Japan - A beached economic whale
What's going on in Japan and how is it affecting/being affected by the economic and financial crisis in Southeast Asia?
Background
In February 1997, I warned that if Japan's proposed fiscal retrenchment proceeded, economic recovery would stall, and Japan would run the risk of a major economic depression, analogous to the US depression of 1937, and the Showa depression in Japan in the late 1920's/early 1930's. I made the point that Japanese conditions were, essentially, similar to those in the US in 1936/7 - neither business nor consumer confidence had yet recovered and a major fiscal cutback risked unleashing a serious economic decline.
While structural reform is required long-term, Japan needs extended fiscal pump priming until the private sector of the economy gets going. I also argued that a "Maastricht" fiscal tightening approach, which the Japanese Authorities had proposed to pursue, would be likely to lead to "death by a thousand cuts" - prolonged economic stagnation.
The Japanese went ahead and implemented the proposed fiscal retrenchment; the economy and banking problems worsened; in reaction further measures have been put in place to support the banking system and the fiscal tightening has been relaxed - but serious concerns are now surfacing as to the economic and financial outlook for Japan. Industrial production is falling - down 3% year on year; stock to sales ratios are rising sharply; bankruptcies have trebled since 1996; household spending has fallen 4% or more in five out of the last six months. Retail sales are declining; housing starts have been weak; vehicle sales have fallen sharply; the rate of unemployment has nearly doubled since 1992; as the effects of the VAT tax increase last year drop out, actual deflation threatens: imports are declining, but the current account surplus is not increasing, reflecting the impact of falling sales elsewhere in Asia.
Impact of Crisis in Southeast Asia
Indeed, the impact of the economic and financial crisis in Southeast Asia on Japan is far greater than on Europe or the USA - in terms of both reduced demand for Japanese exports and substantial further banking losses.
The questions are as to what are the causes of Japan's problems - worsened by the Asian crisis; how are they likely to be addressed, and what is the likely outcome? Japan has two different, but inter-related problems. The first and most intransigent, is one of lack of demand - its citizens save too much and economic growth can no longer be sustained purely on export growth per the Japanese model of the 1970's and 1980's. Japan is experiencing Keynes "liquidity trap" problems - very low interest rates have failed to stimulate demand. The second area is structural - Japan is controlled by a rigid and conservative civil service and has failed to de-regulate its markets sufficiently to allow market forces to drive forward the economy or to unleash entrepreneurial potential; the banking system is paralyzed by its bad debt problems.
Many argue that Japan needs a major financial "blow out" - with banks actually failing - to induce wholesale structural reform and an economic renaissance. While accepting the latter are needed, my concerns are that a major banking collapse would, in the near term, depress demand yet more and bring down good businesses as well as bad and could unleash a major depression. The argument runs, however, that without this, the structural problems will not be addressed, which will constrain the Japanese economy even more, longer term.
I do not expect the radical "blow out" scenario to occur in such a conservative country as Japan. More likely are continuing periodic, positive fiscal stimuli and gradual de-regulation, with the Japanese economy continuing for some time at nil or (at best) very modest growth, as has been the case over the last six years. Japan's manufacturing capability remains strong and the economic pick-up in Europe should contribute, if not offset, the fall in Japanese exports to Asia. Also there is no evidence of the political will required to reform the economy, in such a way that the conservative attitudes and bureaucratic controls that have dominated thinking will be subject to radical change. Nor is there the political pressure in the absence of a credible Opposition, to espouse a radical platform. I expect emergency fiscal packages to contain the risk of a depression on the scale of 1929/30 in Japan or 1937 in the USA, although I anticipate negative growth in 1998/9.
The Bank of Japan will continue to pump money into the financial system and this will continue to spill over into asset markets overseas, for some time to come - where such flows may diversify, more than expected, to Europe once the Euro is up and running, given Japan's "excessive" holdings of and exposure to US Treasuries.
I do not expect Japanese consumers to be motivated successfully to increase their spending habits in this environment, and the hollowing out of the Japanese economy will continue, with production transfers to what have now become much cheaper bases in Southeast Asia. In short, I expect the Ministry of Finance and the Bank of Japan to prop up the banking system against the risk of systemic risk; and to conduct fiscal and monetary policy so as to avoid a major depression - and to have learnt from 1997 that significant fiscal retrenchment is not, for the time being, an option; but not to embark on radical deregulation maneuvers.
Outlook
In this scenario, the Yen can be expected to stay weak, with large continuing Japanese capital outflows, but where the Bank of Japan has the reserves to manage the exchange rate. Ironically, while I do not, therefore, believe that Southeast Asia can look to recovery in Japan as a stimulant to their economies; longer-term self-generated recovery in Southeast Asia is likely to provide some stimulus to the Japanese economy, in terms of a recovery Asian demand for Japanese exports.
Japan will be under continuing political pressure from the USA and Europe to get on with structural reforms, which should have some impact; but I do not see the Japanese situation as capable of rapid structural reform - nor do I believe this would necessarily be desirable.
The rest of the world will, therefore, continue to have to live with a "beached whale", Japanese economy, in terms of growth, but still powerful in terms of manufacturing industry and continuing to be a major source of liquidity/savings for the financial markets and economies of North America and Europe.
-Howard Flight, MP
Deputy Chairman
Guinness Flight Hambro |
