly contraction since the global credit crisis.

Honda, 59, an academic who’s known Abe, 60, for three decades and serves as an economic adviser to the prime minister, had opposed the April move and was telling him to delay the next one. Enter Krugman, the Nobel laureate who had been writing columns on why a postponement was needed.

“That nailed Abe’s decision -- Krugman was Krugman, he was so powerful,” Honda said in an interview yesterday in the prime minister’s residence, where he has an office. “I call it a historic meeting.”

It was in a limousine ride from the Imperial Hotel -- the property near the emperor’s palace that in a previous construction was designed by Frank Lloyd Wright -- that Honda told Krugman, 61, what was at stake for the meeting. The economist, who’s now heading to the City University of New York from Princeton University, had the chance to help convince the prime minister that he had to put off the 2015 increase.

Confronting Honda and fellow members of Abe’s reflationist brain-trust -- such as Koichi Hamada, a former Yale University economist, and Kozo Yamamoto, a senior ruling-party lawmaker -- were Ministry of Finance bureaucrats.

Opposing Forces

While Honda himself is a veteran of the agency, he parted ways with his former colleagues on whether the increase was vital to sustaining confidence in Japan’s credit profile, having the world’s largest public debt burden. With Honda’s stance against fiscal tightening well known, he says ministry officials called on him, repeatedly, as they lobbied for the 2015 tax bump to go ahead.

A former finance minister and predecessor of Abe as head of the Liberal Democratic Party -- Sadakazu Tanigaki -- had negotiated the two-stage increase in the consumption tax with the Noda administration, which enacted the legislation in 2012.

The plan to double the levy from 5 percent sparked a party revolt that led to more than 50 lawmakers fleeing Yoshihiko Noda’s Democratic Party of Japan, and contributed to his lower-house election defeat to Abe.

Foreign Pressure

The concept of outside opinion influencing Japanese decision-making is known as gaiatsu, or foreign pressure, in Japanese, and has historical precedent since at least the arrival of U.S. Commodore Matthew Perry’s squadron in 1853 in Tokyo Bay, which led to an opening in the nation’s trade policies. Gaiatsu also has been used as cover by Japanese officials when they’ve pushed through controversial measures.

Krugman plays down his role, saying the Nov. 6 meeting with Abe “was very straightforward.”

“He had questions and I hope I answered them clearly,” Krugman said in a telephone interview yesterday. “I told him the kinds of things I’ve been writing -- I hope I made a good case. What effect it had on him is unknown to me. He’s certainly not going to blurt out ‘I’m sold.’”

Following Abe’s Nov. 18 decision to postpone next year’s tax increase by 18 months, Krugman said: “I’m happy to see what they’re doing.”

Abe had swept to office in December 2012 on a campaign platform of ending two decades of economic stagnation. A coterie of reflationists including Honda, Hamada and Yamamoto, long on the margins of Japan’s policy debates, had convinced Abe -- who had been prime minister once before in an administration cut short by illness and electoral losses in parliament’s upper house -- that ending deflation was a key component of revival.

GDP Impact

The tax rises inherited from the previous government posed a challenge. Abe unveiled a 5.5 trillion yen ($47 billion) stimulus package in December 2013 to help the economy prepare for the 3 percentage-point rise in the consumption levy in April to 8 percent. It didn’t stop gross domestic product from falling an annualized 7.3 percent in the second quarter. Data this week showed a further 1.6 percent drop in July-to-September.

Abe had set a year-end deadline for a decision on whether to proceed with the next scheduled boost in the tax rate, to 10 percent in October 2015. As lawmakers and advisers presented their views, Honda thought the intervention of a prominent foreign economist might help.

Krugman or perhaps Joseph Stiglitz, another Nobel laureate in economics who in the 1990s criticized the International Monetary Fund for recommending fiscal tightening to crisis-hit Asian nations, might be helpful, Honda thought.

‘Disastrous’ View

By chance, Honda says he learned that Krugman was visiting Tokyo to speak at two conferences in the capital.

Days before his departure, Krugman wrote in the New York Times that “the whole business with the consumption tax drives home a point a number of people have made: the conventional view that short-term stimulus must be coupled with action to produce medium-term fiscal stability sounds prudent, but has proved disastrous in practice.”

“I knew Krugman would be great but I didn’t think he’d come to Japan just for one meeting,” said Honda. “Then I heard by chance that he’d be here, and there was no way I was going to waste that chance.”

Honda succeeded in organizing a 20-minute meeting between the prime minister and the U.S. economist. It went about double the allotted time.

Abe’s Residence

With a handful of aides and secretaries present at the reception room on the fifth floor of Abe’s residence in the Nagatacho district southwest of the Imperial Palace, Krugman began by praising Abenomics, describing how much he respected the program to revive Japan after 15 years of deflation, Honda said.

The only problem was the sales tax, Krugman said, according to Honda. Honda, Hamada and another aide, Eiichi Hasegawa, kept quiet. Honda says that by the end of the meeting, he was convinced Abe would decide on postponement.

Hamada, who had advised Abe on his pick for Bank of Japan governor, said that “Abe listened to Krugman’s view very carefully.” Hamada said in an interview Nov. 18 that “he probably helped the prime minister make up his mind.”

Abe himself highlighted his discussion with Krugman when speaking on the national public television broadcaster NHK three days ago.

Escaping Deflation

“He said we should be cautious this time in raising the sales tax and if we weren’t it would break the back of the economy,” Abe said. “He said if that happened, we wouldn’t escape deflation, it would be uncertain whether we could revive the economy and repair the nation’s finances. I think that’s the case.”

As for the current plan to boost the sales tax in 2017, Krugman says: “I understand that at some point they are going to need more revenue. I would prefer a conditional delay -- ’we will raise it after inflation is at 2 percent or something.’ I understand that’s not likely.”

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