Better Economic Policy Won't Save Japan
When I was a wee thing, just a slip of a girl launching herself into the mad and exciting world of economic policy reporting, you used to hear a lot of talk about Japan's Lost Decade. From World War II to about 1990, Japan posted the most miraculous economic transformation of the 20th century. Self-flagellating magazine articles and paranoid novels were written by anxious Americans who saw--all too clearly!--that Japan's mighty economic engine would soon overpower lazy, atomistic Americans, forcing us into a sort of well-transistorized serfdom. Then the Nikkei crashed and the mighty engine stalled*. And unlike your Camry, it proved difficult to repair. Japan alternated between stagnation and recession for the better part of a decade. Then longer. Eventually, the "Lost Decade" stretched past 20 years. It is now approaching the quarter-century mark.
Many times during this Longest Decade, Japan has made some policy change, and analysts have proclaimed that finally--finally!--Japan was getting serious about good economic policy, and turning things around. Abenomics was the latest and arguably the best of these reforms.
Prime Minister Shinzo Abe's "Three Arrows" of fiscal stimulus, monetary easing and structural reform were designed to attack three of the biggest problems that economists have identified with Japan's economy: insufficient consumer demand, deflation, and a highly protected and inefficient domestic sector that bears little resemblance to its world-class exporting powerhouses. Economists reacted enthusiastically. Markets reacted enthusiastically. Gross domestic product began to look positively perky. And now the big oops: Japan just posted its second straight quarter of negative growth, which is a good working definition of a recession.
Commentators this morning are focusing on Japan's decision to raise its consumption tax, which seems to have put a damper on consumer ardor. Undoubtedly this didn't help, but left unsaid is this: Despite a really good package of reforms, Japan's economy is still so fragile that a 3 percent hike in the sales tax (even one accompanied by a $51 billion stimulus program) is enough to push it back into recession.
The sales tax was a modest attempt to curb Japan's substantial budget deficits, which are in turn an attempt to prod the economy back into generating some growth. Those deficits have been running at an annual rate of 8 to 9 percent since 2008. It's true that Japan has achieved near-legendary levels of government debt without any sign of a fiscal crisis, but surely they can't borrow 8 percent of GDP forever. If the economy really can't survive on a more modest fiscal program, then Abenomics is merely delaying the inevitable.
What this suggests to me is that there may simply be limits on what good economic policy can achieve. This is not a very useful thing for an economics columnist to write, because then what are we supposed to suggest week after week? But there it is: Japan's economic problems, particularly its long demographic shift, may simply not be very amenable to better policy. Japan's exports have a lot more competition than they used to, and the country is heading for the demographics of an Assisted Living facility. Better monetary policy won't change either of those facts.
As you may have guessed, this problem is not uniquely Japanese. The whole world is in the middle of that same demographic transition, in more or less dramatic forms. Productivity in the richest countries is growing more slowly than during the decades after World War II, which means that the world as a whole is not innovating as fast as it used to. Again, fiscal stimulus is not going to fix that. Fiscal and monetary policy can smooth temporary fluctuations in output. I'm less than convinced that they can, by themselves, improve our economic capacity. Oh, you can make a huge mess with really bad decisions: deflation, hyperinflation, nationalization, confiscatory taxation, and debt crises can have nasty impacts on your economic output that will outlive your macroeconomic mistakes. But ultimately, fiscal and monetary stimulus are better tools for managing temporary crises than long-term growth problems.
Don't look all smug, Republicans; I'm talking to you, too. Really bad supply-side policies unquestionably have terrible effects on economic growth. There's not much evidence that you can claim the same for piddling changes in marginal tax rates. I'm not saying that the Bush tax cuts had no impact on economic growth. But it's small beer in the face of an ocean of economic activity, much of which is undertaken, or not, for reasons that have nothing at all to do with government policy.
Of course we should still advocate for better policy. First, because the margins matter, and second, because a lot of marginal changes may, over a lot of time, add up to real differences in the underlying economy. (That's why I think we need to assess new regulations not on an individual cost-benefit basis, but as part of an overall regulatory burden that needs to be minimized even if the individual regulation might do some good.)
But we should be modest about what our advocacy can achieve. People are not automatons, the economy is an organic outgrowth of their activity, not a malfunctioning machine. There is no button we can push to make it do what we want; at best, we can prod the vast beast in a slightly different direction.
* Technically, Rising Sun (1992) was written after the Nikkei crashed, but Michael Crichton didn't realize that this meant our dystopian future was experiencing some unexpected production delays.
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