Transcript | 7. lecture: Japan’s Crisis - University for modern Slovakia

In the previous lecture we showed that the Austrian School sees the major cause of crises and business cycle lying in the manipulation of money's value and volume by central banks. At the same time, it claims that governments hinder markets from cleaning up during crises, thus prolonging them. Or it replaces one bubble by another, usually even worse that sooner or later also burst. A very apt example of such government behaviour and consequences thereof is Japan.

Japan experienced a huge boom especially during the fifties and sixties, but also partly during the seventies and eighties. High economic growth, increase in competitiveness, penetration into global markets with steel industry, later in automotive and electronic industry. In seventies and eighties, almost no one doubted that at the turn of the millennium, Japan will be the world's best economy.

Opinions varied about the cause of this growth. Most authors thought that it is the strong government regulation policy, system of state-supported strategic sectors and strong link of policies between firms and banks that fuel this growth. Today, when the first ten years of the new millennium are behind us, the forecasts of Japanese economy have yet to be fulfilled. What happened? How is it possible that the Japanese economy is balancing at the edge of recession for over twenty years and is not using its potential?

In the eighties, there was a huge bubble in Japan. Real estate prices had risen to astronomical heights, in a short time the stock and land prices tripled. At the beginning of nineties, the share capital of Japan (total value of all shares of firms and companies) was twice as much as share capital of the United States, country with twice as much population and GDP. And then the bubble burst in a spectacular fashion. Stock exchange (Nikkei Index) collapsed from 40k in 1989 to 15k in 1992, real estate prices fell by 80% between 1991 and 1998. Since the outbreak of the crisis, the Japanese government did all it could to hinder markets from cleaning up and to maintain the existing structure of the economy. Interest rate was reduced to zero by the central bank, the Bank of Japan, and the government pumped money into the economy through various economic rescue packages. Only during the nineties, ten rescue packages were implemented worth 100 trillion yen. The government bailed out banks and businesses, mainly in construction and heavy industry. Anyway, the most affected businesses by the crisis corresponds with the Austrian School, which claims that artificial credit expansion leads to unreasonably high investment in capital-intensive industries.  

When low interest rates and bailouts failed, the Japanese government embarked on implementing massive public investments, exactly along the lines of Keynesian School. It built senseless and unnecessary infrastructure projects and literally poured the country with concrete. Krugman aptly describes it: In 1996, Japan's public investments relative to GDP were four times higher than those in the United States. Japan poured as much concrete as the U.S. into their country, even though they do not even half the U.S. population and only four percent of U.S. territory.

Around 2003, the Japanese economy began to show some signs of recovery, which was mainly due to an increase in exports. However, the recovery was only temporary and weak, the growth again declined in the next years to minimum values. The only really visible effect of the massive stimulation and interventionist policy, is the astronomical increase of public debt. The debt along with various "off-budget" funds peaked at 200% of GDP and has become a huge burden of the Japanese economy. Japan is now the most indebted country among the developed countries.

The Austrian School believes that everything, what the Japanese government has made in its twenty years-long fight against recession, was virtually entirely against the beliefs of the school. Huge resources are thus trapped in a bad structure of the economy and are missing in other sectors and activities that could move the country forward. What is the opinion of the opponents? Even Krugman acknowledges that one of the reasons that inflated the bubble was that "Japan's banks lent more, with less regard for quality of the borrower, than anyone else's. In so doing they helped inflate the bubble economy to grotesque proportions". Krugman, however, does not see a problem in the central bank monetary policy, but in the fact that at the beginning of the eighties, bank regulations and criteria for obtaining banking licenses were relaxed, which significantly increased the risk of moral hazard.

Krugman does not see a problem in the different state interventions, through which the Japan's government tried to combat the recession. He claims that it would be much worse without them. He sees the main problem in the so-called liquidity trap. According to Krugman, the main government's role during a crisis is to maintain the employment and use production capacities, and that the most important governmental instrument is to print more money. However, the Japanese government was doing that, its central bank reduced the cost of money to zero and it still did not help. Krugman and Keynesian are sure about what is needed to be done, I paraphrase: The classic response associated with the name of John Maynard Keynes is that if the private sector is not spending enough to maintain full employment, public sector must seize initiative. Let the government borrow money to use them to finance public investment projects and provide jobs for people so that they can spend earned money, leading to a creation of more jobs and so on. The Great Depression in the United States was ended by a massive, deficit-financed public works known as World War II. Why not try to start the growth in Japan by its peaceful alternative.

Well, the Japanese tried that as well, as we mentioned above, to no avail. Krugman, however, does not give up. Fortunately, he does not propose a war; he claims that according to certain theories, the country could fall into the liquidity trap because of weak banking sector. Even this, however, Japan tried to address in 1998 by pouring money into banks, in the total amount of 500 billion USD. It did not help; the liquidity trap was still prevalent.

So Krugman played his last trump, he said that Japan actually needs inflation, I paraphrase: The only thing that can pull the economy out of the liquidity trap is the expected inflation, which deters people from accumulating money. Once we take seriously the liquidity trap - and the Japanese example clearly shows that we should take it seriously - then we cannot avoid the conclusion that the expected inflation is a fundamentally good thing because it helps to get out of this trap - end of paraphrase.

Again, probably not a coincidence that the Austrian School point of view is vastly different. The Austrian School has always regarded inflation to be harmful and the so-called growth deflation to be the natural and desirable situation, which would have existed if the interest rates and money supply were not distorted by central banking and fractional reserve system.