November 15, 2009
Will We Go the Way of Japan? No, Unless US Government Policies Discourage Growth
Will We Go the Way of Japan? No, Unless US Government Policies Discourage Growth-Becker
Japan has had a very slow rate of growth in its GDP since 1991, averaging just a little over 1 percent. Given this slow growth, and the government's continued failed efforts to prop up their economy by running large fiscal deficits, the ratio of government debt to its GDP has risen from only about 50% in 1995 to by far the highest ratio in the developed world, at about 170% in 2008. Estimates indicate that it could rise to over 200% by next year as the budget continues to spill red ink, and may grow even much further during the next decade. Such a large debt ratio has been manageable so far only because interest rates have been very low, at about a little over 1%. But these rates have recently been rising as concern is growing about the fiscal solvency of the Japanese government.
The danger of any explicit default on this debt is minimal since it is all denominated in the Japanese currency, the yen. Any country can reduce the real value of a debt burden in its own currency by printing money to finance a good chunk of its government spending, and thereby create inflation that destroys part of the real burden of the debt. I do not expect that to happen in Japan unless the debt burden becomes intolerable down the road.
All this is background for comparisons between Japan and the US. As Posner indicates, the American ratio of debt to GDP is now about 50%, where Japan was in 1995. It is also rising rapidly as the government continues to increase its spending on banks, the stimulus package, likely also on health care, maybe subsidizing employment of the unemployed, subsidizing mortgages, and in many other ways. The ratio of federal government spending to American GDP was quite stable at about 20% for about 40 decades, but this ratio has been rising rapidly during the past year, and it is beginning to approach 30%. The government debt is not yet a great burden because, as in Japan, interest rates are low, so that annual interest payments on the debt is not a sizable fraction of total government spending.
It is unlikely that US government spending will decline during the next decade, even though some of the short term spending on banks and stimulating the economy will probably fall sharply. Any spending declines from these directions will be more than replaced by much greater spending on Medicare, Medicaid, and other government financed health programs, on social security, and on various other entitlement programs. The direct impact on the debt burden of such budget deficits can be reduced only by higher taxes or inflation. Eventually, I do expect much greater inflation in the US. The Obama administration has also been vocal about its plan to raise taxes, especially on higher income persons, as soon as the recession is clearly over and the economy is growing again. That would be a serious mistake.
The best solution to reducing the real burden of the public debt is neither inflation nor higher taxes, but more rapid growth of the American economy. This involves lower, not higher, taxes on investments and incomes of small and large businesses. It also requires greater concern about the fact that the US is falling behind many other countries in the proportion of its young population, especially males, who receive a higher education. In addition, much greater attention needs to be paid to correcting the depressing statistic that the fraction of boys who drop out of high school has been stuck at about 25% for several decades, even though the economic and other benefits of finishing high school and going to college have risen dramatically. To its credit, the Obama administration has given high priority to improving the K-12 performance of American students, especially those from minority backgrounds.
In effect, the desirable policies to stimulate growth involve a retreat from the anti-business rhetoric that pervades Congressional Democrats and some of the top players in the executive offices, and a more pro-consumer and pro-business mentality. It is necessary to maintain the minimalist anti-trust policy that developed during the 1980s and 1990s under Democratic as well as Republican administrations, to retreat from the policy that banks and other businesses, such as GM, cannot be allowed to fail when they are mismanaged.
Desirable policies also include the elimination of efforts to restore union power in the private sector, and resistance to the desires of some members of Congress to have the US retreat from a free trade policy> They also want to impose onerous regulations on businesses of all kinds, especially the more successful ones. I am perhaps particularly disturbed by the anti-immigration rhetoric of leading members of Congress since immigrants have contributed so much to the dynamism of the American economy and society.
Sizable advances in productivity and the resulting sharp economic growth can ease the burden of growing government spending, and prevent anything like the expanding debt to GDP ratio and stagnation of the Japanese economy. Can the US do it? Certainly! Will the US do it? Not with the present composition of Congress, and with the tendency of the President to allow some of the more destructive members of his political party to get their way.
