Japan’s economy: Nowhere to hide

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Looking at Japan’s latest attempts to restore life to its moribund economy makes me think of the old Martha and the Vandellas song, with the chorus: “Got nowhere to run to, baby / Nowhere to hide….” The problems of Japan run so deep that whatever solution Tokyo’s policymakers offer up, the potential downside could be more frightening than the intended benefits.

But we can’t blame newly installed Prime Minister Naoto Kan for not trying. Since replacing the discombobulated Yukio Hatoyama this month, Kan has proposed a host of initiatives, which have actually sparked some rare optimism in Japan. T-shirts with the Obama-inspired slogan “Yes We Kan” have been a local hit. But Kan he? It seems to me that his contradictory programs won’t provide Japan with what it really needs – growth.

Growth, though, is what Kan is promising, or at least a Japanese version of it. In a long-term economic strategy report approved by Kan’s cabinet a few days ago, his government vowed to achieve 2% real growth annually over the next decade. That may not sound like much, but to Japan that would be scorching. The economy has reached GDP growth of 2% or more only five times since 1992, according to IMF data.

To meet that target, Kan intends to support new industries, like green energy, and tighten trade links to a growing Asia. But a big part of Kan’s program is to try to unlock consumer spending in Japan, thus boosting domestic demand, eradicating excess capacity and finally putting an end to deflation. Like his predecessor, Kan intends to achieve those goals by turning to turn Japan into something like a European welfare state, with improved medical and child day-care services and outright subsidies to help families with young children. Here’s what Kan said in a June 11 policy speech:

If people are anxious about or distrustful of the social security system –whether it be about medical treatment or nursing care, pensions or child rearing–they will lack the confidence to allocate their money to consumption. Additionally, many aspects of social security can bring about growth by creating employment.

Kan’s idea is actually a good one, since Japanese continue to save too much and spend too little. But there’s a big catch with this plan – he may not be able to afford it. Japan’s government debt is approaching 200% of GDP – the highest in the developed world – and Kan is feeling the same pressure to rein in fiscal deficits as his counterparts in Europe. Earlier this week, Kan’s government approved a plan to balance the budget over the next decade. Here’s what Kan said about the country’s national finances:

The state of Japan’s public finances is now dire, being the worst of any developed country. Fiscal policy which relies excessively on deficit bond issuance is no longer sustainable. As seen in the instability in the eurozone which originated in Greece, we risk fiscal collapse if we neglect mounting public debt and lose confidence in the bond markets. The scale of Japan’s outstanding debt is enormous, and will not vanish overnight. This is why it is vital to start right away on fundamental reforms leading to fiscal health.

To me, Kan’s twin goals – boosting social security and curtailing deficits and debt – seem mutually exclusive. Kan thinks otherwise. He insists there is a way to repair the country’s finances while maintaining his social welfare spending:

The view that the economy, public finances and social security are opposed to one another needs to be turned on its head. We should rather see that they exist in a mutually beneficial, “win-win” relationship… Through the inherent function of fiscal policy, our efforts to restore fiscal health will secure stability in the social security system, providing reassurance to the people and leading to sustainable growth.

Yet the fiscal pressure is so great that Kan is simultaneously proposing new taxes that completely run counter to his end goals. Kan intends to double the sales tax to 10% in coming years as a way to raise revenue to plug the deficit. But that will suppress the same consumer spending Kan intends to unleash. The state handouts Kan is giving with one hand he’s immediately taking back with the other. Kan will never be able to get Japanese spending if they think their taxes are going to go up.

And while increasing the tax burden on the average Japanese, Kan is also talking about giving corporations a tax cut. Again, I see the logic here. Japan’s corporate tax rate, at 40%, is higher than in other major economies, and by reducing it, the government can encourage companies to invest more, thereby creating jobs and, in theory, greater tax receipts. But my worry is that Japanese firms won’t invest much more anyway. In an economy with high costs, low growth and excess capacity, I’d guess that many firms have little incentive to build new factories or open new offices.

So what we have here is a contradictory mix of welfare spending, deficit reduction, tax hikes, tax cuts – does any of this make sense? The heart of the problem facing Kan is that the government’s finances are such a mess that his policy options are severely constrained. That doesn’t bode well for the future of Kan’s policy agenda.

Remember what Martha was trying to run from in her pop hit: “the heartaches that I know will come.” Japan and its new leader may not be able to avoid the coming heartache either.

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