What Japan Needs To Do Is Buy Some ProsperityRudi Dornbusch
After two years of increasing strain, Japan's economy is on the rocks. For the first time in memory, output has dropped two quarters in a row. Confidence has never been lower. Banks are bankrupt, companies are breaking lifetime job commitments, retrenchment is everywhere. Deflation is under way; the International Monetary Fund estimates that Japan's gross domestic product will fall short of projections for fiscal '93 by 5%.
Criticism of the government's policies, unprecedented in this consensus society, is now common, as is the call for a bold program of fiscal stimulus to head off collapse. Japan needs a major fiscal move far beyond what is on the drawing board today.
Japan is suffering from four interacting troubles:
-- In the aftermath of stock- and land-price collapse, corporations and banks have wrecked their balance sheets. Banks cannot lend as they rebuild their capital positions; companies cannot invest because their net worth is sharply down; households do not buy durables because people are so much poorer.
-- The decline in spending has brought on a recession. Companies have excess capacity and far too much labor on the payroll. They are cutting costs and commitments: Investment in machinery has plunged, and pruning of employment is expected to reach 1.5 million.
-- The stronger yen, driven by a record trade surplus, is cutting into export opportunities at the very time breathing room on that front could offset the declining home economy.
-- The confidence of households and business has plunged, translating into less investment, lowered consumer spending, softened bank lending, and lower asset prices. Political troubles distract the government's attention from economic priorities. The public, aware of this fact, loses even more confidence.
Japan has three options. The first--do nothing--was the approach of the past two years and has no credibility.
The second option is to talk down the yen from the current level of 105 to the dollar to a range of 110 to 115. Since it was talked up over the past year by the U.S. Treasury, why not talk it back down? This would provide immediate export relief for Japanese companies. Devaluing the yen to maintain sales and profits is attractive to Japan but understandably unacceptable to the U.S. (and to Europe, which hides behind the Treasury's skirts). Everybody has trouble with jobs and profits, the West will argue. Nobody should be allowed to export their job problems with massive trade surpluses as a result of undervalued currencies. A yen depreciation should most decidedly not be part of the script. A major cut in the Japanese external surplus, from 3% at present, remains the U.S. target.
The third option, fiercely resisted by the Finance Ministry, is a big tax cut a la Reagan. There have been a few fiscal packages in the past year, but they were too little and too late to reverse the slide. Until now, the ministry has resisted all proposals to get ahead of the curve and actively drive prosperity with a bold and massive stimulus. It is clear that it is obsessed with revenues. Anticipating the aging of Japan in the 21st century and the consequent need for fiscal strength, the ministry cites the deficit-ridden U.S. economy as an example of addiction to lax public finance beyond cure.
Under the pressure of events, the ministry is now caving in. An emergency fiscal program is on the table providing for tax cuts next year. But there's some small print that provides for new taxes two years down the road. In line with the ministry's fixation on revenues, consumption taxes will double by 1995 to recoup the money lost by the tax cut. In fact, the delayed tax increase more than makes up for the contemplated largess. Economists are rightly skeptical whether short-lived pump priming will have much effect at all. The Reagan tax cuts gave the U.S. a decade of sustained growth; Tokyo's tax cuts may not even yield an extra 2% growth--too little to trim the surpluses, far too little to restore balance sheets and confidence.
DIG DEEP. Unlike any other industrialized country, Japan is in an ideal situation to buy itself some prosperity. Even in this recession, the budget is balanced, and there is no public debt to speak of. Surpluses such as Japan enjoys today are there to be used when emergencies arise. What else are they good for? Tokyo's enviable public-finance position should be used boldly to buy prosperity. Germany used its once- strong public finance to buy near-instant conversion of the East. True, there are deficits now, but surely that is better than not remedying the legacy of communism in eastern Germany.
Similarly, Japan should dig into its deep pockets to finance tax cuts on an ambitious scale. Doubling the proposed program might be a start--say a 12 trillion-yen tax cut and a five-year moratorium on tax hikes. That strategy would add very little to the public debt but would drastically change the outlook for prosperity and for Japan's good trade relations with the rest of the world. Tokyo needs to deliver on all those summit promises of strong growth in domestic demand.
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