Japan's demand
conundrum R Taggart Murphy
introduces the accompanying article by Michael
Pettis.
My salary was reduced 10% on April
1. Are students bitching about my lousy teaching?
Have I been less productive on the research front?
Less willing to shoulder my share of
administrative burdens? All this could be true -
or not - but has nothing to do with my pay cut.
From slacker to Nobel Prize winner, every
one of my colleagues at the University of Tsukuba,
northeast of Tokyo, is seeing his or her salary
fall. As are all professors at all of Japan's
national universities. And, indeed, everyone in
Japan who is paid, directly or indirectly, by the
Japanese tax-payer - or, more precisely, paid by
all the borrowing the Japanese government has been
doing since taxes now cover less than half the
Japanese government's expenses.
After all,
that's the point of the exercise. With the outstanding
debt of the Japanese
government topping 220% of GDP, something's got to
give - or so they say. Not that cutting the
salaries of civil servants is going to do anything
measurable to solve this debt problem, but at
least it's a gesture in the right direction.
Particularly when Prime Minister Noda, backed as
he is by the Ministry of Finance ("MOF") and much
of the ruling Democratic Party of Japan, is
seeking to push a very unpopular hike in the
consumption tax through the Diet.
Maybe if
all those bureaucrats and us useless professors
are seen to suffer, the ordinary salaryman, shop
owner, housewife, and construction worker will be
a bit more willing to suffer along with us -
swallow hard, tighten their own proverbial belts,
and endure a 5% increase in the price of
everything they have to buy.
Ah yes,
suffering. The Japanese have blown wads of money
on white elephants - the bridges to nowhere, those
endless concrete river banks and pointless sea
walls that have wrecked the Japanese countryside,
not to mention the cushy amakudari posts
for retired bureaucrats and all that - and now
everyone (including the odd gaijin
professor here and there) has to suffer.
Problem is - it's not clear how all this
suffering is going to "fix" Japan's fiscal
problems. People usually react to pay cuts and tax
hikes by buckling down, spending less, and saving
more. Companies see this happening and put
investment plans on hold, hoarding cash and doing
what they can to get by with fewer people while
paying them less. The government is not the only
employer in Japan cutting wages.
So where
is demand to come from if both households and
companies go austere? After all, consumption taxes
only generate revenues if people buy things.
Orthodox Keynesian economics calls for the
government to step in to fill the demand gap when
households and companies can't or won't spend, and
as the irrepressible [Nomura Research Institute
chief Economist] Richard Koo has been reminding us
now for well over a decade, it was lots of
government spending over the last 20 years that
kept Japan from tipping over into depression. But
that's how we ended up with cumulative fiscal
deficits at 220% of GDP, a number that has all
kinds of folks fretting about endgames,
calamities, meltdowns and other such scenarios.
Now, the Japanese government still pays
only a 1% annual interest rate to borrow money for
10 years, and even if the yen has gotten a bit
weaker in the past few weeks, there has been no
global flight from the Japanese currency. So
neither the bond markets nor the foreign exchange
markets show any discernible sign of factoring
apocalypse into their pricing.
But who is
to say that awful things might not soon happen if
policy makers don't get serious now? When getting
serious involves hiking taxes, cutting paychecks,
and freezing all those white elephants dead in
their tracks, however, demand is going to
collapse, and with it any chance of higher tax
revenues.
Unless that demand comes from
overseas. You won't find many people saying it
openly, but the only way this tax-hiking,
pay-cutting plan is going to work is if Japanese
companies start exporting more (or to be precise,
export more than Japan imports). In other words,
Japan is going to have to fall back on that old
tried-and-true recipe that has been around since
the Korean War: export-led growth.
But
export-led growth only works when somebody out
there absorbs the extra exports - or to put it
more precisely, somebody out there increases their
current account deficit (or reduces their surplus)
in exactly the same amounts with which Japan
intends to increase its current account surplus.
(The current account measures all current
financial flows - as opposed to investment/capital
flows - to and from the rest of the world. It
consists of payments for trade in goods and
services plus transfers - foreign aid; overseas
workers' remittances - and dividend and interest
flows. Because of all the extra oil Japan has been
importing to make up for the post-3/11 loss of
nuclear energy, Japan is now running a trade
deficit. Interest and divided income are
sufficient to keep Japan's current account in the
black for the time being, but those will not last
forever.)
At a time when practically
everybody is trying the same thing Japan is -
cutting back on spending at home - news that Japan
intends to pile on by increasing its own current
account surplus will not be greeted with accolades
elsewhere, which is why few of Japan's public
spokesmen are willing to draw the dots explicitly.
Michael Pettis has now done so, in the
accompanying article. [See China set for stormy seas, Asia Times Online, Apr 19, '12]
Pettis, a professor at Peking University
and a Senior Associate at the Carnegie Endowment,
brings a China-based perspective and his article
begins with an analysis of the "rebalancing" in
which China is said to be engaged. The rebalancing
of which Pettis writes is a supposed shift away
from an export/investment driven economy to one
led by consumption. (This may sound familiar to
Japan observers, since such a rebalancing has also
been a purported goal of the Japanese government
for close on 30 years now.)
Pettis is
skeptical. His skepticism stems from his unusually
keen appreciation of macroeconomic accounting
principles, principles that cannot be violated as
long as money is used to conduct economic affairs
between countries. Although these principles can
and should be understood by anyone with an
elementary grasp of macroeconomics, they are
usually ignored or deliberately misconstrued by
politicians who do not want to explain, for
example, precisely what has to happen for a trade
deficit to be reversed. (Hint: Becoming "more
competitive" or slapping tariffs on imports will
not in and of themselves do the trick.)
