Does Japan show us the way out of secular stagnation?

December 2, 2013

Is America’s economy adrift in the doldrums? Lawrence Summers, perhaps the nation’s most inventive applied economist, thinks so. Speaking to an IMF forum last month, he described America’s current condition as “secular stagnation” in which we are stuck in a rut of weak demand, low growth, and low employment. This is the “L-shaped” recovery, or — strictly speaking, non-recovery — some warned about after the financial freeze of 2008. It is also sometimes dubbed “the new normal.”

“We may well need in the years ahead to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activities, holding our economies back below their potential,” Summers said. The phenomenon is not new; after all, before 2008, when Alan Greenspan had ensured endless cheap money through low interest rates, leading to asset bubbles, the real economy did not respond.

“Even a great bubble wasn’t enough to produce any excess of aggregate demand,” Summers said. “Even with artificial stimulus to demand, coming from all this financial imprudence, you wouldn’t see any excess.”

Summers explained that monetary policy is inadequate in trying to deal with our predicament because the “natural rate of interest” to ensure full employment and growth is now negative. When you take into account inflation, it is even lower. Central banks can hardly offer below 0 percent interest rates, because anyone holding cash would rather hoard it under the mattress rather than be charged for its safekeeping.

Quantitative easing may have served a purpose, but now it is an impotent policy. Worse, even though it is redundant, markets have come to depend on it and go into a tailspin whenever Fed Chairman Ben Bernanke mentions the T word — tapering. It seems unless we are careful, Summers warns, we are going Japanese, meaning that, like Japan’s economy in the last two decades, we could find ourselves caught in a downward spiral in which falling growth chases falling prices chasing falling demand chasing falling employment.

Japan was once the world’s tyro economy, rocketing to 10 percent annual growth in the 1960s before gradually slowing to 4 percent in the 1970s. By the end of the century, however, Japan was in deep trouble. Growth screeched to a halt, an asset price bubble burst, and the country resorted to a bold Keynesian experiment, pumping money and demand into the economy through massive public works programs.

It didn’t work. They switched to “structural reform” measures, to deregulate the economy and dismantle the hidebound traditions found in Japanese corporations, and added more quantitative easing.

Nothing seemed to do the trick. Growth remained sluggish and deflation took hold. Whatever may be said against inflation, deflation is far worse, a debilitating condition that stifles economic initiative, kills growth, and causes widespread misery. Then the banking crisis of 2008 and its aftermath caused worse suffering in Japan than almost anywhere in the world. Exports, which have traditionally spurred Japanese growth, collapsed by 27 percent in 2009. It was time for a radical experiment.

Last year Japan’s prime minister Shinzō Abe introduced a drastic program known as Abenomics, a heady cocktail of massive QE, doubling the amount of money in the system in just two years, making exports cheaper by curbing the tendency of the yen to increase in value, increasing government spending, and raising taxes. It was an experiment without precedent or parallel. Without help from the IMF or outside influences, Japan set about kick-starting its way out of its debilitating trough.

After a year of swallowing Abe’s medicine, some slender signs of recovery are emerging. Last month, Japanese exports surged to their biggest annual increase in three years, not least thanks to the fall in the value of the yen, down 14 percent against the dollar. Price deflation is giving way to modest inflation, the first in five years, which helps businesses find a profit, and it is on its way to Abe’s target of 2 percent. Output is increasing.

It is not all bright news. Wages are falling behind prices and there is not enough investment. But Abe is confident that if the world economy picks up, Japan, the world’s third-largest economy, will not only benefit but be able to play its part in returning the world to prosperity. That is a big if. So long as America’s economy remains flat, Japan’s break for growth cannot gather pace. Indeed, it is likely to falter.

The rest of the world, too, is awaiting America’s lead. The Chinese look to Japan as an example of what can go wrong if wages start to outstrip growth. The economic miracle hits the buffers. It ends in a lost decade, or longer. Europe meanwhile is busy looking after itself, restructuring and paying off debt, which hinders worldwide growth, while it waits for America, as ever, to pull it out of the ditch.

As Summers warned last month, America is in no position to provide stimulative measures. Hampered by a rump faction in Congress devoted to a dogmatic misunderstanding of how economics works and a belief that the whole notion of government intervention is wasteful and unnecessary, the Obama administration is powerless to prod the economy to move faster. Thanks to the painful, unjust and arbitrary automatic spending cuts demanded by sequestration, we are busily paying off debt when what we need are measures to promote growth.

