Thread - Superb in-depth Optimists vs. Pessimists debate on Japan:
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The Optimists
The Optimists' Prescriptions
The Pessimists
-- The Problems --
Washington--March 3--Japanese authorities are trying to put a positive spin on the fact that the country largely escaped public criticism from the finance ministers and central bankers from the Group of 7 industrialized nations at their Feb. 20 meeting.
However, many economic officials from the G7 and the major international financial institutions remain harshly critical of Japan's policies, and see a limited window of opportunity for Japan to reverse its 9-year decline.
Opinions about Japan's long-term economic outlook in the G7, the IMF, other major international agencies and many private think tanks range from very bad to terminally negative, although there is widespread agreement about the nature of the weaknesses and challenges facing Japan.
THE MAJOR WEAKNESSES
Japan's weaknesses are many and varied, coming in short- and longer- termguises, officials and analysts agreed.
The immediate issues are:
--Deflation;
--Recession;
--Rising unemployment;
--An insolvent banking sector; and
--Continually declining domestic demand, which could exacerbate the first three issues.
Over the longer term, the pressing structural issues that could ultimately contribute to the country's economic demise include:
--An industrial base carrying massive overcapacity that is nonetheless
stagnant and falling further behind because the lack of demand is forestalling much-needed investment in technology;
--A demographic bubble that will cause an immense increase in government spending on pensions and other age-related services just as the Japanese workforce is shrinking and job losses are accelerating;
--A restrictive immigration policy that means labor cannot be imported to make up the labor shortfall;
--A decline in the kind of consumer-oriented product and technical
innovation that powered the economy in the 1970s and 1980s;
--An ossified and bureaucratized political system that brooks no efforts that would undermine the status quo, and
--Continued macroeconomic mismanagement.
- THE OPTIMISTS --
There are officials and private analysts who believe Japan has not yet passed the point of no return. They believe that with the correct mix ofpolicies and reforms, Japan can once again take its place as a major player on the global stage.
However, they can be called optimistic only in relative terms, compared with those who are convinced Japan's era has ended. And the optimists are depressingly realistic about Japan's short-term prospects, with none of them seeing the potential for a meaningful recovery anytime in the next 5-to-10 years.
Clyde Prestowitz, director of the Economic Strategy Institute here, pointed out that even though "Japan is in big trouble right now," it has nonetheless "demonstrated over the centuries a high degree of cohesion and ability to adapt to different circumstances."
Among its strengths, Prestowitz noted that Japan is "a very wealthy country, with very powerful human resources and very powerful technologies in a lot of areas. The reports of the death of Japan are premature, highly exaggerated and smack, to a degree, of hubris."
Prestowitz stressed that Japan is, very slowly, reforming its economy.
"As recently as 2 to 3 years ago, the notion that Nissan would be on the block was totally unthinkable. The notion that Merrill Lynch would go in and take over Yamaichi was unthinkable," he said.
Adam Posen, a senior fellow at the Institute for International Economics here who also qualifies, in the scope of this focus, as an optimist, said that at the bottom of Japan's troubles lies the "combination of wrong ideas about economics and political ossification."
The country's secular decline is "not quite yet inevitable, but Japan just isn't doing what it can to pull itself out.
Posen cited short-term measures such as a reflationary monetary policy and longer-term ones, including bringing "millions of women" into the workforce and relaxing immigration laws, as potential fixes. But he questioned what could bring the creaking political system to enact such reforms.
A high-ranking international monetary official who follows Japan closely, and who spoke on condition of anonymity, proposed the answer to Posen's question: Things "could get so dire that it shakes up the political system and forces in a new model, new ideas emerge, and policies change."
The monetary official cited as a potential catalyst Japan's rising joblessness. Its official unemployment rate stood at 4.33 percent in December, but a rise to 10 percent or 12 percent could start a social revolution, he said.
"So far Japanese industries have been surprisingly willing and able to continue their old policy of keeping on staff during an economic downturn," the monetary official said.
"But this is not an ordinary economic downturn. Over the past 18 to 21 months, the level of GDP in Japan has contracted by 5 percent. This is truly unprecedented among the industrial countries in the post-war period," he said, stressing that unemployment has gone up by "nowhere near matching the huge margin of slack in the economy."
"So unless things pick up very quickly--which no one expects--I think the unemployment might very well be the catalyst for political change in Japan," he said, forecasting that as unemployment spikes higher "pretty soon...I think the political attitudes and the ability of certain interest groups to maintain sacred cows is ultimately going to be eroded as happened, say, with the trade-union movement in the U.K." during the 1980s.
- THE OPTIMISTS' PRESCRIPTIONS --
All prescriptions for restructuring are based on an assumption that Japan's political system somehow is transformed into one that allows reformist policies to be written into law, the optimists said.
The senior international monetary official's prescription was clear:
Abandon efforts at short-term fiscal or monetary stimulus and pursue the "much broader structural reforms needed to shift the (economy's) emphasis from the industrial sector into non-tradable goods and services, just as happened in the U.S. and the U.K." over the last 10 to 15 years.
The official pointed out that in the U.S. and U.K., "deregulation and restructuring created a lot of jobs in the service sector that are high-wage jobs," but he stressed that "that process is way behind in Japan."
A senior US economic official, also requesting anonymity, agreed that short-term macroeconomic policy changes would only affect Japan's economy "at the margins." He concurred that the longer-term structural issues must be addressed, despite the short-term pain.
