Thursday, November 18, 2010

Could the United States Become “Japan”?

Hovering over the disappointment associated with the current state of the economy comes the occasional pundit warning that we face a “lost decade,” or that we face the same fate as Japan. The reference to Japan is intended to conjure up an image of a country doomed to minimal economic growth, high unemployment, and even higher indebtedness for the foreseeable future. While the United States may in fact be faced with a future like the one described, it is not a given by any means, and it will not be because we suffered the same fate as Japan. There are sufficient differences between the situations faced and experienced by the two countries to make the analogy inappropriate.

Japan’s crisis of the late 80s and early 90s came at a time when its economy was reaching a point where a period of readjustment was inevitable. Its export-lead economy was driven for decades by the ability to turn out quality goods at a low price. At some point, success eliminates the “low price” option and manufacturing has to move to poorer countries. At this point Japan lost a lot of its competitive edge; it was, in fact, training its next competitors. Japan never made a successful transition to a more balanced economy. The years of cash flow from the extraordinarily successful export business combined with low interest rates to produce an enormous speculative bubble, one far larger than the housing bubble generated prior to the current crisis. The crash from that bubble is still being felt today, twenty years later.

Richard Katz, in a March/April, 2009 article in “Foreign Affairs” provides a clear and succinct description of the differences between Japan then, and the United States now.
“The consequences of the 2008 U.S. financial crisis will be different from Japan's slump in the 1990s for three reasons: the cause of the current crisis is fundamentally different, its scope is far smaller, and the response of policymakers has been quicker and more effective.”

“Japan's malaise was woven into the very fabric of its political economy. The country has a thin social safety net, and so in order to protect jobs, weak domestic firms and industries were sheltered from competition by a host of regulations and collusion among companies. Ultimately, that system limited productivity and potential growth. The problem was compounded by built-in economic anorexia. Personal consumption lagged, not because people refused to spend but because the same structural flaws caused real household income to keep falling as a share of real GDP. To make up for the shortfall in demand, the government used low interest rates as a steroid to pump up business investment. The result was a mountain of money-losing capital stock and bad debt.”

“Japan's crisis pervaded virtually its entire corporate world. In sector after sector, debt levels and excess capacity ballooned and profitability remained low. White-elephant projects, from office buildings to auto plants, were built on borrowed money under the assumption that if times got tough, the government and banks would bail out the debtors. But the banks were too poorly capitalized to write off bad loans. And for every bad loan, there was a bad borrower whose products were not worth the cost to make them. The cumulative total of bank losses on bad debt between 1993 and 2005 added up to nearly 20 percent of GDP.”

“The United States' subprime mortgage fiasco of 2007-8, in contrast, was primarily the result of discrete, correctable mistakes brought on by ideological excess and the power of financial-industry lobbyists rather than intractable structural problems.”
It is really hard to comprehend the scale of the speculation that occurred in Japan
“The scope of the Japanese crisis and the scope of the U.S. crisis are also fundamentally different. From 1981 to 1991, commercial land prices in Japan's six biggest cities rose by 500 percent. The subsequent bust brought prices down to a level well below that of 1981; as of 2007, they were still 83 percent below the 1991 peak. In the United States, the real estate bubble was not as inflated, and the bust has been less severe. From 1996 through the 2006 peak, housing prices in the 20 biggest U.S. cities rose by 200 percent. Most forecasters think prices will drop by 30-40 percent from the peak levels before bottoming out in 2009 or 2010. No one is suggesting that prices will fall below the level of 1996.”

“Most of the United States' nonfinancial corporations are still healthy. Whereas the debt of Japanese corporations was several times their net worth, in the United States, corporate debt amounts to only half of companies' net worth, the same level that has prevailed for decades. The ratio of nonperforming loans among nonfinancial companies is only 1.6 percent, and productivity growth remains solid.”
The present policy makers had the advantage of having Japan’s response to learn from.
“The Japanese and U.S. crises differ in many ways, but the starkest contrast is in the response of policymakers. Denial, dithering, and delay were the hallmarks in Tokyo. It took the Bank of Japan nearly nine years to bring the overnight interest rate from its 1991 peak of eight percent down to zero. The U.S. Federal Reserve did that within 16 months of declaring a financial emergency, which it did in August 2007. It has also applied all sorts of unconventional measures to keep credit from drying up.’

“It took Tokyo eight years to use public money to recapitalize the banks; Washington began to do so in less than a year. Worse yet, Tokyo used government money to help the banks keep lending to insolvent borrowers; U.S. banks have been rapidly writing off their bad debt. Although Tokyo did eventually apply many fiscal stimulus measures, it did so too late and too erratically to have a sufficient impact. The U.S. government, by contrast, has already applied fiscal stimulus, and the Obama administration is proposing a multiyear program totaling as much as five to six percent of U.S. GDP. When it comes to crisis management, it is far better to do too much than too little.”
In reading about this issue, one is struck by how fundamentally different the two countries are, and by how easy it is to be optimistic about the future of the United States, and by how difficult it is to foresee a healthy Japan.

