Will Obama Going Keynesian on Steroids Be a Redux of Japan's Failed Experiment?

[Torie]

Obama apparently is going to borrow another trillion to go on a wild spending spree to generate consumer demand etc. The WSJ has a editorial that Japan has been there, and done that, and due to capital being moved to less productive uses, from the private sector to the public sector, with private capital being crowded out by the government's voracious appetite to divert it to its own uses, the result was stagnation. Heck, FDR tried it too, and it didn't work out very well no matter what they say. We needed a war to end the malaise. I suspect equity returns for the foreseeable future will be quite anemic. This dog probably won't hunt any better than its ancestors did.

Barack Obama-san

As January 20 nears, Barack Obama's ambitions for spending on the likes of roads, bridges and jobless benefits keep growing. The latest leak puts the "stimulus" at $1 trillion over a couple of years, and the political class is embracing it as a miracle cure.
[Review & Outlook] AP

Not to spoil the party, but this is not a new idea. Keynesian "pump-priming" in a recession has often been tried, and as an economic stimulus it is overrated. The money that the government spends has to come from somewhere, which means from the private economy in higher taxes or borrowing. The public works are usually less productive than the foregone private investment.

In the Age of Obama, we seem fated to re-explain these eternal lessons. So for today we thought we'd recount the history of the last major country that tried to spend its way to "stimulus" -- Japan during its "lost decade" of the 1990s. In 1992, Japanese Prime Minister Kiichi Miyazawa faced falling property prices and a stock market that had sunk 60% in three years. Mr. Miyazawa's Liberal Democratic Party won re-election promising that Japan would spend its way to becoming a "lifestyle superpower." The country embarked on a great Keynesian experiment:

August 1992: 10.7 trillion yen ($85 billion). Japan passed its largest-ever stimulus package to that time, with 8.6 trillion yen earmarked for public works, 1.2 trillion to expand loan quotas for small- and medium-sized businesses and 900 billion for the Japan Development Bank. The package passed in December, but investment kept falling and unemployment rose. By the end of the year, Japan's debt-to-GDP ratio was 68.6%.
[Review & Outlook]

April 1993: 13.2 trillion yen. At exchange rates of the day, this was a whopping $117 billion giveaway, again mostly for public works and small businesses. Tokyo erupted into domestic politicking over election practices, the economy went sideways, and the government fell. New Prime Minister Morihiro Hosokawa floated tax cuts, deregulation and decentralization to spur growth. But as the economy worsened -- inflation-adjusted GNP shrank 0.5% in the April to June quarter -- the political drumbeat for handouts increased.

September 1993: 6.2 trillion yen. Mr. Hosokawa announced a compromise "smaller" stimulus of $59 billion, along with minor deregulation. He dropped plans for an income-tax cut. The stimulus included 2.9 trillion yen in low-interest home financing, one trillion yen for "social infrastructure," and another trillion for business. The economy didn't respond. By the end of the year, Japan's debt-to-GDP reached 74.7%.

Is any of this beginning to sound familiar? There's more.

February 1994: 15.3 trillion yen. This stimulus included 5.8 trillion in income-tax cuts, 7.2 trillion in public investment, 1.5 trillion for small business and employment-support, 500 billion for land purchases and 230 billion for agricultural modernization. The income tax cut was temporary, effective only for 1994. The economy stagnated and Prime Minister Hosokawa resigned amid a corruption scandal. By the end of the year, debt-to-GDP was 80.2%.

September 1995: 14.2 trillion yen. The Socialist government of Tomiichi Murayama, with a wobbly coalition, rolled out a $137 billion whopper, with 4.6 trillion in public works, 3.2 trillion for government land purchases, 1.3 trillion in business loans, and more. Mr. Murayama resigned in early 1996, and in June Prime Minister Ryutaro Hashimoto agreed to raise consumption taxes to 5% from 3%, starting in April 1997, to reduce the fiscal deficit.

In 1994 and 1995, Japan spent 3.1% and 2.9% of its annual GDP, and (helped by central bank easing) the economy did respond with modest growth for about two years. Debt-to-GDP hit 87.6%.

April 1998: 16.7 trillion yen. When growth starting slowing again, the re-elected LDP turned to old medicine: 7.7 trillion yen for public works. The $128 billion grab-bag also included 2.3 trillion for the disposal of bad loans. The government announced four trillion yen in (again) temporary income-tax cuts, spread over two years. Mr. Hashimoto resigned in July after voters registered their discontent at the polls.

November 1998: 23.9 trillion yen. Desperate to get the economy moving, Prime Minister Keizo Obuchi rolled out the country's largest-ever stimulus, valued at $195 billion. The giveaway included 8.1 trillion yen in social public works, 5.9 trillion for business loans, one trillion for job-creation programs, 700 billion in cash handouts to 35 million households, and more. By the end of the year, debt-to-GDP hit 114.3%.