But the U.S. official stressed Japan's pain was being prolonged by the near-paralysis of the political system.
Longer-term restructuring will entail "short-term costs," the official said, noting that the U.S. went through it in the 1970s and 1980s--"deregulation, etc., which provoked regional recessions."
Despite the often-sharp pain, the US economy ultimately emerged stronger, more flexible and more productive, the US official said.
The official acknowledged that while the US had many of the same problems as Japan, "theirs are worse."
However, he stressed that "the fundamentals of the Japanese economy--the educated workforce; the high savings rate; the elaborated industrial and managerial structure; the networks around the world; the massive capital stock-- mean Japan will come out stronger," if it does decide to really attack the issue of reform.
--THE PESSIMISTS --
Washington--March 3--While opinions on Japan's economic future range from bad to worse, some G7 and international monetary officials don't envision its complete economic downfall. Yet may others believe the country that brought the world Sony, Toyota and Toshiba faces the prospect of falling off the economic map.
Some G7 and monetary officials put a brave face on their opinions because, as U.S. Treasury Assistant Secretary Ted Truman has put it, the alternative would be "slashing my wrists."
They believe that with the right kind of political shake-up, Japan can still adapt its economy to the changing world around it.
But that opinion is by no means widely held.
There are many G7 and international monetary officials--not to mention private analysts--who believe it is too late under any scenario, because the Japanese people will accept a continual reduction in their standard of living to avoid overturning the political order.
A restricted policy paper prepared by a G7 government and obtained by Bridge News contains a section headed: "Don't hold your breath for results."
It cites political stagnation, the failure of fiscal and monetary stimulus, the "little progress made so far" on restructuring the banking sector, the fact that Japan is "rapidly running out of options on the macro policy side," and the increasing deflationary pressures.
And a senior economic official from the G7 country told Bridge on condition of anonymity that the policy paper "is more optimistic than I am."
A recent Economic Brief from Bank of America states bluntly that Japan's leaders, "have shown scant signs of adopting corrective actions.
Instead, they side-step the true sources of Japan's problems, and their inconsistent and illogical statements only serve to confuse."
It pointed out that the Bank of Japan and the Ministry of Finance are engaged in a "political tug-of-war" that has "led both institutions to pursue the wrong strategy."
Bank of America noted that both Japanese bond yields and the yen are "subject to political manipulation," and it speculated that the recent monetary easing was, "just another diplomatic gesture designed to placate international leaders..."
Another senior international monetary official, who asked not to be named, told Bridge News: "In the 1990s the world had to adapt to a Japan in recession. In the next decades we will have to adapt to a Japan in decline."
William Cline, chief economist at the Institute for International Finance, the umbrella organization for the world's major investment banks, funds, and insurance companies, agreed.
"We will have to get used to the fact hat Japan is off the economic screen," he said. "We'll have to learn to live without Japan as a locomotive for the world economy for some time to come."
Indeed, several observers have noted that Japan's structural and political problems are so deep-rooted that at this point in time, under current conditions, the country's economic-growth potential over the next 20 years is below 1 percent annually.
THE MEDIUM-TERM OUTLOOK
Adam Posen, a Japan specialist at the Institute of International Economics here, noted that Japan has "already thrown away 10 percent of output in over the last several years through recession.
Looking ahead, in the "best-case scenario, there will have to be a massive asset redistribution in the country--they will have to clean up the banks, reallocate funds to the social safety net, and deal with government debt," he said, pointing out that public-sector debt has risen to above 100 percent of GDP.
But the worst case would be if the "Japanese people lose faith in the country and money starts flying out into US Treasuries or something else--the yen falls through floor, then you've got a real mess," he continued.
In the immediate future, Japan's paralysis "pounds on Korea and the other Asian economies. Japan is not only not importing from there, it is competing with them on exports, and it has cut back on (foreign direct investment) to these countries, hurting them in the areas of management, technology, information, and relationship financing," Posen said.
A senior US economic official, who also asked not to be named, conceded there is no way for Japan to be "an engine of growth for Asia in this cycle. If Asia is going to recover, it will be without Japan."
And he stressed that at the moment the country's "policy tools have been disarmed."
"What happens with a recessing economy and no ability to do real monetary or fiscal stimulus, you have to wait until the capital stock deteriorates to a point where the overcapacity is diminished," the U.S. official said.
That eventual reduction of overcapacity could enable Japan to begin rebuilding, but from a very low base and only after a 5- to 10-year consolidation, the official concluded.
A senior international monetary official, who is a relative optimist, conceded that even if Japan quickly embarked on a broad-based structural reform, "Realistically I think one has to acknowledge that certain reforms are no panacea for raising growth immediately."
The monetary official noted that in the U.S. and U.K. the evidence shows that restructuring can be beneficial "for raising growth over the longer run, but it takes some time--5 to 10 years easily before one sees the full benefits."
He concluded that in Japan, "many of these reforms will require not only institutional change and new administration, it also will require changes in behavior and customs--cultural changes--that under the best circumstances will take some time to implement."
In the meantime, the cycle of recession and deflation shows no indications of abating.
One G7 monetary official, who helps manage his country's foreign-exchange reserves, said he is beginning to wonder more and more why he continues to hold yen-denominated assets.
The world is rapidly moving towards a G2 (dollar and euro) as regards currency reserves," the official said. "And fairly soon, even the Japanese won't want to hold yen."
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