Tuesday 27 Sep 2022 | 17:12 | SYDNEY
Tuesday 27 Sep 2022 | 17:12 | SYDNEY

Reader riposte: Japan\ deficits


Stephen Grenville

21 February 2011 14:30

Kien Choong asks:

Could you clarify the 'cold turkey' approach' I thought the problem (as Richard Koo describes it) is that liabilities far exceed debt (ed. note: we assume 'debt' should actually be 'assets'), causing debtors to save. Wouldn't making companies bankrupt cause asset values to fall, thereby aggravating the problem' Bankruptcy also involves people loosing jobs; not all employees will be kept by the new owner. So there are real effects; this isn't just an accounting event.

I would have thought that the 'cold turkey' approach would entail writing off liabilities, no'

Yes, an alternative 'cold turkey' approach would have raised unemployment and reduced growth in the short term. Firms would have gone bankrupt and their assets would have been sold at fire-sale prices to others. Yes, liabilities would have been written down, with lenders taking a big hit. All this would have been very painful.

The question is whether it would have put Japan into a persistent downward spiral or would have set the stage, after the pain, for a regenerated, dynamic Japan to emerge. The physical assets would have been in new hands. The banks would have had clean balance sheets, ready to fund investment spending. Some of the sclerotic structural constraints would have been swept away.

The alternative, less painful, strategy, pursued for two decades, has kept GDP up, but has left Japan with some awkward problems. Government debt, as a percent of GDP, is more than twice as high as that of the UK, Italy, Ireland, Spain and Portugal, and 50% higher than Greece. On projections by the Bank for International Settlements, the debt/GDP ratio is headed for 400-600% of GDP.

And the budget imbalance is not going away: it's still of the same order of magnitude as the European countries, which are commonly considered to be in trouble from their large deficits. As Japan ages further, fewer Japanese will want to hold this debt.

Moreover, two decades of balance sheet restructuring doesn't seem to have cleaned up all the mess. This 2010 IMF paper notes that 'corporate indicators also tend to be weak by international standards. This difference is particularly large in the non-manufacturing sector and compared to U.S. and U.K. firms.' The paper urges a policy of 'reducing excess leverage and supporting corporate restructuring to enable new investments to flourish'.

What about the possibility that a tougher stance would have put the economy in a downward spiral' Of course the IMF ('It's Mostly Fiscal') would be expected to offer reassurance, but it may well be right when it says: 'Although fiscal consolidation has short-term costs, the potential long-term benefits are considerable, and reforms that raise potential growth could support consolidation.'

Other countries have had bigger asset bubbles burst and have adjusted more quickly. In Hong Kong during the Asian crisis, apartment prices fell to a quarter of their peak price, but the economy adjusted quickly and successfully. Just about all its manufacturing sector moved to China by the end of the 1990s, but Hong Kong renewed itself as a financial and services supplier.

I don't know whether a different strategy might have worked for Japan. My guess is that budget deficits and balance sheet restructuring are not the only issues. But as I said, I'm ready to bow to Richard Koo's superior knowledge. I certainly accept that cold turkey can be too brutal. In the Asian crisis of 1997-8, countries like Thailand had to dramatically restructure in short order. No-one would wish that sort of adjustment on Japan. But young Japanese must ponder just what legacy has been bequeathed to them by the leisurely pace of adjustment so admired by Richard Koo.