Published in Financial Times 2/8/2013
Debate is heating up in Tokyo about the advisability of hiking Japan’s consumption tax. Which should come first- economic growth or fiscal reconstruction? The prime minister must decide in a matter of weeks.
It’s after midnight and I’m sitting in a Roppongi bar discussing the subject with a knowledgeable Japanese bureaucrat.
“It’s essential to raise taxes,” he says, cradling a well-aged Islay malt. “If we don’t, investors will lose confidence and our bond market will collapse.”
“Aren’t you risking a serious recession?”
“A temporary blip, maybe. But the strengthening of public finances will be good for future growth.”
The year was 1997. The Asian crisis was already in full swing. Japan’s own banking system was on the brink of collapse. Yet Japanese bureaucrats had convinced the prime minister of the day, the popular and dynamic Ryutaro Hashimoto, that raising taxes on consumers was a national priority.
In the event they drove the Japanese economy off a ten trillion yen fiscal cliff. If you tax something you are likely to end up with less of it. So it was with Japanese consumption. In a matter of months outright deflation had reared its ugly head. Retail sales fell into a protracted slump from which they have yet to emerge.
Soon afterwards Hashimoto was forced from office, his reputation for competence in tatters. The story goes that he bitterly regretted following the advice of his bureaucrats right until his untimely death in 2006.
The tax hike failed even in its own terms. Central government tax revenues fell more than 20% over the subsequent fifteen years and Japan’s debt-to-GDP ratio – a mere 40% at the time – snowballed to over 150%.
Meanwhile, Japan’s bond market, far from collapsing, embarked on an astonishing bull run that took 10 year yields below 0.8%.Even after the recent scare about the Fed’s tapering of asset purchases, Japanese bond yields, almost uniquely, are no higher than a year ago.
According to Hegel, the only thing we learn from history is that we never learn anything from history. Japanese politicians have seemingly been doing their best to prove him right. Mr. Abe’s predecessor as prime minister, the hapless Yoshihiko Noda , had bipartisan support in April 2012 when he pledged to double the consumption tax in recessionary conditions.
Even the charismatic Junichiro Koizumi – he of the Elvis impersonations and world-class haircut – paid lip-service to the necessity of a tax-hike, though he was sufficiently pragmatic not to do anything about it on his own watch
So it is entirely in character for Japan’s policy-making establishment – including, apparently, Mr. Abe’s own finance minister – to clamour for Noda’s fiscal tightening to be implemented on schedule. This is despite the horrible precedent of 1998; despite the UK example, which shows how contractionary fiscal policy weakens the effects of quantitative easing; despite the fact that post-2008 there has been nary a sniff of a sovereign debt crisis anywhere (in monetary terms the countries of the Euro-periphery are no more sovereign than Detroit).
Not just the policy-makers are at fault. Japan’s populist press loves to hyper-ventilate about the country “going bust,” as do respectable business magazines. In reality, Japan is the world’s largest creditor nation. But such is the power of the narrative that an analyst whose claim to fame is a decade of wrong-headed predictions of bond market apocalypse has just been elected to the Diet.
The idea that Japan has “too much debt” is easy to propagate. The idea that it also has too many assets – in other words that its balance sheet is too large for the scale of the economy – is harder to grasp. The policy implications are very different too. The right solution is belt-loosening, not belt-tightening; more consumption and less saving. Rather than taxing household spending, the government should be targeting the mountains of idle cash lying on corporate balance sheets and promoting higher wages and dividend pay-outs.
Mr. Abe is the first Japanese politician to grasp the overwhelming necessity for reflation, which is why he won a landslide victory last December and triggered the most powerful stock market rally in fifty years. It would be nothing short of tragic – for himself, for Japan and for the prospects of global reflation – if he were to follow in the footsteps of the late Ryutaro Hashimoto.
Nobody knows the exact formula for leading an economy out of fifteen years of deflation, but the probability of success is almost certainly higher if monetary and fiscal policy pull together, rather than in opposite directions.
Mr. Abe is due to make a decision in September. Suspending tax hikes until nominal GDP growth has reached his target of 3% for three successive years would send a clear signal that reflation is his over-riding priority.
Consumers, mortgage-holders and job-seekers would surely raise a glass of good cheer to that.