Will We Go the Way of Japan?--Posner
Japan spent the 1990s unsuccessfully trying to recover from a collapse of the Japanese banking industry caused by the bursting of a housing bubble, despite aggressive monetary and fiscal policies. As a result of those policies, Japanese national debt soared, but was financed mainly internally because of the very high Japanese personal savings rate. With its large surplus of exports over inputs, moreover, Japan accumulated dollars (and other currencies), which also reduced the debt burden. Interest rates remained very low, in part because of chronic deflation. The low interest rates stimulated the "carry trade": investors would exchange Japanese yen for local currencies in countries that had high interest rates. This is a form of arbitrage, but tends not to erase international interest-rate differences, as one might expect arbitrage to do.
Japan was hard hit by the current economic crisis, in part because of its dependence on exports. It responded with aggressive monetary and fiscal measures, as before--with what appear to be potentially disastrous results, if one may judge from data in a recent article in the Wall Street Journal(Richard Barley, "Japan: The Land of the Rising CDS," Nov. 11, 2009, p. C20). The International Monetary Fund predicts that next year Japan's ratio of national debt to GDP will be an astronomical 2.27, forcing Japan to continue borrowing heavily abroad. Interest rates remain very low, in part because Japan is again experiencing deflation. Rating agencies have reduced Japan's bond rating to AA-, yet the government, lulled by low interest rates, apparently has no sense of urgency about the country's mounting debt burden, a burden aggravated by the rapid aging of Japan's population. International financial markets believe that there is some probability that Japan will default on its debt. The "CDS spread" (the percentage of a debt that someone desiring insurance against the debt's defaulting must pay for the insurance) on Japanese government debt is almost 1 percent (.75 percent).
The United States differs in many respects from Japan, but is beginning to look more and more like it. We too experienced a banking collapse in the wake of the bursting of a housing bubble, and our monetary and fiscal responses, though aggressive, may not have been highly effective. The fiscal stimulus--the $787 billion federal spending program enacted in February--was enacted late and is poorly designed, and some think too small. And there is concern that, like Japan, we are babying our weak banks by allowing them to overvalue the assets and underestimate the liabilities on their balance sheets. The stress tests conducted last spring, for example, both underestimated the stress the banks were under (by assuming an unemployment rate--unemployment being highly correlated with bank-loan defaults--substantially lower than it became within a couple of months after the tests) and disregarded likely defaults of bank loans that will mature after 2010.
Our government, too, is lulled by low interest rates into believing that we can continue to run huge deficits without raising taxes or cutting spending significantly, simply by borrowing. Our public debt (the amount of federal government debt that is contractually obligated, as distinct from accounting reserves for entitlement programs such as Medicare and social security), of which almost half is owned by foreign governments and other foreign investors, has reached $7.5 trillion, which is more than half our GDP, and is on course to increase by at least a trillion dollars a year for the indefinite future. Like Japan, we have an aging population, which is pushing up entitlement costs. Our government seems not to have any economically realistic or politically feasible plans either to raise revenue or cut spending, but instead plans ambitious new spending programs (notably but not only on revamping health insurance). Proposed economies seem tokens. There is an air of complacency about deficit spending and public debt--again like Japan.
Because of our low inflation rate (it is close to zero) and the Federal Reserve's "easy money" policy (as a result of which our banks are holding a total of $1 trillion in excess reserves), the dollar has now become a favorite currency for the carry trade: dollars exchanged for local currencies earn interest more or less effortlessly, though not without risk. The carry trade may be a factor in the recent rises in commodity prices; indeed there is fear of additional asset-price inflation (bubbles) as a result of all the dollars sloshing around in the world economy.
Should the U.S. economy grow more rapidly than the public debt, we'll be okay. But the government's focus appears to be not on economic growth, but on redistribution (the major goal of health reform) and on creating at least an aura of prosperity, at whatever cost in deficit spending and future inflation, in time for the November 2010 congressional elections.