Here are the core principles. An economy
with more domestic savings than domestic
investment runs a current account surplus. The
savings have to be invested overseas, otherwise
they are either invested domestically or they are
destroyed, putting the savings/investment gap -
and the current account - back into balance.
Conversely, a country with more domestic
investment than domestic savings by definition
runs a current account deficit. If the extra
investment is not financed by foreign savings, it
does not happen, in which case there is no gap and
thus no current account deficit.
Why?
Because the current account is precisely equal to
the capital account plus changes in official
international reserves. A country running a
current account deficit cannot do so unless money
comes in from overseas to finance it. If a country
cannot beg, borrow, or steal the financing, it
cannot run the deficit any more than you can spend
more money than you have; you have to get it from
somewhere. Similarly, a country running a current
account surplus has to be exporting capital (or
accumulating international reserves - ie, claims
on other countries) since by definition it is
being paid by foreigners.
Now we get to
the most important principle of them all - until
we start doing business with the moon, the sum
total of all the national current account balances
must be zero. If a country increases its current
account surplus - which will happen automatically
if its savings exceed its domestic investments -
then another country's current account deficit
must increase (or its surplus decrease).
What happens if no such country exists?
Then the country seeking to increase its current
account surplus cannot do so and its savings are
destroyed (or its bankers find increased domestic
investment opportunities, perhaps because its
government builds white elephants).
Pettis
applies these principles to what is going on in
China and the likely outcomes of that country's
policy mix. He notes that China's current account
surplus has declined since 2007 from 10% to 4% of
GDP, but says that is not because of any decline
in savings (another way of saying rise in
consumption) but because of an increase in
domestic investment.
Other things being
equal, he expects the decline of the current
account surplus to reverse itself. Why? Because
"Beijing is finding it impossibly hard to raise
the consumption rate", and because "it is
extremely important that it reduce the investment
rate before debt levels become unsustainable" (if
this sounds familiar to us Japan types, that's not
a coincidence.)
But of course other things
are not equal. Because China can increase its
current account surplus only, as noted above
vis-a-vis Japan, when other countries are willing
and able to increase their deficits (or reduce
their surpluses).
Looking around the world
these days, one wonders who is going to do that.
The Europeans, where the countries of peripheral
Europe are being forced to cut back on all kinds
of spending; ie, forced to save more? The United
States, where both the Barack Obama stimulus
package and the George W Bush tax cuts will come
to an end soon, while presidential politics
degenerates into a "more austere than thou"
circus? Remember, less spending means more savings
and thus, other things being equal, reduced
current account deficits.
So we come to
Japan, where Pettis notes that all the austerity
talk out of Nagatacho and Kasumigaseki threatens
to put Tokyo on a direct collision course with
Beijing.
There is one serious problem with
Pettis' analysis. He writes of the early 1990s
that "rather than privatize assets and transfer
wealth directly to the household sectors, the
Japanese [began rebalancing] by having the
government assume private sector debt." Yes, the
government did assume private sector debt (if one
can call the Japanese banking system "private";
given pervasive Ministry of Finance control,
better to write "nominally private") but I have no
idea what assets Pettis is referring to.
Equity and real estate assets that had
been run up in the late '80s bubble lost as much
80% of their value over the subsequent decade, and
as to the "assets" built after 1991 and paid for
by Japanese government debt, the revenues from
many of these airports-in-sight-of-each-other,
bridges-to-nowhere, and billion-dollar tunnels
lopping off 10 minutes from commuting times don't
even cover their operating costs, much less their
up-front investment.
While Richard Koo is
absolutely right that shoveling money into the
economy in the form of these "assets" kept Japan
from depression, there is effectively no way to
"privatize" most of them - no one would buy them.
It is not a matter, as Pettis seems to think, of
"reluctance" on the part of the Japanese
authorities "to solve its debt problems by
privatization".
Alas, however, this
misunderstanding re-enforces Pettis' broader point
- that the policy mix being debated in Tokyo today
and seemingly championed by Prime Minister
Yoshihiko Noda can succeed, if implemented, only
by restoring Japan's trade surplus - and thus
increasing its current account surplus. That, in
turn, can only happen if counterbalancing deficits
increase elsewhere - or surpluses elsewhere go
down, which if Pettis is correct about China, is a
non-starter.
It has been 90 years now
since John Maynard Keynes pointed out in The
Economic Consequences of the Peace that
squeezing money out of people does not bring
prosperity. What may appear to work for the
individual household, company, or even country
produces only misery when everyone tries to do it
at the same time.
That's how we got the
Great Depression. For some decades after that
catastrophe, the world seemed to have learnt its
lesson. But hearing what is coming out of
Washington, Beijing, Tokyo, Berlin, London,
Frankfurt and Brussels, one can only assume the
lesson has been forgotten.
The only hope
Pettis offers is a possible "reduction in
commodity prices, including oil, which will help
absorb some of the changes in trade balances". But
he doesn't "see much other relief". Nor do I,
short of global elites collectively re-discovering
that making ordinary people poorer is not a
formula for prosperity.
R Taggart
Murphy, a former investment banker, is professor
in the MBA Program in International Business at
the University of Tsukuba's Tokyo campus and an
Asia-Pacific Journal coordinator. He is the author
of The Weight of the Yen (Norton, 1996)
and, with Akio Mikuni, of Japan's Policy Trap
(Brookings, 2002).
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