Setting Sun
Japan: What went wrong?
By Paul Krugman
(posted Thursday, June 11, 1998)
In an early-'90s Dilbert, an
excessively trendy manager exhorted
his team to "search for excellence in
the total quality chaos, or whatever
the Japanese are doing this month."
Only a few years ago, the business
sections of airport bookstores were
largely given over to tracts revealing
the supposed secrets of Japanese
management and the menace Japan
posed to the United States. Then it
turned out the Japanese were human,
after all, and everyone lost interest.
Western pundits, having once placed
Japan on a pedestal, now either prefer
not to discuss the subject or see
Japan's failures mainly as an occasion
for smug self-congratulation.
But the new story is much more
interesting than the old one. How could a
wealthy, productive, sophisticated country
have gone from enviable growth in the 1980s
to stagnation in the '90s, and now be slipping
into a downward spiral of recession and
deflation? True, Japan is not a country on the
edge of chaos--as Indonesia or Russia is--but
that only adds to the mystery. Japan isn't a
place where the state is weak, unable to
collect taxes or convince investors that their
property rights are secure. Nor is it a country
at the mercy of skittish foreign investors who
must be persuaded to roll over its debt: Japan
is still the world's largest creditor. So what's
the explanation?
nefficiency? Japan has many inefficiencies
that limit its productive capacity--too many
mom-and-pop stores, not enough
computerization in the office, and so on--but
inefficiency per se is not the immediate
problem. What Japan lacks right now is not
supply but demand: Japan's consumers and
investors just aren't spending enough to keep
the country's shops and factories busy.
And the usual remedies for inadequate
demand aren't working. Interest rates have
been pushed down almost as far as they can
go. Like the Fed, the Bank of Japan normally
targets the interest rate on overnight loans that
banks make to each other. The difference is
that this rate is more than 5 percent here, but
basically zero there. The big public spending
projects the Japanese government launches
every now and then do create some jobs, but
they never seem to yield enough bang for the
yen: The economy keeps relapsing, while
government debt keeps mounting.
here are three common explanations for
Japan's plight.
Explanation 1 is that it is mainly a
financial problem. Japan's corporations are
too burdened with debt, its banks too
burdened with bad loans that have never been
acknowledged. On this view, what Japan
needs is a long, painful financial
housecleaning.
Explanation 2 is that the problem is
mainly psychological. When the "bubble
economy" of the 1980s (remember when the
square mile under the Imperial Palace was
supposedly worth more than all California?)
burst, goes the story, consumers and investors
went into a funk that has depressed the
economy, and the depressed economy has
perpetuated the funk. On this view, what
Japan needs is a jump-start--say, a massive
but temporary round of tax cuts and public
spending programs that will restore confidence
and get people spending again. (Although it is
tactless to say this, the model everyone
privately has in mind is the way wartime
spending jolted the United States out of the
Great Depression. Thank you, Adm.
Yamamoto!)
xplanation 1 doesn't make sense to me. If
Japan's problem is demand, not supply,
how do corporate debt and bad loans cause
that problem? You might say that the answer
is obvious: Overindebted companies can't
borrow more, and the banks are in no position
to lend anyway. But Japan's investment as a
percentage of gross domestic product is the
highest among major advanced economies.
And banks have been lending, too--after all,
where do you think those excessive debts and
bad loans came from? The problem is that
even these high rates of investment aren't
enough to absorb the huge sums that
consumers apparently want to save.
Until recently I was more sympathetic to
Explanation 2. But lately I have started to
wonder whether the stubborn unwillingness of
Japan's economic engine to catch is, as many
foreigners seem to think, merely because the
jump-start hasn't been big enough or sustained
enough. And so (like a small but growing
number of people, including at least one
influential Japanese economist) I have started
paying attention to Explanation 3--that Japan's
troubles really stem from a subtle but deadly
interaction between demography and
ideology.
ere's the story: Japan, like the United
States only much more so, is an aging
society. Thanks to a declining birth rate and
negligible immigration, it faces a steady
decline in its working-age population for at
least the next several decades while retirees
increase. Given this prospect, the country
should save heavily to make provision for the
future--and lacking the kind of pay-as-you-go
Social Security system that allows Americans
to ignore such realities, it does. But
investment opportunities in Japan are limited,
so that businesses will not invest all those
savings even at a zero interest rate. And as
anyone who has read John Maynard Keynes
can tell you, when desired savings consistently
exceed willing investment, the result is a
permanent recession.
If this is the problem, there is in principle
a simple, if unsettling, solution: What Japan
needs to do is promise borrowers that there
will be inflation in the future! If it can do that,
then the effective "real" interest rate on
borrowing will be negative: Borrowers will
expect to repay less in real terms than the
amount they borrow. As a result they will be
willing to spend more, which is what Japan
needs. In short, this explanation suggests that
inflation--or more precisely the promise of
future inflation--is the medicine that will cure
Japan's ills. The trouble--the other half of the
Japanese trap--is that while the conclusion
that Japan needs inflation emerges from what
looks like impeccable economic logic, we live
in an era in which central bankers believe (and
are believed to believe) in price stability as an
overriding goal. The peculiar result of the
credibility of modern central bankers as
inflation hawks is that no matter how much
money the Bank of Japan prints now, it
doesn't matter: It can't lower the nominal
interest rate, because that rate is already zero,
and because people don't believe that it will
allow inflation to break out any time in the
future, it can't lower the real interest rate
either.
his theory is offensive to many people.
Deep economic problems are supposed to
be a punishment for deep economic sins, not
an accidental byproduct of swings in the birth
rate. Inflation is supposed to be a deadly
poison, not a useful medicine. Above all, it
seems implausible that the proposed solution
to such severe difficulties could involve so
little pain. And while I think logic and
evidence are on my side--that demography,
not crony capitalism, is the villain, and
inflation is the answer--it is certainly possible
that I am wrong.
But Japan worries me. It's not just that
we are talking about a huge economy here, an
economy whose woes can drag down a lot of
smaller countries with it. What really disturbs
me is this: If we don't really understand what
has gone wrong in Japan, who's to say the
same thing can't happen to us? |
