Japan's Keynesian experiment

By Dennis Rice
web posted March 1999

If you ask a Keynesian what to do about economic slumps, you will generally be told that it is essential that there be increased government spending and monetary expansion to revive growth. But when we look across the ocean to Japan, we have ample reason to wonder whether that kind of an approach has any value at all.

As a result of the crash of an economy riddled with favoritism and senseless regulation, Japan has been in the economic doldrums for several years now. What is becoming apparent is that the Japanese government, far from adopting a laissez-faire attitude to the downturn, is in fact pursuing all the routine Keynesian remedies. By those standards, the economy is supposed to be experiencing a rebound by now. However, that is anything but the case.

On the monetary front, the Japanese are doing a great deal of what interventionists like to call pump-priming. The central bank's discount rate has fallen from 9 per cent in 1980 to near zero today. According to one report, central bank assets grew by 36 per cent during the 12 months previous to November 1998. In stark contrast to what Keynesians would expect such explosive monetary growth to achieve, the Japanese economy is now perched on the verge of serious deflation. More ominously, long term interest rates are actually beginning to rise.

The reason for the rise in long term interest rates can be traced to Japan's adoption of Dr. Keynes' prescriptions for fiscal policy. Government spending has been ballooning over the past few years, supposedly to lift the economy up by boosting demand. Last year, the government set aside almost $520 billion (U.S.) for bank bailouts, in addition to a $207 billion economic stimulus package mainly for public works. The result? Unemployment levels that continue to grow and skyrocketing debt. The projected budget deficit is now predicted to reach 10 percent of gross domestic product, among the highest in the industrialized world.

Undeterred by such troubling statistics, the central planners have recently come up with an even more desperate scheme to jolt the economy: free shopping vouchers. Almost $6 billion worth of coupons will simply be given away to youngsters under 15 and low-income earners over 65. One reporter interviewed some eager teens who supported the voucher program "...because it would help them buy Sega's new Dreamcast video game unit."

The business community is, understandably, less than ecstatic about these policies. Significant parts of the economy now resemble a zombie on life support. The Japanese stock market's performance continues to be anemic. It would be difficult to argue, though some undoubtedly would, that the Japanese are just not trying hard enough to implement the Keynesian approach. If deficits of 10 per cent of GDP aren't doing the trick, does anyone seriously think that deficits of 30 or 40 per cent would? By now it should be clear: the Keynesian approach is not working because it seriously misunderstands the reasons for the contraction of the Japanese economy.

Japanese central bank credit expansion in the 1980's fuelled a mindless consumption boom, pushing real estate and stock values far above any sensible valuation. That malinvestment boom has fizzled out over the past decade, resulting in a cascade of bankruptcies. Since the salvage value of a bankrupt firm is rarely equal to the money that was originally put into it, it is imperative that the lost capital be replaced as cheaply as possible, so that the firm can rebuild and grow under new management. Unfortunately, that objective is now being confounded by the government's ravenous appetite for debt.

Rather than taking pressure off the bond markets by slashing outlays, the borrow and spend policies of the Japanese government are having the effect of making capital more expensive and scarce by destroying it in public works projects and giveaways that offer not a cent of profit but rather massive losses. As long as this trend continues, profitable investment in the private sector, the only true engine of growth in any economy, will remain elusive along with hope for recovery.

With stormclouds gathering on our own economic horizon, no doubt we will soon hear calls to undertake the kinds of Keynesian initiatives we now see in Japan. Given the Japanese experience with those policies, it is the kind of advice which is best ignored.

Dennis Rice is a writer living near Winnipeg, Manitoba

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