The Economy

Dec. 21, 2004
Japanese economy stumbles toward recovery.

The pattern of continuing robust growth in the U.S. certainly has not been matched by the Japanese economy, which remains mired in recession. For the fourth quarter of 1999 Japanese real GDP declined at a 5.5% annual rate, following a 3.9% annual rate of decline in the third quarter. This makes 1999 an extremely odd year for Japanese GDP, since it rose at annual rates of 6.3% and 3.9% for the first two quarters of the year. The usual complaints have been voiced about the quality of the Japanese statistics, which are actually grossly inferior to those issued by U.S. government agencies, yet there seems to be little doubt that Japanese real GDP did not advance last year. In recent years, of course, weak growth in Japan has not hurt either the U.S. economy or the U.S. stock market. The minuscule gain of 1.4% in Japan's real GDP in 1997, coupled with an actual decline of 2.8% in 1998, had no ill effects on this side of the Pacific. Nonetheless, the return to recession in Japan will hurt the recovery in Southeast Asia, leading to an even more lackluster year for U.S. exports than I previously had predicted. The Japanese figures were unusual in the sense that the 5.5% annual rate decline in total GDP was accompanied by a 20% annual rate gain in capital spending; usually it is consumption that leads in the early stages of recovery, with investment the laggard. However, that gain was offset by a 22% drop in public sector investment, a 7% drop in consumer spending, and a 24% plunge in residential construction (all at annual rates). The decline in net exports also reduced real growth by 2.0%. The turnaround in real growth from +5.1% in the first half of 1999 to -- 4.7% in the second half is largely attributable to the fact that the government actively pump-primed the economy in the first half, but then cut back on spending in the second half. At least at this stage of the business cycle in Japan, the government spending multipliers are quite large. Eventually, the recent Japanese moves toward financial transparency, deregulation, and privatization, even if hesitant and overdue, will get the economy started again. Yet so far that has failed to occur. Furthermore, in spite of huge deficits, extremely low interest rates, and negative growth, the yen has strengthened in recent months, hence adding to the current Japanese economic woes. At the moment the Japanese economy does not seem to be able to grow without massive injections of government spending. Yet in the U.S. prosperity has coincided with cutbacks in government spending and higher tax rates. Are the two economies that different? Not really. The difference is caused by the phase of the business cycle. When the economy is at full employment and bursting at the seams, government programs should be designed to boost productivity growth, which means reducing the growth rate in spending and leaving tax rates alone. Because the tax elasticity is greater than unity, the surplus will continue to increase. Once Keynesian economists used to talk about the "fiscal drag" from large surpluses, but it now has become apparent that the gains in stock prices and productivity overwhelm any contractionary impact of higher taxes and lower spending. During a recession, though, measures that would boost productivity in the long run do not accomplish their stated objective much in the short run. Such measures will generally boost investment but leave consumption in the lurch. Thus, the appropriate policies for countries mired in extended recessions, at least until the recovery is well under way, are more government spending, tax rate cuts, and a somewhat weaker currency. Japan has followed through on only one of these items. While real GDP is expected to rebound this quarter, on a longer-term basis the Japanese economy is not likely to return to a sustained recovery until policymakers institute a big tax cut that would gradually be phased out after the recovery, and take more vigorous steps to reduce the value of the yen to its value consistent with purchasing power parity. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected].

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