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Tuesday, May 20, 2003

Japan's Crisis Revisited

Stephen Roach again. Yesterday he informed us concerning Japan that "one of these days the logjam was destined to be broken. It's just a question of when - and under what circumstances. That day could well be at hand." Now I have learnt with the passage of time that forecasting when 'endgame day' might finally come in the case of Japan is an extremly hazardous business. Back in October (when few of you were reading me!) I posted a piece comparing Takenaka to Yamomoto (the reference being to the financial carnage that any Japanese 'hard landing' might cause over on Wall Street) which, apart from the theatricality, I would willingly post again if I thought Roach was right. Right, I mean, in the sense that 'high noon' is coming. Having burned my fingers by being precipitate first time round, I'm adopting a more cautious 'wait and see' approach. In particular in the meantime I've read Karel van Wolferen's The Enigma of Japanese Power which I highly recommend to anyone wanting to understand what is happening in Japan. Among other jems you can find there is the idea that Japan, in some ways is a non-geographical federal state, power in this case being distributed not between the regions, but between the competing power centres situated in the various ministries. The notion of a Japan which speaks with a single voice is therefore something of a contradiction in terms. However the current power battle between 'reformers' and 'non-reformers' plays out in practice, you can bet your life the path will be 'non-linear'.

Returning to the more substantial point, for once I am in complete disagreement with Stephen. Playing Russian roulette with the Japanese body politic will not give the desired result. First, it is a risk averse society and will never be persuaded to volunteer to press the trigger (but then I guess that is another dimension of the weak dollar policy, to try and leave them - and the Europeans - no alternative). But, secondly, what if - as I've being arguing here at Bonobo Land - the 'reforms' as they're presently conceived are a remedy worse than the disease. What if there is no growth 'recovery' as Stephen understands it, waiting just round the corner for Japan, and if all those government bonds which the BoJ is quietly accumulating will one day be virtually worthless - for if deflation accelerates, and the debt continues to grow, there will be no way to pay it off, ever, and one day the world will wake up to this unpleasant reality. What if the reform that is really needed is a complete change of mindset, a 'cultural' revolution which opens to the world, and at the same time opens the doors wide to immigration as the only short term stop-gap for an ageing and declining population. And what if Japan is only the first, and what if we are addicted to growth in a world where - like 'good lovin' - it proves hard to find. These are difficult and deep questions, and the answers won't be coming out of my keyboard in a rat-tat-tat fashion. Looking for solutions is going to be difficult, but the first step is to find the problem.

In that vein, it is critical to ponder the broad outlines of Japan’s potential endgame. There can be no mistaking the near-term implications of legitimate reform initiatives for the Japanese economy: Initially, reform-driven restructuring of the financial system and nonfinancial corporations will be extremely tough medicine to take. Unemployment will undoubtedly rise a good deal further from its near record level of 5.4%, as will the risks of renewed recession and intensified deflation. There is also the related risk that the pain of restructuring could lead to a financial crisis that obviously would have a more pervasive impact on the Japanese and world financial system. But with possession of the world’s largest reservoir of saving and currency reserves, Japan can afford to take these risks. In the end, there is no alternative to additional cyclical distress if, in fact, Japan is finally serious about the heavy lifting of reforms. What Japan cannot afford to do is strangle its economy. And at this late date, that remains the most realistic alternative to reform.

These developments could have equally important implications for the rest of Asia and the broader global economy. More than a decade of near stagnation in Japan has all but neutralized its role as an engine of Asian growth. Whereas Japan accounted for approximately 10% of pan-Asian GDP growth over the 1985–94 period (on a purchasing power parity basis), our estimates suggest the share fell to a mere 4% in the 1995 to 2002 interval. Successful reforms will not change the balance of Asian growth over night. But as Japan comes out the other side, an externally-driven Asian economy will re-acquire an autonomous source of domestic demand. Today’s Japanese consumer probably has the greatest pent-up demand potential of any major economy in the modern era. As reform-induced layoffs mount, an increasingly saving-short Japanese consumer will undoubtedly exert even more restraint. But when there is a sense that the worst of the headcount carnage may be nearing an end — possibly 2–3 years down the road — a sharp rebound in private consumption is likely and Japan will then be in a good position to reclaim its role as the growth engine of Asia. The Japanese reform story is also critical for the world economy — especially the global rebalancing that a lopsided, US-centric world so desperately needs. The burden of this realignment must be shared by all. Just as a saving-short US economy must rein in the excesses of domestic demand, the structurally-impaired economies of Japan and Europe must unlock stagnant domestic demand by implementing long overdue reforms. Given America’s massive and ever-widening current-account deficit, I continue to believe that a sustained and significant weakening of the dollar will put increasingly greater pressure on Japan and Europe to shift the mix of economic growth away from currency-sensitive external demand. The recent weakening of the dollar lends credence to just such a possibility. Mounting pressures on the Japanese banking system only add to the tension, underscoring the perils of inaction. In the end, reforms are the only way to a successful global rebalancing. And wouldn’t you know it? Just when the world had written Japan off, the world’s second-largest economy may be starting to deliver.
Source: Morgan Stanley Global Economic Forum

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