November 1999: 18 trillion yen. In a "last push," Mr. Obuchi's government spent 7.4 trillion yen to prop up businesses, 6.8 trillion yen for social infrastructure projects like telecommunications and environmental projects, and two trillion yen for housing loans, among other things. Debt-to-GDP reached 128.3%.

Japan's economy grow anemically over that decade, but as the nearby chart shows, its national debt exploded. Only in this decade, with a monetary reflation and Prime Minister Junichiro Koizumi's decision to privatize state assets and force banks to acknowledge their bad debts, did the economy recover. Yet recent governments have rolled back Mr. Koizumi's reforms and returned to their spending habits. But Japan does have better roads.

Now we're told that a similar spending program -- a new New Deal -- will revive the U.S. economy. How do you say "good luck" in Japanese?

[Verily]

A bit revisionist, of course. Japan's previously strong economy had also been propped up by major government spending, so the spending was nothing new if somewhat larger. (Toyota and other important Japanese companies received massive subsidies from the government; Honda is noteworthy as really the only major Japanese company to not have been propped up by government funding.) As a result, when the economy went south in Japan, the government already had major obligations to the corporations to keep things afloat. Generally speaking, the United States does not have said obligations--with exceptions, of course.

[Sam Spade]

Really, you should include all the years since 1998 or so (latest 2002) with the United States using the same strategy.  An increase in debt is not growth if it retains no value.

Anyway, this article is quite correct.  Throwing stimulus at things isn't going to work.  Well, it'll produce anemic growth at enormous costs - at least that's the lesson of the Japanese (and to a certain extent, FDR).  Raise taxes at the same time and you'll get no growth at all - maybe a worsening.  It's the same deflationary story all over again.

[Linus Van Pelt]

And yet over at the New York Times at the beginning of this month we had the Nobel-prize winning Paul Krugman with the opposite description:

"The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn’t just a hypothetical argument: it’s exactly what happened in two important episodes in history.

The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.

The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment."

http://www.nytimes.com/2008/12/01/opinion/01krugman.html?_r=1&ref=opinion

Ah, economics - we may have a little underdetermination of theory by evidence in the house. Speaking a little more seriously, though, it's a little suspicious that the WSJ leaves out these years in particular. And their evidence doesn't seem all that strong. 1994-5 in fact looks pretty good for the Keynesian case, and surely the rise in debt-to-GDP isn't helping their case - isn't the whole point of Keynes that you go into deficit (thereby raising debt) in a recession and then pay it down when times are better?

[Sam Spade]

Personally, I don't disagree with Krugman that tight fiscal policy is not the answer.  It isn't.  Similarly, no one would dispute that there was some growth in FDR's 1935-36 period, as there was in the mid-1990s in Japan.

Here's the problem - very little of that growth was privately financed - nearly all was public.  It would not sustain itself without the continued pumping of money.  Heck, during the Great Depression, what exactly was that growth?  Very little.  Unemployment?  Didn't move much outside of government-created jobs.

The key point that Krugman ignores is that the reaction was FDR and Japan was natural, if not predictable, and it'll happen here too (and he'll probably support it - well, at least the tax raises).  If Obama spends, let's be conservative here and say $5 trillion over the next 3-4 years in a massive Keynesian gambit, we could well probably have some growth by 2011-2012 - 2 to 3% maybe max.  Also, out debt-GDP ratio will skyrocket to, I don't know, say 75%. (it's about 35% now)

Well, the 2-3% growth will convince people that we're getting out of the mess.  And then, they'll say, we need to start paying down all the debt we took on to get us.  And how do you do that - well, cut spending and raise taxes.  And then 1937/1997 happens again.  In other words, the problem with Keynes is - well, when are the down times really over?

But there's a little problem here - the Bush tax cuts expire in 2010.  Technically, if they expire, that's going to be a tax raise - a mildly significant one.  Now, it'll be priced in a little, and old people will be dying faster than lemmings jumping off a cliff in 2010, but it should just be noted...

I still want to make my more interesting point - which is that we've been playing this game since the late 1990s.  And this decade has essentially been the same as Japan's lost decade.  So, we're heading for two.

[Torie]

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Ya, the bold is the thing. Raising taxes is generally agreed not to be the right medicine to use to jump start the economy. But maybe cutting spending and taxes might be, particularly spending on things that don't help the economy much in and of themselves, or whose impact is very short term.

[Lunar]

Obama apparently is going to borrow another trillion to go on a wild spending spree to generate consumer demand etc.

somebody's got some assets that would prefer deflation...

[Lunar]

Personally, I don't disagree with Krugman that tight fiscal policy is not the answer.  It isn't.  Similarly, no one would dispute that there was some growth in FDR's 1935-36 period, as there was in the mid-1990s in Japan.

Here's the problem - very little of that growth was privately financed - nearly all was public.  It would not sustain itself without the continued pumping of money.  Heck, during the Great Depression, what exactly was that growth?  Very little.  Unemployment?  Didn't move much outside of government-created jobs.

