Abenomics has a long way to go
No easy ride to get Japanese economy back on track
Nuanced consequences of Reinhart-Rogoff austerity debate
by Andrew Milligan
Tue 30 Apr 2013
Data mistakes in research by Harvard economists Carmen Reinhart and Kenneth Rogoff have caused widespread repercussions in the debate over whether austerity can lead deficit-hit states out of recession – or whether it makes things worse. Just as many politicians and economists jumped onto the bandwagon in January 2010, when the academic duo’s ‘Growth in a time of debt’ was published, so others have seized on the critique by rival scholars to dismiss the idea that fiscal austerity is required at this stage of the business cycle.
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In truth, the situation is much more nuanced than many claim. It was always too simplistic to say that Reinhart and Rogoff ‘proved’ a direct causal effect, rather than an association, between the level of public sector debt and economic growth. Of course, there are channels in both directions. If economic growth is too slow, then a government trying – unsuccessfully – time after time to kick-start growth via inefficient public spending will raise the debt/GDP ratio. Conversely, if public debt servicing threatens to become too damaging, then a government can use financial repression to steer sufficient domestic savings towards state bonds. Ceteris paribus, a crowding out effect will lower growth. Japan is commonly held as exemplifying either channel, but there are other countries which combine a high public sector debt/GDP ratio and a very low rate of economic growth; Italy certainly comes to mind.
While Reinhart and Rogoff have been widely quoted, they are far from the only academics to endorse this analysis. Kumar and Woo (‘Public debt and growth’, IMF Working Paper, 2010), Cecchetti et al (‘The real effects of debt’, BIS, 2011), and Greenlaw et al (‘Crunch time, fiscal crises and the role of monetary policy’, US Monetary Policy Forum, 2013) are just three papers to mention. To quote Greenlaw: ‘Countries with high debt loads are vulnerable to an adverse feedback loop.’ To quote Cecchetti: ‘Beyond a certain level, debt is a drag on growth.’ Kumar showed the association of rising debt with slower growth. A key feature is to focus less on public sector debt and consider the threat to growth from overall debt levels – private as well as public. Can we explain the low level of consumer spending in countries such as the UK solely as a result of fiscal austerity? Surely we should rather point to historically high household debt levels and the need for private sector deleveraging?
In his commentary, ‘Austerity on trial in Tokyo’ (23 April 2013) Trevor Greetham argued that ‘Japan may show the world a way out of the debt trap … if, contrary to conventional wisdom, fiscal stimulus leads to economic recovery … then by implication Europe’s austerity could be shown to be the problem, not the solution.’
If only it was that easy! It must be remembered that Abenomics promoted by the new Japanese prime minister comes in three parts: a monetary and a fiscal stimulus as well as structural reforms. Even the fiscal element can be split into two: a large short term stimulus to help Abe win the upper house election this summer, before consumer tax increases in 2014-15 designed to begin reducing the structural deficit. The Japanese government has been most impressive with its vim and verve in the past six months – a positive contrast with the political headwinds facing France or Italy. However, hard battles lie ahead. Japan needs a long list of structural reforms to raise the long-term growth rate: agriculture, corporate governance, health care, innovation, labour force, service sector competition etc. A key issue is whether vested interests will prevent the execution of such a wide-ranging catalogue of measures.
As Greetham says, ‘The only effective stimulus may be fiscal’. Yet too many people are looking for a single silver bullet. The solution to a private and then public sector debt crisis requires a series of policy tools: fiscal, monetary and especially structural. We must wait to see whether Abenomics can maintain longer-term momentum to achieve success over a wider front.
Andrew Milligan is Head of Global Strategy at Standard Life Investments. He writes in a personal capacity.