Subject: Japan and the Limits of Keynesianism - McCardle - Atlantic
From: "Michael Andrews" <[email-masked]>
To: "Devon Archer" <[email-masked]>, "Eric Schwerin" <[email-masked]>, "Neil Callahan" <[email-masked]>, "Curtis Hastings" <[email-masked]>, "Hunter Biden" <[email-masked]>
Date: Tue, 28 Dec 2010 15:00:41 -0500

Japan and the Limits of Keynesianism
DEC 28 2010, 12:24 PM ET30

Japan's budget is in a truly terrifying state.  Reading about the  
government's behavior reminds me of the worst accounts of compulsive  
spenders on the verge of personal bankruptcy--a sort of "What the  
hell, we're screwed anyway, so let's not think about it and maybe go  
to Cabo for the weekend."  The budget's structural position is what is  
known technically to economists as "completely hosed"; borrowing now  
exceeds tax revenue, and debt service costs now eat up almost half of  
the tax revenue the government collects.  "Unsustainable" is too weak  
to describe the situation; I don't know how they're doing it now.

To be sure, a lot of people have been awaiting the inevitable collapse  
of the Japanese government's finances for the better part of a  
decade.  I know all the arguments for why this isn't such a big  
problem:  their debt is financed domestically, much of it through the  
postal savings system that pays little for its borrowing, and the  
Japanese are extremely patriotic about their nation's financial  
needs.  That may shift the locus of the problem, but it doesn't  
actually solve it; eventually, no matter how patriotic they are, the  
Japanese are going to want to use some of those savings to support  
themselves in their old age.  Some sort of crisis virtually has to  
ensue.

When I was starting out as a journalist, I frequently had Japan used  
to illustrate Adam Smith's precept that "there's a lot of ruin in a  
nation"; any time someone was tempted to get hysterical about  
government borrowing in America or elsewhere, someone else would  
inevitably point out that Japan's debt burden was well over 100% of  
GDP, and the country still hadn't collapsed.  But while there is a lot  
of ruin in a nation, there isn't actually an endless supply, and Japan  
may well be finally approaching the limits.

Felix Salmon views this as a symptom of a broader political failure:

The situation in Japan is particularly depressing because the country  
has no major ethnic or political rifts. Sure, there's political  
jostling, both within and between the parties. But it's nothing  
compared to the vitriol and mistrust that we see in the US, and  
somehow I can't imagine Greece-style riots in Japan either. But still  
the technocrats can't make any headway.

The lesson here, I think, is that it's very, very hard for a  
government to enact a serious fiscal adjustment unless and until the  
bond market forces its hand. The Brits are trying, of course -- and  
we'll see whether or not the coalition government can succeed. But as  
we saw with George W Bush, the fiscal rectitude of one administration  
can be more than wiped out during the course of the next.

Even now, with the attention of the world more concentrated on  
sovereign fiscal issues than ever, the Japanese government can still  
contrive to raise agricultural subsidies by 40% and send child-care  
payments soaring, including payments to families who don't need the  
money. It's even getting rid of highway tolls. Oh, and it's cutting  
the corporate tax rate.

 From a bond-market perspective, this basically just means an ever- 
greater supply of JGBs: we're still a very long way from any real  
credit risk, given the political power of the owners of those bonds.  
But as a lesson in fiscal political economy, Japan is much more  
worrisome.

I see it a little bit differently: Japan has simply reached the limits  
of Keynesian policy in an economy which has never managed to jolt  
itself back up to a healthy rate of growth.  Demographics is obviously  
a big contributor to that slow growth, and there are a whole host of  
secondary factors one could nominate, but whatever the reason, they  
have now had two decades of anemic growth, which they have fitfully  
attempted to address with stimulus.  Maybe not enough stimulus, maybe  
badly designed, but they've certainly tried to follow the basic  
Keynesian playbook:  borrow money and spend it when times are bad, in  
the hopes that you can bring back growth.

But for Japan, at least, the growth has not materialized.  Few  
economists would advise undertaking a fiscal adjustment, on the scale  
that Japan requires, in the face of the current crisis.  The problem  
is, there hasn't been a good time for retrenchment in 20 years.  I  
can't blame the politicians for trying to restore some semblance of  
normal growth in the run-up to elections.  But at some point, they're  
going to have to cut back, whether or not it's a good time.

Matt Yglesias suggest that it's irrational to retrench ahead of the  
bond market, when what they ought to be doing is trying to have more  
economic growth, but their lack of economic growth really isn't for  
lack of trying.  I think every economist who has ever had an opinion  
on currency has been solicited, at one point or another, to come up  
with a plan for Japan, but they've all failed, either because the  
plans weren't politically feasible, or because the money supply simply  
stubbornly refused to inflate no matter how hard it was pumped.

Given the menu of actual policy options, it would probably be best for  
Japan to attempt fiscal adjustment now.  The earlier you deal with a  
fiscal problem, the smaller the problem is . . . and doing it in  
advance gives you rather more discretion about how and when the cuts  
are made, which gives everyone, espeically the people who are now  
dependent on the government, time to adjust.  But it's not hard to see  
why it hasn't.  Which of us would volunteer to be the guy who cuts  
pensions and farm subsidies while there's a recession o