by Steve La Rocque, USIA Staff Writer
Interview reprinted from USIS Washington File
December 3, 1998
Washington—Japan faces an economic triple threat and must find the political will to overcome that threat, according to Marcus Noland, an economist at the Institute for International Economics (IIE).
"Japan has three problems in decreasing order of urgency": first, a macro-economic problem of falling aggregate demand, second, a financial sector problem, and third, structural problems of over-regulation and corporate governance, Noland said in a November 30 interview at IIE headquarters in Washington, DC.
Japan's Shrinking Economy
"The economy is shrinking; the economy is in a recession," he said. "Japan is now facing deflation, and what some people have called a Keynesian liquidity trap in which it is difficult to cut interest rates any further, because they are essentially at zero.
"Some people have advocated that the Bank of Japan begin printing money, and print money until it convinces people that prices are going to rise," Noland continued. "There are some people in Japan who agree with this position, but that is a minority view."
Noland noted that government efforts to spur the economy via fiscal policy have often been stymied by the Ministry of Finance.
"On fiscal policy, the government has undertaken a series of supplementary budgets and special fiscal measures. The problem is that the Ministry of Finance basically doesn't like these (measures)," he said.
"When the government of Japan has announced these new fiscal measures," Noland added, "the Ministry of Finance has acted to offset those additional expenditures by cutting expenditures in other parts of the budget, or by raising taxes or fees elsewhere in the budget."
The result, according to Noland, has been to diminish the impact of the government measures. "The actual impact has only been a third of its advertised impact," he said.
The Boy Who Cried 'Wolf'
Noland added that "today Japan is like 'the boy who cried wolf.'"
"They have announced so many of these (packages) in the past, and (the packages) have been so disappointing," he said. "Even if the government follows through on its latest package, it may not have the impact on confidence and expectations about the future vitality of the economy that (the package) might otherwise have had."
The government's willingness to spend significant amounts of money to deal with the country's financial problems is "politically significant," but the problem lies in implementing plans, Noland said.
"Many people are skeptical," he said. "It is unclear whether the government will take over insolvent banks that do not voluntarily give themselves up for nationalization. It is unclear what will happen to the management of those banks.... It is unclear how the good loans and bad loans will be separated, and as a consequence there is a fear that healthy banks will be forced to absorb some of the bad loans of the insolvent banks."
Noland noted that Japan is the world's second largest economy and the world's largest creditor country.
"It is unlikely that Japan could come under the same sort of pressure that a smaller, more open economy like South Korea's or Thailand's has come under in the last couple of years. So in that sense, although it is a trillion-dollar problem, the government of Japan has a lot of resources at its disposal, it could probably try to muddle through," he said.
However, Noland stressed, Japan's financial difficulties are closely tied to economic problems elsewhere in the region.
"One of the obvious possibilities (for resolving Japan's financial problems) is for Japan to try to restore aggregate demand through external demand, or export its way out of the crisis," he said. "That is feasible, but that could have a very negative impact on other countries in the region, especially Korea which has already seen its exports to Japan shrink, and competes relatively closely head-to-head with Japan in third country markets such as the United States.
"A strategy of export-led recovery by Japan would adversely affect the rest of Asia," he said.
Noland noted that Japan has announced a series of measures designed to bolster economies in the rest of the region.
"This is certainly desirable. It is to be welcomed," he said.
However, Noland continued, "in some sense it reflects an underlining political fact, which is that at this point in time it is easier for the government of Japan to pledge to write checks for the rest of Asia than to undertake painful reforms internally."
Reforming the Global Financial System
Noland stressed that Japan has an important role to play in "the future architecture of the world financial system" because of the size and strength of its economy.
"If one were to envision enhanced resources going to multilateral agencies such as the World Bank and the IMF (International Monetary Fund), Japanese contributions would be absolutely essential to this," he said.
According to Noland, any effort to reform the global financial system must consider two major areas.
"One is what are the policies adopted in each individual country. This is a subject of enormous discussion these days. What is the appropriate exchange rate regime? What are the most appropriate policies toward capital controls? In large part those issues and other internal issues such as bankruptcy laws and labor laws; those are essentially the province of individual national governments. And individual national governments have to look at their own circumstances and make the choices they think are the best.
