Japan's Warning to the World
Japan's renewed descent into recession -- its sixth in the past two decades -- comes with an urgent if obvious warning to the U.S., Europe and the rest of the developed world: Don't let this happen to you. Japan's famously stagnant economy may not be all that unique.
True, Japan's predicament is exceptionally difficult. Extraordinary central-bank stimulus has helped boost markets, but hasn’t been enough to prevent the economy from shrinking for two consecutive quarters. Prime Minister Shinzo Abe was right to postpone a planned sales-tax increase, but there's only so much that fiscal policy can do in a country with a giant government-debt burden. This leaves Abe with the difficult task of pushing through much-needed structural reforms -- such as exposing farmers to competition and increasing the role of women and foreigners in the labor force -- in the midst of an economic slump.
How did Japan get here? Although by some measures the country's economic performance over the past 20 years hasn’t been as bad as it seems, most economists agree it would have been much better if Japan had done two things after its asset-price bubble burst in the early 1990s: pursued a much more ambitious fiscal stimulus program, and moved quickly to force banks to recognize losses and recapitalize.
Instead, Japan's ill-timed effort to balance its budget with a consumption-tax increase in 1997 sent the economy into recession, and a paralyzed banking sector contributed to an extended period of stagnation that has done much more to worsen the debt burden than well-targeted government spending would have. From 1993 through 2013, gross government debt grew at an average annualized rate of 5.3 percent -- a pace that normal economic growth would have largely neutralized. In the absence of that growth, the gross-debt-to-GDP ratio went from 80 percent to more than 240 percent. That's by far the highest among 179 countries tracked by the International Monetary Fund.
Japan's challenges in the early 1990s bear a striking resemblance to those of the broader developed world today. Government spending programs in the U.S. and Europe have fallen short of what the International Monetary Fund says is needed to reinvigorate growth. Banks are undercapitalized, contributing to a malaise that has seen euro-area business lending shrink for two years straight. Economists are warning of an extended period of stagnation unless governments act to increase potential growth -- by investing in infrastructure, encouraging more people to join the work force and promoting competition.
Judging from the agreement they reached at the past weekend's Group of 20 meeting in Brisbane, Australia, the leaders of the world's largest nations have a pretty good idea of what needs to be done. What's lacking is political will. Maybe a look at Japan's experience will provide some.
(Updated to reflect Prime Minister Abe's decision to postpone a sales-tax increase.)
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