The mood in the United States is one mainly of anger. Anger, properly focused, can be a positive attribute. A recent New York Times article describes the mood in a Japan experiencing twenty years of deflation and diminished expectations as “resigned.” It is hard to see resignation as a component of a bright future.
“Just as inflation scarred a generation of Americans, deflation has left a deep imprint on the Japanese, breeding generational tensions and a culture of pessimism, fatalism and reduced expectations. While Japan remains in many ways a prosperous society, it faces an increasingly grim situation, particularly outside the relative economic vibrancy of Tokyo, and its situation provides a possible glimpse into the future for the United States and Europe, should the most dire forecasts come to pass.”

“In 1991, economists were predicting that Japan would overtake the United States as the world’s largest economy by 2010. In fact, Japan’s economy remains the same size it was then: a gross domestic product of $5.7 trillion at current exchange rates. During the same period, the United States economy doubled in size to $14.7 trillion, and this year China overtook Japan to become the world’s No. 2 economy.”

“But perhaps the most noticeable impact here has been Japan’s crisis of confidence. Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create a new economic order in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.”
If you think the real estate market is in bad shape in your area, consider Japan, even twenty years after the crash.
“Yoshinori Kaiami was a real estate agent in Osaka, where, like the rest of Japan, land prices have been falling for most of the past 19 years. Mr. Kaiami said business was tough. There were few buyers in a market that was virtually guaranteed to produce losses, and few sellers, because most homeowners were saddled with loans that were worth more than their homes.”
Japan also faces a challenging demographic future, one that many countries will face, but Japan will get there first. Nicholas Eberstadt tells the story in a “Foreign Affairs” article, The Demographic Future.
“Broadly speaking, all the developed economies will face demographic slowdowns and population aging in the coming decades, but Japan stands to be the most heavily burdened by the looming trends. It has had the steepest and longest fertility falloff in modern history. In 2008, the country recorded around 40 percent as many births as it had 60 years earlier. Japanese childbearing is currently estimated to be nearly 35 percent below the replacement level. But Japan has also enjoyed rapid and continuing improvements in public health since the end of World War II. The Japanese have an average life expectancy of 83 years, higher than any other country in the world. Taken together, the country's fertility, migration, and mortality trends are propelling Japan into demographic decline, and into a degree of aging thus far contemplated only in science fiction.”

“Over the next two decades, according to U.S. Census Bureau estimates, the surfeit of deaths as compared to births is expected to drive Japan's total population down from 127 million to 114 million, a ten percent decrease. The relative decline in the working-age population is projected to be even steeper, from 81 million to 67 million, or a 17 percent decrease. All the while, the number of Japanese senior citizens would be rising -- and by 2030, the country's median age will be above 52 years, with 30 percent of the total population 65 or older. The economic implications of these impending changes are far from positive. Even with healthy aging and later retirement, these trends suggest a marked contraction in the country's labor supply. Moreover, the social and economic strains from Japan's looming old-age boom could further complicate efforts to maintain even the country's current sluggish rates of economic growth.”
That is a future that the United States will not face for some time.
“The United States will avoid the demographic stagnation and decline that faces most other OECD countries. The U.S. population, according to U.S. Census Bureau projections, is set to grow by 20 percent, or over 60 million people (from 310 million to 374 million), between 2010 and 2030. By such projections, the United States' population growth rate will nearly match India's. According to these calculations, the United States' rate of population growth approximates that of the world's average, meaning that the U.S. share of global population is not set to shrink. Virtually every age group in the United States is set to increase in size over the next 20 years. Unlike all other affluent countries, the United States can expect a growing pool of working-age people (a moderate but steady rise averaging 0.5 percent per year over the next 20 years), and it can expect a slower pace of population aging than virtually any other state in the OECD.”

“The United States' demographic exceptionalism is explained by the country's relatively high fertility rate and its continuing influx of immigrants.”
While the anxiety grows in the United States over the growing national debt, Japan has to face all of its issues with continued growth in its debt also. At best, it is expected to grow proportionately (as a fraction of GDP) with that of the United States. The difference is that the 2009 starting point had the United States carrying a debt burden of about 53% of GDP. Japan’s debt was at about 189% of GDP. Japan was exceeded in indebtedness only by Zimbabwe at 283%.

This exercise left me optimistic about the economic future of the United States. I have a hard time being optimistic about Japan. Economists seem to expend their energies studying the past. Every once in a while the future engulfs them and provides some new old data for them to ponder. Let’s say their predictions of the past are usually better than their predictions of the future. We can hope that Japan figures out a way to solve their dilemmas and prove the dire predictions wrong. In any event, it will be interesting to watch this unfold.

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