So... all of the government employed people spent their money on what, the tolls for government-repaired bridges? 

How do you know things wouldn't have been far worse without it?

[Filuwaúrdjan]

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Ya, the bold is the thing. Raising taxes is generally agreed not to be the right medicine to use to jump start the economy. But maybe cutting spending and taxes might be, particularly spending on things that don't help the economy much in and of themselves, or whose impact is very short term.

The response of most European governments to the Depression was to cut spending. Didn't work out so well either.

[Sam Spade]

Personally, I don't disagree with Krugman that tight fiscal policy is not the answer.  It isn't.  Similarly, no one would dispute that there was some growth in FDR's 1935-36 period, as there was in the mid-1990s in Japan.

Here's the problem - very little of that growth was privately financed - nearly all was public.  It would not sustain itself without the continued pumping of money.  Heck, during the Great Depression, what exactly was that growth?  Very little.  Unemployment?  Didn't move much outside of government-created jobs.

So... all of the government employed people spent their money on what, the tolls for government-repaired bridges? 

How do you know things wouldn't have been far worse without it?

Did I ever say that things wouldn't have been worse without it?  No.  (I had a nice long response but it got eaten - leave it at this)

[Lunar]

Fair enough, just want to make sure no one is taking particular slices of economic history to derive conclusions irrespective of causation.

or something

[Beet]

Japan's slowdown in 1997-98 was exaggerated due to the Asian financial crisis. Undoubtedly the 1996 tax hike was premature, but with 40% of Japan's exports going to Asia, and a large number of Japanese financial loans and investments in countries affected by the crisis, their devaluation vis-a-vis the yen had a significant impact toward turning Japan to recession. It was at that time that Japan's woes really crystallized in the Western mind, as well. Without the financial crisis, Japan might have ended up with a similar fate as Western European countries which experienced a mini-boom in the late 1990s even though long run trend growth had slowed.

Another factor is Japan's abnormally low birth rates and strict immigration policy- even if US policy is no more successful than theirs, we will see more growth simply due to a higher birthrate and more immigration.

Thirdly, Japan's high savings rate is not something that simply materialized in the 1990's. Japan has had a high savings rate since World War II. It is a cultural difference that transcends economic policy- the US has a consumer culture, Japan has a savings culture. When the recession ends, American consumption is more likely to resume growth than the Japanese did.

And finally- long run trend growth of 2% is not the end of the world. It was not too long ago that most economists that that you couldn't get much below 5.5% unemployment and above 2.5% growth without creating unsustainable inflation. This country has a high enough GDP to ensure a comfortable living for all of its citizens- providing we made the political choice to do so.

[Lunar]

I'm with Beet now on this one.  Never studied comparative economics, but Japan does have those knocks against it.

Will our savings rate be pushed upward due to turbulent times though?  If you don't know if you're about to lose your job, are you really going to buy that motorcycle?

[Matt Damon™]

So America's savings rate jumps from -3% to 0%?

[Sam Spade]

Will our savings rate be pushed upward due to turbulent times though?  If you don't know if you're about to lose your job, are you really going to buy that motorcycle?

It most certainly will.

[Torie]

I wonder what Japan's growth rate has been since 1990. I appreciate it that it should be evaluated on a per capita basis given its zero population growth when comparing Japan to nations which have had population growth.

[opebo]

...Heck, FDR tried it too, and it didn't work out very well no matter what they say. We needed a war to end the malaise.

No, you misunderstand.  The war was the Keynesian cure.  The piddling little bit they tried before wasn't even 10% of what was needed.  The lesson is, Torie, that we need to spend far more than FDR did in the 1930s, or than Japan did in the 1990s.

[Erc]

Well, at some point the Fed's going to run out of levers it can pull without seriously overreaching itself--we're already near the liquidity trap as it is.

With the Fed increasingly out of the picture, you only really have two options:  serious fiscal policy like Obama is suggesting, or doing nothing.

As has been implied here and there, you do run the risk of Riccardian equivalence biting you in the ass if you use fiscal policy, but not everybody out there is going to anticipate the inevitable future tax rises (or care about them)...and, with the credit markets the way they are these days, the segments of the population that aren't currently doing any appreciable saving will use much of whatever stimulus they get.

As for the concern about the inevitable tax rises causing the same sorts of problems in the future...eventually, the economy is going to recover, massive intervention or no (it will just be far more painful in the meantime without it).  At some point, the economy will be doing well enough that it can take (and might actually use) the necessary tax hikes and spending cuts without throwing the country into a recession.  As long as this is timed correctly (easier said than done, as the historical examples demonstrate), you should be fine...you're not simply postponing the recession.

[Swing low, sweet chariot. Comin' for to carry me home.]

Well, at some point the Fed's going to run out of levers it can pull without seriously overreaching itself--we're already near the liquidity trap as it is.

With the Fed increasingly out of the picture

I would think the Fed is even more in the picture.  They've become the buyer of last of resort.