What Does the Earthquake Mean to Japan's Fiscal Future?
Monday 14 March 2011
There is no doubt that this terrible earthquake is worse than the Kobe tragedy of 1995. Kobe was a 7.4 on the Richter scale, but the quake that hit Sendai was 8.9 — many hundreds of times more powerful. And then there was the tsunami. The devastation is so great that no one knows how catastrophic it is likely to be in the end. But the worst of it lies ahead.
Consider: In the case of an 8.9 quake, the odds are there will be one aftershock of more than eight on the scale and 10 of more than seven. So far we have only had one that has been more than a seven. Meanwhile, aftershocks are moving toward Tokyo. The quakes so far have weakened buildings far, far from Sendai, including in Tokyo, making them vulnerable to more shocks. In effect, there may be several Kobes ahead that will be hitting installations that are already now prone to collapse or malfunction.
Japan’s Prime Minister, Naoto Kan, called this the greatest tragedy since World War II. People are slowly beginning to imagine how the country will cope going forward, but it didn’t take the blink of an eye for the fiscal deficit hawks to descend in force. They suggest that Japan can ill-afford another big round of government expenditures, given what they call its looming “national insolvency.” How must it feel to people in shock to hear the news bulletins telling them that their government is broke and unable to help the population? Particularly when it isn’t true.
Media folks like to cite Japan as Exhibit A for the failure of aggressive fiscal policy. But this was not always the case. Prior to the end of the bubble era, Japan “chose” a low employment path — essentially holding the employment ratio constant — with high aggregate demand, which generated rapid growth in productivity. Policy makers maintained demand at a high level through a combination of very large government deficits, high investment demand, and generally a high flow of net exports after 1980. However, toward the end of the 1980s, the government deficit rapidly fell and the budget moved to balance in 1990. When the U.S. “double-dipped” in the early 1990s recession, and as other Asian countries began to effectively compete with Japan for world markets, foreign markets demanded fewer Japanese products. Then came the Asian financial crisis, followed shortly afterward by the bursting of the high tech bubble in the US. Together, these negative influences lowered aggregate demand and contributed to a deep and prolonged recession. The country’s “stop-start” fiscal policy, undertaken from the mid-1990s until around 2003, didn’t help. Japan suffered from repeated and misguided attempts to elevate budget reduction above employment and growth policies. As recently as last year, this fiscal stance remained firmly entrenched in Tokyo. During the Upper House elections, Japan’s Prime Minister, Naoto Kan, publicly mooted doubling the country’s consumption tax from 5% to 10% in order to “fund” the public deficits.
You have to credit the deficit hawks with consistency. But as Ralph Waldo Emerson noted, “A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.” This kind of consistency is now embraced by small-minded politicians who continue to peddle a falsehood when over 10,000 people are now presumed dead.
Let’s be clear: Japan does not face a fiscal crisis in the sense of going broke. Japan has a sovereign currency, and therefore its government has always had the capacity to purchase anything and everything for sale in yen. But the country’s fiscal situation has been weakened by the inconsistent “stop/start” policies that have been adopted over decades, which in turn have led to sluggish economic growth, creating the huge budget deficits that the fiscal hawks now regularly decry. When you have a collapse in private spending, then public spending has to increase both in absolute terms and as a proportion of GDP to make up for that if you want output growth and incomes to be stable.
Even allowing for Tokyo’s inconsistent application of fiscal policy over the past two decades, it is worth noting that had the Japanese government continued its planned deficit reduction in 1997 and not provided further budgetary stimulus by 2003 (when the Ministry of Finance finally abandoned its futile “fiscal consolidation”), the situation would have been significantly worse than what it already is. To acknowledge that persistent budget deficits do not cause interest rates to rise and do not cause hyperinflation does not imply that the policy options embraced by the government have all been good. But simply stated, things would have been much worse in their absence (with much higher corresponding budget deficits).
Globally, today’s deficit reduction fetishists suffer from collective amnesia: they have already forgotten that fiscal policy has saved the world from a Great Depression. The policy response adopted in 2009, although insufficient (to judge from the presence of still high levels of unemployment), put a floor on global aggregate spending power and virtually demolished everything you’ll read in modern mainstream macroeconomic textbooks about the efficacy of fiscal versus monetary policy. Yet some three years after the great financial crisis of 2008, and now within hours of the worst human tragedy to befall the Japanese people in decades, we have completely lost track of what’s happened. And so we are basically setting ourselves up again for the next crash.
In the specific case of Japan, the social situation in the wake of this catastrophe will become untenable unless the government provides further fiscal support. Naturally, people will debate about how they might do that given that you can only build so many highways or bridges. But today the case for rebuilding basic infrastructure after one of the biggest earthquakes of the last century is a policy no-brainer. And even after the obvious reconstruction tasks facing Japan, an aging society brings greater demand for personal care services, and that is one labor-intensive growth area that should still be targeted by the government.
Perhaps the deficit hawks hate government spending so much that they are prepared to tolerate the mass unemployment and massive wealth losses that would accompany a zero discretionary fiscal response. Are they also suggesting that we should risk a nuclear meltdown as well in pursuit of this principle, given the damage to the country’s nuclear reactors? That would be truly cheating future generations, because the costs of not intervening with fiscal policy in this kind of circumstance would bequeath a disastrous environmental legacy to Japan that would last for decades, possibly centuries, as any resident of Hiroshima or Nagasaki could easily attest. Beyond that apocalyptic point, when you lose your home because you can no longer pay the mortgage after losing your job, the wealth impact is huge and long-lasting.
An earthquake of this magnitude is something one would never wish on any country. Given the reservoir of social capital that has sustained Japan through two very difficult decades, the country is probably better equipped than most to deal with this terrible situation. And if it finally moves Tokyo’s policymakers beyond their misguided deficit reduction obsession, then the resultant policy response will represent the most honorable way of respecting the memory of those 10,000 or more who lost their lives, to say nothing of the millions who are now suffering from the tragedy. To retreat into stale arguments about how the government can’t “afford” to help at a time like this not only reveals economic illiteracy, but also the moral bankruptcy at the heart of the neo-liberal agenda now driving today’s policy makers globally.
Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.
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