Free Markets, Free People

Japanese “Lost Decade” Redux

It certainly seems like it. Reason magazine finds the current way the US is addressing the economic crises to be pretty familiar:

The scenario was eerily familiar. A long real estate bubble that had expanded extra rapidly for the previous five years suddenly burst, and asset prices came crashing back down to earth. Banks and financial institutions were left holding piles of worthless paper, and the economy soon headed south. The national government responded to the crisis by encouraging more lending and spending previously unfathomable amounts of money on public works projects in an effort to stimulate consumer spending and restart growth.

Of course that’s where we are now and what that led too in Japan has come to be known as the “lost decade” (now three decades old).

One of the things we’ve pointed out is there is an element within this model that both Japan and now the US has used that is focused on “pain avoidance” (GM and Chrysler are prefect examples of that). Part of that is driven by the belief by those in power that the government can address problems within markets and lessen the impact. The second part of that, of course, is by convincing the public that’s the case, they then have to try to do what they claim they can do. But the law of unintended consequences has a bad habit of pushing its way into such situations and turning them sour:

The Japanese experience shows that when the government is an active participant in the market, many firms would rather accept state support than initiate the inevitable financial reckoning. Such a status quo does not provide a sustainable foundation for the economy. Instead, it restricts economic growth and creates a cycle of stagnation.

A friend, talking about the recession and eventual recovery, said that we’ll come out of it “okay” because “Americans are neurotically productive”. True. But so are the Japanese. While we have a fantastic workforce which is among the most productive in the world, even they won’t be able to overcome restricted economic growth caused by the government’s deep intrusion into various markets.

Comparing Japan’s reaction to the US reaction in similar circumstances is instructive:

When a recession began to set in after the 1990 stock market crash, Japan responded by reversing its tight money policy, cutting rates to 4.5 percent in 1991, 3.25 percent in 1992, 1.75 percent from 1993 to 1994, 0.5 percent from 1995 to 2000, and as low as 0.1 percent in September 2001.

A similar pattern took place in the United States. From 2000 to 2002, the Federal Reserve slashed the target discount rate from 6 percent to 0.75 percent. Fearing irrational exuberance, to borrow Alan Greenspan’s famous phrase, the Fed then raised the rate as high as 6.25 percent in June 2006. But now that the bubble has burst and the economy contracted, the Fed has cut the discount rate 12 times, lowering it to the current 0.5 percent. Federal Reserve Chairman Ben Bernanke has repeatedly stated that he sees interest rate cuts as a way to “support growth and to provide adequate insurance against downside risks.”

In both the Japanese and the American cases, post-bubble policy makers believed that lowering interest rates would make credit easier to obtain, thus recreating the environment that had spurred economic growth to begin with. But this meant that the supposed cure for a bubble created by easy credit was to extend even more easy credit.

These rate cuts only perpetuated the distortion of economic decisions and prevented savings, investment, and consumption from realigning with true preferences, as opposed to the illusory ones created by easy credit and artificially low interest rates. The lesson is that when monetary policy is used to “smooth” or “tweak” the market, it inevitably causes unintended consequences that in some cases can be very damaging to long-term economic growth.

Of course it is hard to say what future growth might be had the US government not done what it has done. But again, using Japan of that era vs. the US of that era, the difference is between 1.3% growth on average vs. 3.5% growth here. In economic terms that is a huge difference.

Reason also does a nice job of dismantling the “failure of regulation” argument. As they point out, what must be examined is how the regulatory environment then in place spawned the crisis vs. the claim that not enough regulation was in place.

For instance, government housing policy of the era:

The push to expand homeownership had two big effects. First, it greatly increased the number of buyers, driving up housing prices. Second, it provided mortgages to a large number of people who had a high risk of default.

That policy was further enabled by the capital reserve requirements which, in effect, encouraged heavy lending and an insensitivity to risk. Instead of admitting that and understanding that such policies are dangerous, the reaction has mostly been to ignore that and shift the blame to the private sector with calls for “more regulation”.

And then, going back to the “pain avoidance” point (justified as “too big to fail” by the government), what has happened is, as in the case of GM and Chrysler before the bankruptcies, government propping up failed businesses:

The Bank of Japan tried to ease economic pain by loaning large amounts to businesses. But the attempts to recapitalize the market ignored underlying management problems in the dying firms. It was a costly mistake. Intense lobbying from special-interest groups representing various sectors of the Japanese economy perpetuated the ill-fated loans and funneled government money to zombie businesses.

