During the 1980s, Europeans knew little about Japan but wanted to know more. Since Japan’s financial crash in 1990-92, Europeans have felt they can safely ignore Japan in order to focus on China. This is a mistake. Japan has a lot to teach us about what can happen after a financial crisis and how that crisis can be mismanaged. And those issues will be at the heart of the general election that Japan will hold next Sunday, August 30th.
In the 1990s, Japan moved from being a world-class economy to bottom of the rich-country class. In 1992 its income-per-head was fifth highest in the OECD; by 2002 it had fallen to nineteenth. Now, 19 years after Japan’s stock and property markets began to collapse, the country still has falling wages, consumer spending and prices, has a public debt that, at nearly 200% of GDP, makes Italy’s look prudent, and has suffered one of the biggest drops in GDP as a result of the global financial crisis. Moreover, like Italy, it has an ageing, shrinking population, and its productivity growth has been too slow to overcome the resulting industrial and financial burdens.
The lessons from Japan begin in economics. The first is that after a crash, it is vital for the government to intervene rapidly in the banking system, using public money, and to force banks to disclose losses and to restructure. That lesson was learned well, in both Europe and America: the Japanese took eight years to act, while America and most European governments have acted in less than two years. The second lesson, though, still lies ahead: it is that, with deflation and a fragile financial system, companies may keep on cutting their debts. This is what kept the Japanese economy weak from 1998 until about 2005: banks were willing to lend but companies refused to borrow and spend.
In post-crash conditions central banks need to worry at least as much about deflation as about inflation. And neither they, nor national Treasuries, should move quickly to tighten monetary policy or to raise taxes. Japan shows that stagnation, with weak consumption and weak corporate investment, can result if policy makers focus on the old problems of inflation and budget deficits rather than the new one of deflation.
The economic lessons move into politics. The most remarkable feature of Japan’s decline has been political: except for nine months in 1993, Japanese voters have stuck with the same conservative government, the Liberal Democratic Party, that had ruled the country since 1955. Why? Although the LDP was incompetent, corrupt and scandal-prone, the opposition did not look or behave much better. This is surely familiar to Italians: Silvio Berlusconi has stayed in government for seven of the past nine years essentially because of the divisions and weaknesses of the opposition, even while Italy’s economy has slid down the European rankings.
On Sunday in Japan this looks likely to change. The Democratic Party of Japan is far ahead in the opinion polls. Some commentators still say the DPJ is not ready for government, is divided, and offers no real change. We should wait to see. But it is wrong to say they offer no real change.
Potentially, they are offering new cures for two significant illnesses. The first is inequality. In the past decade, LDP governments allowed businesses to hire part-time and temporary workers with lower wages and fewer rights than regular workers. Thus, just like in Italy, a two-tier labour market was created. Now, one-third of the workforce has those conditions, and absolute poverty has increased. The DPJ promises to unify the labour market and to increase social spending. This will be hard to finance, with the budget deficit already nearly 10% of GDP. But it is the right idea: Japan has American-style public spending and taxation (around 35% of GDP), and needs to move closer to European levels of 40-45% to avoid social instability.
The other is the control of government by a reform-resistant and often corrupt bureaucracy. This is Japan’s “caste”, a system dominated by self-serving and inward-looking public officials. It will be a tough fight. I wish the DPJ good luck in taking on the fight, but hope that the party can stay united enough to see it through.