Thursday, 24 January 2013

When Keynesian Policies won’t work

Japan is set to try yet another fiscal stimulus but this is more about politics than following the ideas of Keynes.

Keynesian policies has made a dramatic return after been shunned as a viable policy option.  Firms and households have reined in their spending due to uncertainty over the future while banks cut back on lending after the global financial crisis.  The resulting slump in demand has opened up a role for governments to fill the gap in spending which is the core premise of Keynesian economics.  But this government action is only ever meant to be a stopgap to boost demand until normal economic conditions resume.

So a stimulus package after an economy has been stagnating for two decades is beyond what Keynes would proscribe.  But this is what the government in Japan is set to embark on.  As well as a likely waste of money, the extra government spending is also a worry considering the high level of public debt in Japan and previous stimulus policies which have resulted in a glut of public works being carried out leaving Japan with lots of roads and bridges which are hardly used.  But worst of all, it is used as an excuse to put off reforms needed to rejuvenate the economy and may doom Japan to another decade of missed opportunities for economic revival.     

The newly elected government, head by the new Prime Minister Shinzo Abe, released plans this month for a stimulus package worth 10.3 trillion yen (US$116 billion).  Abe has also bullied the Bank of Japan into lifting the target for inflation from 1% to 2% as part of a push toward more aggressive policy to get the country out of deflation.  But this is the same prescription that has been administered before in Japan and the outcome will probably be the same too – a short term boost bought with more debt.  To add to this, the Liberal Democratic Party (LDP) which Abe heads does not have the best track record.  Its previous numerous stimulus packages have been more notable for extending the LDP’s hold on power through building needless infrastructure in remote regions to secure votes.  The LDP maintained its stranglehold on Japan for over 50 years of almost uninterrupted rule and was only voted out of government in 2009 despite presiding over two decades of economic stagnation following the bursting of one of the largest ever asset bubbles at the end of the 1980s. 

The LDP is expert at looking as if it is doing something while not actually dealing with the core problems, but even more perversely, it is making things worse by adding to Japan’s mountain of debt.  Government debt in Japan which reached 237% of GDP in 2012 – the highest among developed countries.  Government debt is still increasing at a rapid rate with a budget deficit of 10% in 2012.  Japan’s only saving grace is that it is mostly Japanese banks buying government bonds and Japanese savers have tolerated the meagre returns which banks have been able to offer up as a result.  So Japan has been saved from a debt crisis like that which has plagued Europe but it has also allowed politicians to put off making the necessary changes and ballooning debt must eventually have consequences such as higher interest rates which may trigger bigger problems. 

The persistent sluggishness of the Japanese economy suggests that it is not a shortfall of demand that can be fixed by a fiscal shot in the arm but changes need to be made to help the economy work better.  For a country that relies heavily on exporting, it is relatively closed off to imports which reduces competition and results in higher costs for households and businesses.  Japan has many global firms but it is also a tough place to start a business.  Wages and prices also need to be able to move so the economy can adapt to new circumstances.  Change in Japan will not come from the policies enforced top-down but need to bubble up from below through the activities of individuals and start-ups and the government just need to put in place the reforms to make this happen.  Yet, there are few signs of this happening even after an economic slump lasting over two decades.  It is a scary look into the future for leaders in Europe.

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