Financial Times February 12th 2012
The road to fiscal hell is sometimes paved with the best intentions. As Europe’s politicians seek to win electorates round to brutal budget cuts, they would do well to look to the experience of Japan, which shows how counter-productive austerity can be in a post-bubble recession.
When Japan’s bubble economy imploded in the early nineties, public finances were in surplus and government debt was a mere 20% of GDP. Twenty years on, the government is running a yawning deficit and gross public debt has swollen to a sumo-sized 200% of GDP.
How did it get from there to here? Not by lavish public spending, as is sometimes assumed. Japan’s experiment with Keynesian-style public works programs ended in 1997. The consensus then was that they had failed to trigger durable economic recovery and the legacy of tunnels and bridges to nowhere had little social utility.
There was some truth in this argument, but the alternative hypothesis – that fiscal and monetary virtue would be sufficient in itself – proved to be woefully mistaken. Economic growth had been positive in the first half of the “lost decade”, but after the government hiked the consumption tax in 1998 any remaining momentum evaporated. Today Japan’s nominal GDP is lower than in 1992.
The real cause of fiscal deterioration was the damage wreaked on tax revenues by this protracted slump. Central government outlays as a percent of GDP are no higher now than in the early 1980s, but the tax take has fallen dramatically – by 5% of GDP since 1989, the year that consumption taxes were introduced.
Japan’s problems were worsened by the central bank’s hard money fixation . By the time rates were cut to zero, deflation approached 2% – meaning a tax-free return of 2% on the cash under your mattress.
The message is clear – you can’t get blood out of a stone. New taxes and higher taxes can lead to less tax revenue. Stimulatory policies – monetary and fiscal – may appear to have little traction, but their absence can make a bad situation a whole lot worse.
In Europe that would mean a protracted jobs crisis, which would run the risk of political and social fracture. The discrediting of the technocratic elites and EU institutions would leave a space for populist politicians to exploit. Marine LePen has already seen the opportunity and has toned down the anti-immigrant rhetoric of her father’s day in favour of populist economic themes, such as restoring the franc and using an import tax to fund higher wages. Conditions may not be ripe for her yet, but there is always next time.
Japan’s ability to distribute economic pain thinly and widely enabled it to navigate its long deflationary episode without high unemployment. There was no Japanese equivalent of the London riots or the Occupy movements; no belief that a burst bubble means the end of capitalism.
Yet failed austerity policies will ultimately produce a backlash, even in the constipated world of Japanese politics.
The political establishment seems trapped in a macro-economic version of the movie Groundhog Day. The ruling Democratic Party of Japan is proposing to tackle the deficit by doubling the consumption tax. The opposition Liberal Democratic Party, equally under the sway of the financial bureaucracy, agrees. Unsurprisingly both parties are haemorrhaging support.
Conditions are ripe for a populist reaction, and a politician who might catalyze one has arrived on the scene. The independent mayor of Osaka, Toru Hashimoto, is hot-tempered, ambitious and has a big idea – developing Osaka into a second capital city as insurance against a serious earthquake in the Tokyo region.
Whereas the dour Prime Minister Noda has likened himself to a mud-grubbing loach-fish, Hashimoto is as flamboyant as an ornamental carp, albeit one with sharp teeth. A former lawyer and TV personality who sports a Beatles For Sale haircut, he is unusual in demographically challenged Japan for having seven children. He is still in his early forties.
In November’s mayoral election Hashimoto won a landslide victory against a candidate endorsed by both major parties, despite scurrilous media attacks on his family background – his father may have had underworld connections – by right-wing weeklies. Already there is talk of an alliance with other semi-detached figures – such as Shintaro Ishihara, the maverick conservative now on his fourth term as mayor of Tokyo, and Ichiro Ozawa, master of the dark arts of electoral strategy – to create a nationwide alternative to the hide-bound political establishment.
The emergence of what the media have dubbed “Hash-ism” – a pun in Japanese, which makes little distinction between “ha” and “fa” sounds – has set alarm bells ringing. But Hashimoto is no LePen. Japan badly needs decentralization and reflation. If Hashimoto’s popularity were to spur a shift to pro-growth policies that would be a healthy result.
It is unlikely that the austerity endgame will prove so benign elsewhere.