"There are broader institutional questions that obviously have a much more multilateral character," Noland continued. "What should be the appropriate role of the IMF and the World Bank, for example? Or should there even be an IMF or World Bank? There are people who say they should not be. There are people who say they should be bigger. So there is an enormous divergence of opinion on issues such as that."
Noland stressed that the major steps to cure the financial crisis in each country will have to be taken by each individual country.
"What Thailand does about its banking system, and about its bankruptcy laws, and having judicial institutions that are capable of enforcing those laws, is essentially a matter for Thailand. What Korea does about its banking system, what it does about industrial restructuring, is essentially a matter for the Korean government to resolve," he said. "I think that many of the problems really have to be solved at an individual country level."
However, Noland noted, "the external environment that these countries face is important ... and there are two aspects of that external environment in which Japan can play a key role."
"First of all there is simply Japan itself; Japan is the largest economy in Asia. As long as the Japanese economy is shrinking at a rate of three percent a year that is going to make it more difficult for the rest of the region to recover. Exports to Japan from the rest of the region are falling at double-digit rates right now. It simply makes things more difficult for the rest of the region if the Japanese economy is weak. If it isn't purchasing the exports of the surrounding Asian countries, if its banks aren't lending to those countries, if its firms are not transferring technology, a weak Japanese economy is bad for the region.
"Secondly there are these broader issues of the international financial architecture and institutions, be they global institutions, like the IMF, or potentially regional institutions, like an Asian-Pacific monetary fund. Japan will play a key role in those things as well," Noland continued.
"Right now the main action is at the individual country level, but the external environment is important. And Japan can make important contributions both in terms of getting its own economic house in order and in terms of contributing to strengthen international institutions," he said.
Japan's 'Mixed' Economic Policy
According to Noland, Japan's economic policy "has been mixed" over the last year.
"On the one hand Japan has been rather forthcoming—more so than the United States—in terms of direct financial support to the other Asian governments," he said. "On the other hand, Japan backed away from trade liberalization initiatives at the most recent APEC (Asia-Pacific Economic Cooperation) meeting, which could have given the situation in Asia a good shot in the arm—at least symbolically, at least psychologically—in this difficult period. So I would say that Japan's track record is mixed, and largely reflects Japan's domestic political concerns."
"What is going on in Japan probably reflects less any conscious notion of leadership internationally or desire to shirk leadership internationally, but rather it is simply the play of some fairly parochial domestic political forces within Japan," Noland said. "The problem that Japan faces now is that it has significant macro-economic and financial sector problems."
Noland warned that resolution of those problems "will involve large transfers and reallocations and redistribution of wealth and income within Japanese society."
"Redistribution on the scale that will be necessary to solve a whole variety of problems in Japan—the banking problem, under-funded corporate pension liabilities, problems in the mortgage markets, problems in the insurance markets is going to be absolutely enormous," and "politically quite contentious in Japan," Noland said.
For Japan's leaders to successfully implement a fiscal policy, "first you have to convince people that your preferred policy is indeed the correct one," he said.
"Second," he continued, "those policy-makers and those politicians have to be able to put together a political coalition capable of implementing and sustaining those policies. And that is the basic problem Japan has now."
"I think it would be fair to say that the Japanese government realizes (and) understands that it has problems. It is attempting to deal with those problems. It has undertaken a number of specific actions and programs in an attempt to come to grips with those problems. But it's difficult, because those problems and the actions necessary to resolve them involve significant domestic economic dislocation and pain.
"And no politician," Noland stressed, "anywhere in the world, wants to subject his constituents to dislocation and pain. So I think you have today in Japan both components, both a need to make the intellectual case, but also the need to build the political base for undertaking the sorts of reforms that are necessary. I think that the Japanese intellectual establishment and political establishment are grappling with just that set of issues."
"That's the first order of issues the Japanese political system faces, and frankly the implications of those actions or inactions as the case may be on rest of world or Asia is really a secondary consideration," he added.
A Sustainable Debt
In contrast to the views expressed in a recent Wall Street Journal article by economist and Japan expert David Asher, Noland expressed optimism concerning Japan's ability to resolve its economic problems on its own.
