Japan Needs To Face The Music Now

Japan's economic decline is a sad spectacle of denial and defiance. Once a model to emulate, the Japanese economy is now the subject of derision. Once the fastest-growing industrial nation, Japan is now the slowest. Strong corporations remain powerful global players, but the Japanese economy is caught in a vicious downward cycle of shrinking activity, shattered consumer confidence, and ineffective government policies. Just when Japan should take the lead in helping Asia recover, it is part of the problem, not the solution.

A veritable chorus of top Asian, European, and American officials are asking Tokyo to change policies. Malaysia, which built its prosperity on a closed Japanese mercantilist model, is now pleading for Tokyo to deregulate and open its markets to imports from the rest of Asia. At the recent G-7 meeting, Germany, France, and Britain joined the U.S. in an unprecedented public request for Japan to cut taxes to raise consumption, boost domestic-led growth, and buy more from Korea, Thailand, and Indonesia. A confidential study by the International Monetary Fund states that Japanese officials have done too little too late.

Japan's response so far? It denies responsibility. In fact, Japan dramatically changed the terms of trade in Asia by allowing the yen to plummet. It chose to promote exports rather than stimulate its economy and absorb imports. The move followed China's devaluation, putting the rest of Asia in a pincer that set the stage for the current crisis. The competitive devaluations backfired. This January, Japan's exports to Korea were down 42% from a year earlier, and exports to Thailand and Malaysia were off 35% and 16%, respectively.

Japan also has been in denial about its own economic malaise for nearly seven years. Despite prodding by the U.S. and others to deregulate its economy and cut taxes to boost consumption, it has relied on its old mercantilist faith in the magic of a trade surplus. Yet a foreign exchange policy that has weakened the yen by nearly 40% has failed to increase growth.

What may be holding back Japan the most is an obsession with the care and feeding of its aging population. The same centralized, bureaucratically run system designed to concentrate and funnel savings into production is now channeling it into retirement. Tokyo is raising taxes to get its fiscal house in order and is dragging its feet on deregulation for fear of unleashing costly unemployment on its older workers. Economic anxiety is, in turn, leading people to save even more and spend less, further dampening growth. What is surely a noble goal is turning into an economic nightmare.

All the industrialized countries face the same problem. As the U.S. is now discovering, high economic growth ameliorates the Social Security and Medicare burden caused by aging baby boomers. But Japan is unwilling to chance reform and take the high-growth solution. Instead, it is mistakenly choosing no-growth policies.

The transformation of one of the most dynamic economies in recent history into a defensive, stagnant caretaker society is a tragedy of immense proportions. For years, Japan's stubborn unwillingness to cut taxes and deregulate led to chronic trade friction with the U.S. Now, it has undermined Asia's prosperity, and its own.

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