From Ken Rogoff, co-author of the book This Time It's Different and Harvard economics professor.
I worry that our huge government debts will lead us towards a Japanese-style economy. Hopefully we can learn from their experiences.
Japan’s Slow-Motion Crisis
Chinese leaders love pointing to Japan as the prime reason not to allow any significant appreciation of their conspicuously undervalued currency. “Western leaders forced Japan to let its currency rise in the second half of the 1980’s, and look at the disaster that followed.”
Yes, nobody wants to be Japan, the fallen angel that went from one of the fastest growing economies in the world for more than three decades to one that has slowed to a crawl for the past 18 years. No one wants to live with the trauma of the deflation (falling prices) that Japan has repeatedly experienced. No one wants to navigate the precarious government-debt dynamic that Japan faces, with debt levels far above 100% of GDP (even if one factors in the Japanese government’s vast holdings of foreign-exchange reserves.) No one wants to go from being a world-beater to a poster child for economic stagnation.
And yet, visitors to Tokyo today see prosperity everywhere. The shops and office buildings are bustling with activity. Restaurants are packed with people, dressed in better clothing that one typically sees in New York or Paris. After all, even after nearly two decades of “recession,” per-capita income in Japan is more than $40,000 (at market exchange rates). Japan is still the third-largest economy in the world after the United States and China. Its unemployment rate remained low during most of its “lost decade,” and, although it has shot up more recently, it is still only 5%.
So what gives? First, things look a lot grimmer when one gets two hours outside of Tokyo to places like Hokkaido. These poorer outlying regions are hugely dependent on public-works projects for employment. As the government’s fiscal position has steadily weakened, the jobs have become far scarcer. True, there are beautifully paved roads all around, but they go nowhere. Old people have retreated to villages, many growing their own food, their children having long abandoned them for the cities.
Even in Tokyo, the air of normalcy is misleading. Two decades ago, Japanese workers could expect to receive massive year-end bonuses, typically amounting to one-third of their salary or more. Now these have gradually shrunk to nothing. True, thanks to falling prices, the purchasing power of workers’ remaining income has held up, but it is still down by more than 10%. There is far more job insecurity than ever before as firms increasingly offer temporary jobs in place of once-treasured “lifetime employment.”
Although hardly in crisis (yet), Japan’s fiscal situation grows more alarming by the day. Until now, the government has been able to finance its vast debts locally, despite paying paltry interest rates even on longer-term borrowings. Remarkably, Japanese savers soak up some 95% of their government’s debt. Perhaps burned by the way stock prices and real estate collapsed when the 1980’s bubble burst, savers would rather go for what they view as safe bonds, especially as gently falling prices make the returns go farther than would be the case in a more normal inflation environment.
Unfortunately, as well as Japan has held up until now, it still faces profound challenges. First and foremost, there is its ever-falling labor supply, owing to extraordinarily low birth rates and deep-seated resistance to foreign immigration. The country also needs to find ways to enhance the productivity of those workers it does have.
Inefficiency in agriculture, retail, and government are legendary. Even at Japan’s world-beating export firms, reluctance to confront the ingrained interests of the old-boy network has made it difficult to prune less profitable product lines – and the workers who make them.
As the population ages and shrinks, more people will retire and start selling those government bonds that they are now lapping up. At some point, Japan will face its own Greek tragedy as the market charges sharply higher interest rates.
The government will be forced to consider raising revenues sharply. The best guess is that Japan will raise its value-added tax, now only 5%, far below European levels. But is it plausible to raise taxes in the face of such sustained low growth?
Investors who have bet against Japan in the past have been badly burned, grossly underestimating the Japanese people’s remarkable flexibility and resilience. But the fiscal road ahead looks increasingly perilous, with political consensus fraying badly in recent years.
In the end, are foreign leaders right to scare their people with tales of Japan? Certainly, the hyperbole is overblown; the Chinese, especially, should be so lucky. But nor should apologists for deficits point to Japan as reason to be calm about outsized stimulus packages. Japan’s ability to trudge on in the face of huge adversity is admirable, but the risks of crisis ahead are surely greater than bond markets seem to recognize.