"I think Japan can save itself; it's just a matter of undertaking the right policies," he said.
While Japan's debt levels are high, Noland observed, the key question is the sustainability of the debt.
Sustainability is related to the rate of economic growth, he explained. "It is much harder to sustain debt in an economy that is shrinking instead of an economy that is growing.
"It may be the case that a temporary increase in debt is desirable. It is a question as to when that debt comes due. If you are in a situation where the economy is currently shrinking, then worrying about the implications of increased social welfare expenditures twenty years from now is probably misplaced.
Noland used fellow IIE economist Adam Posen's analogy to explain Japan's economic problems: Japan is like a farmer with a reservoir with some water in it. The farmer is currently facing a drought, but has been warned that in 30 years there will be a major water shortage due to global warming. The farmer decides to save the water in his reservoir to guard against the potential water shortage in the future, but in so doing, he loses his current crop. The farmer should have used the water for the crisis he faced today, and not have tried to save it for one he might face 30 years from now.
"The short run problem is simply more important than possible financial problems down the road," Noland said. "I think that one of the problems in Japan is that the Ministry of Finance has historically put far too much emphasis on its concerns about long-run demographic issues.... In the case of Japan, one should be concerned about the level of public debt, of course. But should one let that concern inhibit the use of fiscal policy when the economy is in recession? I think not. If you get the economy growing, then both the public and private debt situations will start looking better than they do now with the economy shrinking at three percent a year."
Noland acknowledged that Japan's demographics will have an impact upon the country's fiscal policy.
"The fact that the population of Japan is graying will have implications for the Japanese economy. One would expect slower economic growth in the future because there will be fewer people entering the labor force. There will be increased needs for social welfare expenditures in terms of health care costs for example. The financing of those expenditures will be borne by a relatively smaller group in the working age population. So clearly demographics do have implications for long run economic performance."
"But that's not the issue Japan faces today," Noland said. "Japan faces a much greater short run issue about what to do about lack of aggregate demand, what to do about the financial sector, particularly the banking sector. While concerns about demographics are certainly justifiable and understandable, one cannot allow those concerns to subvert or distract one from what has to be done in the immediate situation."
"They are facing deflation," he continued. "There is a need for the Bank of Japan to pursue more aggressive monetary expansion than it is doing. There are some people on the Bank of Japan's policy board who understand this. But that is a minority view. It is a very disturbing situation."
Noland discounted the idea that the threat of deflation in Japan may act as a vortex, pulling in healthy economies.
"There are people who fear that," he said, citing John H. Makin of the American Enterprise Institute as the theory's most prominent proponent.
Those who follow this line of thinking argue "that all of Asia now, including China and other parts of Asia are on the cusp of a deflation that could get imported into the United States," he said. "I would say that is a minority viewpoint."
"Even John would say that even if that were the case, there are actions that central banks around the world can undertake to prevent that kind of self-reinforcing downward spiral that pulls a greater and greater set of countries into that whirlpool.
"Yes, there is concern," he said, "but it is a concern that can be dealt with by the proper policies."
The US-Japan Relationship
Noland noted that the history of U.S.-Japanese relations has been marked by great swings in the perceptions the two countries have of each other. The idea of "Japan as Number One" in the 1980s has been supplanted by a type of "American triumphalism" in the 1990s, according to Noland.
Noland said that while the perception of Japan in the 1980s swung too far in depicting Japan as an inexorably rising force, its counterpart in the 1990s—a Japan hopelessly in decline—is similarly off the mark.
Noland said he hoped a more balanced and nuanced view of the relationship might develop in time. "I'm sure some time (the perception of Japan) will start heading back the other way, and the Japanese will look better relative to where they stand today."
(Marcus Noland is scheduled to participate in U.S. Speaker/Specialist programs in Japan and Korea December 5-11 under the auspices of the United States Information Agency (USIA). Noland was formerly a senior economist for international economics on the Council of Economic Advisers, has written numerous articles on international economics and is co-author of "Economic Effects of the Asian Currency Devaluations," "Reconcilable Differences? United States-Japan Economic Conflict," and "Japan in the World Economy." He has also taught at Johns Hopkins University, the University of Southern California, Saitama University, and Tokyo University.)
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