Monday Morning: Japan’s economic woes may offer lessons

The Japanese economy has suffered through 14 years of almost continuous recession, and Japan’s stock market has hibernated for the same length of time.

Japan went into recession in 1990 and still hasn’t recovered, despite brief periods of solid gross-domestic-product growth. For example, GDP grew by 3.9% in 1995 but plunged again to recession levels a year later.

The Nikkei 225 index, which hit almost 40000 in 1989, languished between 12000 and 14000 for the second half of the 1990s, and today is below 8000.

Does the Japanese experience hold any lessons for the United States?

Yes, though there are many problems in the Japanese political and economic structures that limit the meaningfulness of comparisons.

The Japanese Diet is even more beholden to farm interests than the U.S. Senate, for example, and the Japanese banking sector is mired in real estate debt that will never be repaid and should be written off.

The Japanese economic malaise, however, is largely the result of poor economic policy decisions that have choked off every incipient recovery – recoveries that would have allowed the banks and corporations to work their way out of their debt problems.

First, the stimulus packages passed by the various Japanese governments since 1990 generally have been too small to be effective. They’ve taken the form mostly of increased government public works programs rather than tax cuts.

The effects of even these modest programs have been undermined because the money often has been spent on construction programs in politically important areas rather than where it would do the most to stimulate the economy.

Second, when a stimulus program has appeared to be on the verge of success, the government or the Bank of Japan has stepped in and applied the brakes too soon.

This happened in 1995. That year’s growth spurt was sparked by a combination of a 1.6% of GDP public investment program and a cut in the consumption tax to 3%, from 5%, equivalent to 1.2% of GDP.

But just as the economy appeared to be taking off, the government cut back the public spending program in 1996 and 1997, and increased the consumption tax in early 1997 to 5%.

Not surprisingly, the economy stalled out again in 1998 and has continued to be weak ever since.

On other occasions when the economy appeared to be gaining steam, the Bank of Japan stepped in and raised interest rates to prevent overheating, pre-empting recovery as well.

signs of recovery

Our weak economy and market downturn have now lasted more than three years, and some commentators have wondered if we might not, as Japan has, continue to stumble along for several more years.

Most, however, dismiss that possibility because of the far greater resilience of the U.S. economy and because there are fewer structural problems.

In fact, there are signs that the economy is beginning to recover.

Annual growth in industrial production, which was negative last year, is positive at about 2% this year. Real capital spending on equipment and software, which was negative last year, is now positive.

But we can’t rule out the possibility of poor economic policy decisions killing any incipient recovery, just as unexpected April snowstorms kill off budding flowers.

Will the stimulus package that Congress passes in the next few months be too little too late? Will the stimulation of any federal income tax cuts be offset by state and local tax increases? Will the Federal Reserve, which has been flooding the economy with liquidity, tighten the money supply too soon when the economy begins to show real signs of recovery?

One hopes congressional staff members, whose job it is to advise the lawmakers, have looked at Japan’s failures and at least considered the possibility of lessons for this country. Likewise, one hopes the Fed will be patient and risk a little inflation to allow a recovery to take root.

My interpretation of the stock market’s lackluster reaction to the apparent end of the war in Iraq is that many investors also fear that Congress or the Fed will make the wrong decisions and prolong both the weak economy and the sputtering of the stock market.

Mike Clowes is the editorial director of InvestmentNews and sister publication Pensions & Investments.