They say insanity is doing the same thing over and over but expecting different results. Judging from recent media reports, you would have to conclude that Japanese governments are insane.
Japan has been trying for years to rekindle growth and boost inflation. In 2014, however, it raised its consumption tax to 8% from 5% and the economy tipped into recession. Last October it raised its consumption tax to 10%; the economy shrank at an annualised rate of 6.3% in the fourth quarter of 2019.
Commentators accuse Japan of attempting fiscal suicide. The American economist Paul Krugman, already having characterised the 2010s as a decade of misguided global austerity, took to Twitter to accuse Japan of ‘destructive austerity policies’. According to him, Japan chose to tighten its belt and wallow in economic misery when looser fiscal policy could have boosted prosperity.
This sounds insane. But let’s take a step back.
Japan’s per capita GDP growth underperformed both the US and Germany during the 1990s and 2000s, but caught up with them in the last decade. In terms of living standards, Japan has lost ground to the US, but so have other countries.
Between 1990-2019, Japan’s per capita income fell to 70% from 83% of US levels; but France lost almost as much ground and Italy fared a lot worse. Japan is in the same league as France and the UK, just as at the start of its ‘lost decades’. Yet we don’t talk about lost decades for either France or the UK.
Japan’s government deficit has averaged 6% of GDP for the past 20 years. The much-maligned Maastricht benchmark for euro area members is 3% and the current 5-6% level in the US has already raised concern.
The debate on government deficits is politically charged. The same fiscal deficit can be ‘reckless policy’ or ‘responsible stimulus’ depending on which party is in power.
Regardless of political views, an average fiscal deficit of 6% of GDP over 20 years hardly signals ‘destructive austerity’. It also means debt piles up. Japan’s public debt now nears 240% of GDP, far higher than any of its G7 peers. The high debt ratio is the reason why the country is trying to lift inflation.
Japan’s real per capita growth, while somewhat disappointing, has not been an outlier. Given the adverse demographics, however, overall real GDP growth has underperformed. And because of low inflation, overall nominal GDP growth has lagged far behind everyone else. Over the last 25 years, US real GDP has grown on average two and a half times faster than Japan’s; US nominal GDP has grown nine times faster.
The country’s debt is largely held by domestic investors, traditionally a stable demand base. A growing number of economists argue that interest rates are likely to remain low for a long time, and that countries should take advantage of this to borrow even more. In 2007 many economists believed the global economy had reached a ‘great moderation’ and would never again experience a deep recession. It’s prudent to acknowledge that economists might be wrong again.
Japan’s aging population will cause pension and healthcare costs to rise. Should debt servicing costs start increasing, it could put debt sustainability at risk. Reducing the debt ratio is a good idea. The best way to do it would be through faster growth, and under Prime Minister Shinzō Abe, Japan has boosted structural reforms. These have helped, but they have not been enough. That is why the government has been striving to reduce its fiscal deficit.
Tokyo’s lesson is not that austerity kills growth; it’s that even 20 years of loose fiscal policy are not enough to sustainably boost an economy. For all the populist rhetoric against austerity, you can’t rely on loose fiscal policy forever – the bills eventually come due.
Marco Annunziata is Co-Founder of Annunziata + Desai Advisors and a Member of the Board of Advisers on Information Technology at Japan’s Ministry of Economy, Trade and Industry. This article was originally published here.