U.S. Gives Opposite Advice to Japan and Its Neighbors

by Bruce Brown, Niigata University

Japan and the rest of "crisis impacted" Asia face a number of similar problems: high and growing unemployment, stagnating growth in output, falling currency values, a crisis of business confidence and a perceived need for free-market reforms.

So why does the U.S. give completely contrary advice to Japan and the rest of Asia? To Japan, the U.S. says "spend more, cut taxes, increase the budget deficit, defend the Yen, and reduce saving." To the rest of Asia, the U.S. (often through the IMF) says "raise taxes, cut government and private spending, devalue your currencies, increase your interest rates, and save more."

Certainly the problems facing Japan differ from those of its Asian neighbors in some important respects. In contrast to the rest of Asia, Japan has no inflation problem and extraordinarily low interest rates on riskless assets such as government bonds. But do differences such as these explain the contrasting policy recommendations? Perhaps America's view of a particular country's problems (and the appropriate policies to deal with them) is largely determined by the nature of economic relations between it and the U.S. After all, "what one sees depends upon where one stands."

When Americans look at Japan, they see a rich country that should be buying more U.S. made goods. While arguing for long term changes in market practices that place U.S. firms at a disadvantage, most American producers realize that the primary reason for their lackluster sales is Japan's sluggish economy. Conventional policies to pull Japan out of its recession should stimulate consumption of goods made in the U.S.

To Americans accustomed to spendthrift politicians, the difficulty of convincing the Japanese government to cut taxes and increase spending in a recession was baffling. Then the nature of its long awaited stimulus package, with increased construction spending (on costly bridges to nowhere) and temporary tax cuts (sure to be saved rather than spent), seems to confirm that Japanese politicians are ignorant of basic economics and driven by crass, short term political concerns. These policies won't end Japan's recession (or increase U.S. exports to Japan).

When Americans look to the rest of Asia they primarily see a place to manufacture cheap goods (to sell in the U.S.) or to make loans (in terms of dollars). For countries in the region, following the advice to reduce government spending, increase taxes, and raise interest rates will cause a recession. The IMF tells these countries: so long as stability is maintained foreign capital inflow will limit the recession's severity. Devalue your currency. This will reduce the dollar cost of producing goods, expand exports, and make domestic assets a bargain for international investors. Be sure not to default on any loans. And increase interest rates to prevent future devaluations. The higher interest rates will also encourage greater domestic saving and provide a needed risk premium to investors.

To many Americans giving advice, it's almost an afterthought that those standing to gain the most from it are U.S. exporters to Japan and international investors in the rest of Asia.

Although it may be self serving, at least to some degree, is there anything of value in these recommendations? Perhaps there is. Consider tax policy, currency values, and market reforms.

Prior to the massive reduction in personal income tax rates undertaken during Ronald Reagan's first term as president, the U.S. suffered from the kind of prolonged stagnation that Japan is now experiencing. Economists may argue whether it was an increase in consumer spending, or a flurry of increased work effort that was responsible for the rapid growth that followed, but virtually everyone agrees the tax cut was instrumental in stimulating the economy. Permanent tax rate reductions could provide similar results for Japan.

Perhaps Japan should take the advice being given to other Asian countries regarding their currency values and allow the Yen to depreciate. A falling Yen could provide ideal accompaniment to further import liberalization. Prices actually paid by consumers for imports need not rise if institutional barriers are simultaneously reduced. In any case, the primary adverse economic effect of devaluation - inflation, is not currently a Japanese problem. The primary political concern, an even larger trade surplus with the U.S. induced by a lower-valued Yen, would likely create friction. But this would be easier to deal with now rather than later, since the U.S. economy is currently in an expansion.

In any case, many Americans are coming to realize that the primary cause of the trade imbalance is the difference in savings rates. In the past, this has been seen as the fault of Americans for saving too little. The problem could now be described as the fault of Japanese for saving too much. Japan could ask for U.S. help in dealing with its problem. It could point out that even if Yen devaluation did temporarily lead to an even larger trade surplus, this might help restart the Japanese economy. The resulting expansion could then generate the optimism necessary to stimulate consumer spending and increase import consumption in the longer term.

Japan can benefit by selectively responding to generic calls for "financial market liberalization." It is no secret that Japan's financial system has often done a poor job in channeling its massive savings into efficient domestic investments. The "big bang" and increased profile of foreign financial firms can definitely play a role in more effectively allocating funds to consumers and firms. Market reforms do hold out the potential for significant benefits. But given the current economic situation, certain aspects of liberalization should perhaps be viewed skeptically.

Some Americans see liberalization as an opportunity to tap into Japanese savings for investment outside of Japan. While Japanese savers may expect a higher return on their investment as a result, the overall impact on the Japanese economy may be harmful. In addition, such an increased outflow of financial capital from Japan would contribute to downward pressure on the Yen, a result sure to upset the U.S. Developing and implementing policies which encourage investors to find and fund the industries of the future domestically, rather than abroad, represent perhaps the most important component of "financial liberalization" for Japan.

Economic advice from abroad may have value and should be considered by Japanese as they decide on their economic policies for the future.

Doesn't it appear that the costs of projects such as tunnels to Hokkaido and bridges to Shikoku are far greater than benefits? It seems that urban road systems and infrastructure could be improved - why isn't more of the construction money spent here? In the U.S., government can declare "eminent domain" and pay "fair value" for land which they expropriate and use for public purposes. Is it more difficult for government(s) to do this in Japan?

Japanese interest rates are very low on government bonds - but this does not appear to help small entrepreneurial firms much. The difference in interest rates on riskless versus risky loans seems greater in Japan than in other developed countries. It seems Japanese financial markets and banks do a relatively poor job of directing investment funds to smaller firms and consumers. The large amount of bad loans which financial firms continue to carry on their books appears to be making this situation worse. Why can't the Japanese put together a "bailout" program to revitalize the financial sector. The U.S. did this somewhat successfully in 1989. The U.S. experience clearly suggests that waiting to deal with such a problem makes it much worse.

I hope Japanese policy makers have at least some knowledge of the U.S. Great Depression, a period during which the Federal Reserve System thought they were pursuing "expansionary" monetary policy, but which in retrospect was shown to be "contractionary" by such people as Milton Friedman, and more recently, Ben Bernanke. In a number of respects, Japan now looks like the U.S. in 1930 - the primary difference being that the rest of the world is not also in a recession/depression.

May 21, 1998