WASHINGTON, July 25 (UPI) -- Commentators writing about the Japanese economy in the last three to four years have developed a habit of simply recycling their old columns: Japan is always beset by deflation and deepening recession, because of lack of so-called reform, excessively tight monetary policy and disasters in the banking system. Meanwhile, strong growth in the United States and the rest of the world is no more than two quarters away. The reality is quite different.
When Japanese Prime Minister Junichiro Koizumi took office two years ago, I was optimistic, writing "Time for Warren G. Koizumi," on April 25, 2001. There is no question that Koizumi has not lived up to the high standards of U.S. President Warren G. Harding, cutting taxes, reviving public business confidence, and helping the country steer out of a deep recession. Yet complaints that he has not "reformed" miss the point: precisely what were the "reforms" supposed to achieve?
Contrary to most received opinion, the main problem in Japan in 2001 was not the banking system, nor the "excessively tight" monetary policy of the Central Bank, but the relentless growth during the 1990s of the Japanese public sector, whose share of GDP rose from 28.87 percent in 1989 to 37.56 percent in 2002.
Meanwhile, Japanese spending on public infrastructure such as roads, bridges was 6.5 percent of gross domestic product in 2001, more than twice the level of the second highest infrastructure spender, France. In spite of interest rates that were at record lows on a nominal basis for several years, Japanese government debt spiraled to 140 percent of gross domestic product, producing a severe excess of liquid investments, directly and through the banking system, for Japanese private savings, and thereby depressing private sector investment. Even those savings themselves began to decline, as demographic changes and increased competitiveness in Japanese retailing produced an increase in the Japanese propensity to consume and a sharp decline in its historically very high savings rates.
The shift in Japanese retailing has been very significant indeed. Shortly after The Economist magazine first produced its signature Big Mac index, in 1989, the Japanese yen, at 145 yen to the dollar was 38 percent overvalued against the dollar, by the index; a Big Mac cost 38 percent more in Tokyo than in New York. This overvaluation increased to 100 percent by 1995, at which point the yen touched its all time high of 80 yen to the dollar. Today, at 119 yen to the dollar, it is by the Big Mac index 19 percent undervalued compared to the dollar; a Big Mac is 19 percent cheaper in Tokyo than in New York.
At first sight, this is very strange. The yen has appreciated by about 18 percent against the dollar since 1989, at a time when inflation in both countries has been modest, yet a Big Mac has moved from being 38 percent more expensive in Tokyo to 19 percent less expensive.
The explanation for it is not the alleged evil monster of deflation, or at least it is only deflation in the purely technical sense of prices dropping. The Japanese distribution system was in 1989 the most inefficient in the developed world, particularly for foreign goods, with layer upon layer of importers and wholesalers each charging a markup on the goods that moved through their hands, and price competition at the retail level being hopelessly restricted by the highly protectionist Large Scale Retail Store Law. Consequently, an item such as the Big Mac, which was partly imported, partly sourced from inefficient Japanese agriculture, and wholly distributed to the consumer through retail outlets, was far more expensive in Tokyo than it needed to be. Any foreign visitor paying a Japanese restaurant bill in the 1980s will confirm this; the place was outrageously costly, through excessive costs at all levels including and notoriously the real estate on which the restaurant rested, which was so expensive that the Emperor's palace grounds in central Tokyo were in 1989 worth more than the entire state of California.
All that has now changed. Japanese distribution systems have been greatly liberalized, the Large Scale Retail Store Law is gone, and goods and restaurant meals in Tokyo are consequently no more expensive than in any other large, crowded city. Of course, measured by the retail price index, this has produced deflation, technically. But it is a deflation that is wholly beneficial for the consumer, who has been allowed to enjoy, without any great increase in his remuneration, an enormous increase in his standard of living, to fully western levels. The deflation has not produced high "real" interest rates to exporting companies, the prices for whose output have been increasing at approximately world levels, taking into account the exchange rate movements of the yen. They have produced high real interest rates to consumers only to the extent that such consumers were foolish to spend money early through their credit card, when they could have bought the goods more cheaply later as prices declined. Only in real estate have consumers and business suffered from high real interest rates, as real estate prices have deflated from their insane levels of 1989 to levels that, while still high by international standards, reflect only the normal premium one would expect for location on a small, heavily populated and wealthy archipelago.
The consequence is that the structural problems that have been holding back the Japanese economy, and the reforms that were needed in order to make it return to growth, have since 1998 or so been pure bunkum. Banks had a lot of bad debts in the early 1990s, because they lent against real estate at excessive values. However, they are not generating new bad debts now, except to the extent that a sluggish economy pushes more companies into financial difficulty -- imagine, for example, what Citigroup's balance sheet would look like after 13 solid years of recession and deflation. Companies such as Daiei, the supermarket chain that went bankrupt in 2001 are not operationally unviable, or put out of business by superior competition; they are made less profitable by the greater competition in retailing, and their debts are excessive because they paid too much for real estate in the 1980s boom. But their operations are still perfectly efficient, at the frontier of Japanese retailing, and at 80 pen on the yen, or 50 pen on the yen, their debts can be serviced without difficulty. Banks lending to Daiei are in no danger of becoming either insolvent, or of failing to make profits going forward, they just need to recognize reality in valuing their Daiei-related assets.
By 2001, with the revolution in Japanese distribution largely complete, as demonstrated by the Big Mac's healthy price discount in Tokyo, all that was needed for Japan to recover was for the government to stop spending money, stop absorbing more and more of the nation's new resources that economic growth produced. Koizumi has been unheroic in this area, but he has at least turned a deaf ear to the siren songs of Keynesian reflation through government spending, that would have made things very much worse. The Japanese equity market bubble is fully deflated (unlike those in the U.S. or Europe) so that there is now no further drag on the economy to come through further asset price deflation in stocks, and not much to come in real estate.
The Japanese economy is now poised to move forward. By U.S. standards, its rate of GDP growth may appear unexciting, for demographic reasons -- unlike the U.S., whose population is growing by about 1.2 percent per annum, thorough births and immigration, Japan's is shrinking, by about one percent per annum, because of tight immigration policies and a low birth rate. But for the Japanese people, this is a good thing; it means that a 2 percent per annum growth rate in the Japanese economy can in the long run translate into a 3 percent per annum improvement in Japanese living standards. And of course, with low immigration, the social tensions of immigration are also very largely absent, with violent crime rates in Japan far lower than those in the U.S. or Western Europe.
As usual, the pundits have got it precisely wrong. It is the U.S. and Western Europe that are due to spend the rest of this decade mired in unpleasant recession. For Japan, the rising sun is once again about to shine.
