Lessons from Japanese crisis management
It’s the New Year, with property pricessliding, the stock market down more than 40% from its peak, and the governmentembarking on a range of economic stimulus initiatives, many of which are ofdubious quality. But in this story, the "New Year" isn’t 2009; it’s 1992. Andthe country isn’t the US or even New Zealand, but Japan.
Japan’s "lostdecade" through the 1990s saw both urban land prices and the Nikkei share indexeventually bottom out at 75-80% below their peak levels of the early 1990s. Economic growth between 1991 and 1999 averaged just 0.6%pa as the world’ssecond largest economy stagnated. Japan’s GDP per capita has slipped fromsixth in the OECD to 16th since 1993.
The US represents 28% of the globaleconomy, compared to 16% for Japan at the start of the 1990s. So if America were to provide a reprise of Japan’s performance, it would be a bigger handicap for the restof the world in achieving "normal" economic growth over the next decade. Theissue is important for us given New Zealand’s heavy reliance on trade. What’sto stop the US heading down the same path as Japan?
One reason for optimism is the speed andextent of the reaction by the Federal Reserve. The cash rate targeted by theAmerican central bank is now effectively zero. In contrast, Japanese interestrates didn’t get below 1% until 1995, more than five years after the crisisbegan. With low inflation in Japan, interest rates acted as a significantongoing constraint on any recovery in economic growth.
Interest rates are not the only leverthat central banks use to try and stimulate the economy. Quantitative easing,with the Federal Reserve injecting money into the financial system to try andencourage more lending to take place, is also taking place. Once again, thecontrast with Japan is startling â€“ it was not until early this decade that theBank of Japan accepted that it could do more than simply cutting interestrates.
Monetary stimulus is a necessary, but notsufficient, condition to pull the economy out of the financial crisis. Somelevel of transparency and dynamism in the banking sector is also vital. Looking back over the last 18 months, it can be argued that neither of thesetraits has been particularly prominent among financial institutions. Revelations of exposure to, and write-offs of, mortgage-backed securities havebeen delayed as long as possible. But America still beats Japan on this count too. Japanese banks sleepwalked through the 1990s, refusing to call innon-performing loans because they knew it would necessitate recapitalisationand probably result in the loss of control of the bank.
The lack of dynamism in Japan’s banking sector was matched by the stasis of the country’s labour market. The "jobs forlife" mindset meant that the unemployment rate took a decade to climb from 2%to 5.5%. These numbers point to an absence of resource reallocation away fromunviable businesses, severely limiting the potential for a recovery in economicgrowth. Again, the contrast with the US is substantial. America’s jobless rate has risen 2 ½ percentage points over the last year, creating a pool of labourresources for new and expanding firms to utilise once economic conditionsbecome more favourable.
Perhaps Japan’s largest mistakes came inthe fiscal policy area. Much of the fiscal stimulus packages in the 1990s wasaimed at unproductive public works â€“ pork-barrel politics of the highestorder. The fiscal watershed occurred in 1997, when the government looked toaddress its debt problem by increasing taxes. The move proved to be premature,sending the economy back into recession and giving rise to deflation.
Although questions have been asked aboutthe appropriateness of bailing out the banks and the car manufacturers in the US, government officials seem to have pursued a goal of minimising the collateral damagefrom a full-scale banking sector meltdown or auto industry collapse. Inessence, the American approach looks to be minimising the transitional costs ofthe necessary changes, not trying to completely prevent change from occurring.
Nevertheless, the biggest risks for America probably lie in this area of fiscal policy. If rescue packages start occurringyear after year, you know things aren’t right. Each repeated bail-out providesless and less benefit for the economy, with fiscal policy becoming captured byvested interests until the money eventually runs out.
Given the significance of the ongoingfinancial crisis in the US, the economy could well take five years to getproperty back on its feet. But in its decade-long struggle, many of Japan’s problems were self-inflicted, with a failure to learn the lessons of the 1930sGreat Depression. America was the starting point of the Great Depression, andso should have learnt those lessons. And it need only look at Japan for a refresher course on how not to respond to a banking crisis.
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