Summers believes the time for talking is over. “If we continue to be a country that doesn’t increase the fraction of adults that are working, that doesn’t catch up with its GDP potential, that grows at 2 percent or less … we’re gradually going to accumulate debt and have a serious debt problem,” he told the Wall Street Journal’s David Wessel.

It may suit some congressmen to stand in the way of an American recovery. When times are tough, incumbent parties find it hard to be re-elected. Yet as the Republicans assemble a short list of maverick, unelectable, extreme, wacky presidential candidates that could survive a Tea Party-dominated primary season, they are placing the White House way beyond their grasp.

The subversives who dictate congressional tactics hope to achieve their small-government goals by obstruction and obfuscation, however much that may harm the very people who have put them in Congress. Enlightened self-interest has given way to ignorant self-harming. Smothering government initiatives could soon turn America into Japan, leaving Americans with decades of low growth and all the material misery that entails.

There is a Japanese proverb, “If you do not enter the tiger’s cave, you will not catch its cub,” which translates into the more mundane English phrase, “Nothing ventured, nothing gained.” Abe has taken a courageous leap in a bid to end his country’s becalmed economy. So long as a minority of the majority holds its leadership in the House hostage, we are not only likely to repeat Japan’s mistakes, but we will drag the rest of the world back into the mire.

Nicholas Wapshott is the author of Keynes Hayek: The Clash That Defined Modern Economics. Read extracts here.

PHOTO: Japan’s Prime Minister Shinzo Abe claps his hands during the Lower House plenary session of the parliament in Tokyo November 26, 2013. REUTERS/Toru Hanai


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The problem that has been nagging at me is that during this period of low growth there has been the relatively stead level of asset prices – following the credit crunch, as one might have expected asset prices fell, but recently prices have been rising rather than staying low until the recovery is secured. In reality asset prices recovered very quickly and remain stubbornly high despite low growth. So we have this strange set of circumstances where consumer demand is but asset prices are very high.

The main problem here is that asset prices are stuck at levels that make rapid growth unlikely, the Dow has just breached 16,000 for the first time. The world has become capital rich and income poor. This imbalance in the relationship between those who own assets and those that rely on income from these over-priced assets is killing us. The benign environment that exists for the owners of capital is driven by misguided policy making that reduces taxes on profits and allows owners to avoid their tax obligations. This in turn means that:

1. There are too many badly run businesses that are not investing for the future and there are many poor performing business that have not been sold or restructured (Zombie companies)

2. This lack of investment (coupled with the banking crisis in liquidity) in new ideas encourages the owners of capital sit tight on their under-performing assets. The Private Equity industry has been an obvious offender (see the chart below)

3. As businesses bump along the bottom they squeeze employee salaries and so consumer demand drops

4. This imbalance between the owners of capital and employees is accentuated by negative real interest rates and deflation. Small scale savings have been decimated whilst the mega rich have seen asset prices rise and rise e-cause-of-secular-stagnation.html

Posted by daviddenton | Report as abusive

I’m always confused by economists’ collective lament about the horrors of the Japanese economy. There are very few that would claim that the US has a higher standard of living than Japan. Unemployment is far lower, there are trains, and the cities have a level of cleanliness found nowhere in America. This is economic failure ? The failure seems to be with economists’ definition of economic distress.

Posted by brianpforbes | Report as abusive

One more follow up point, deflation is actually necessary for Japan because prices are out of control as it is ($18 to see a movie in the theater, $27 for a CD). Prices are going down because the greediness of Japanese merchants has already set prices far above any reasonable market value.

Posted by brianpforbes | Report as abusive

Great write, insightful! One thing is that the proverb, “If you do not enter the tiger’s cave, you will not catch its cub” is Chinese, NOT Japanese. There is no wild tiger in Japan. Just like many other cultural things, the Westerners tend to introduce Chinese things as Japanese, especially people from the US as they study, or used to study about Asia though Japan. But it is actually not easy to find things that are genuinely originated in Japan, and you cannot ignore the Chinese influence when you try to see the Japanese culture. Maybe it was ‘OK’ to introduce Chinese things as Japanese during China’s communist era in the past…

Posted by ewha | Report as abusive