The United States has already begun to copy this policy, lending billions of dollars to financial institutions and auto companies and buying up billions more in bank equity in an effort to recapitalize the marketplace. The effect has been to keep poorly managed firms alive with taxpayer money.

Had they been allowed to fail and go through the reorganization process, those problems would have at least been addressed. They haven’t, at this point, in most of the financial sector and in the auto sector, it remains to be seen.

Of course the government’s deep involvement in these sectors and businesses sets up a natural conflict of interests. While a business is market oriented, and takes signals from consumers, governments are agenda driven and politically oriented. And it then comes down to a matter of incentives. In the first case the incentive of a business is to serve its consumer base. But that’s not the case with politicians necessarily, is it?

Lawmakers’ incentives are to serve their constituencies or their own political careers. This can put them at odds with the businesses they are suddenly attempting to manage. The more the government is involved in directing business activity, the less likely those firms will succeed in maintaining long-term growth, and the more likely they will turn into Japanese-style zombies.

While we’d like to believe that lawmaker’s constituencies consist of the people in their state or district, in reality they consist of special interests who help keep them in office. The ability to deliver to those special interests and keep their support and dollars flowing is just to much to resist for most.


Studies from Okimoto’s center and the Bank of Japan concluded that data revealing the scope of the economic malaise were suppressed and that regulations were developed with governmental interests in mind.

Given how the discussion has been driven here by the likes of Barney Frank and Chris Dodd, there’s little doubt that regulations will be “developed with governmental interests in mind”.

In reality it all comes down to power, or the illusion of power, and politics. Short-term politics with no real eye on the future impact of actions taken today. And these actions are based in a false premise that the market is not self-correcting and that it must be both controlled and tweaked by government.

Japan bought into that premise, and so has the US:

The principle of creative destruction—the economic mutation that continuously breaks down old forms and creates newer, more productive and efficient ones—was ignored in the hope that legacy corporations could somehow save Japan. From Wall Street to Detroit, under both George W. Bush and Barack Obama, the American government has been equally unwilling to let once-formidable companies fail.

And that, in my opinion, will see us repeat the Japanese experience, despite the small glimmers of hope we’ve been seeing in the reports in recent days. This isn’t about short term increases in home sales and construction spending. This is about the long term economic health of our economy.

Unsurprisingly, I’m not seeing moves by the government that work toward the most positive outcome in that regard.


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9 Responses to Japanese “Lost Decade” Redux

  • Combining economic policies that mirror the Japanese experience with an Administration that is more concerned with the perpetuity of power and you have a recipe for another 30 year long lost decade – American Style.

    • 30 years makes for a lost generation.  Just providing a little truth in advertising (and perspective).

  • Spain probably had the most innnovative and successful banking regulations for this current crisis where banks had to save more capital in good times just for such a situation.

    There housing bubble is larger than ours and unemployment is skyrocketing.

    The idea that any one factor could have prevented this crisis by simply regulating it is false. Sure no-doc/lo-doc regs in California (not exactly GOP central) were dumb, but so was Fannie Mae and Freddie Mac.

  • okay my but should have been creating CDO’s that could not be clearly understood and creating off balance sheet entities, etc. Or allowing entities “too big too fail” to exist.

  • Spain probably had the most innnovative and successful banking regulations for this current crisis where banks had to save more capital in good times just for such a situation.

  • The central problem is that we all (naturally) want to avoid pain, whether due to the “bust” parts of the business cycle or criminal activity, and so we tell our government to devise laws and regulatory schemes to try to avoid the pain.  Unfortunately, the market is so large and complex that, to a large extent, it defies regulation.  Criminals will always exist.  Hence, the laws and regulations always fail at some point, leading to more and more and more in a vain attempt to hold back the tide.

    I don’t suggest that we need NO laws, but I do say that they should be limited to punishing actual criminal behavior and requiring standard business practices that help prevent criminal behavior in the first place.  Laws, regulations and fiscal schemes aimed at eliminating or even smoothing the business cycle are ultimately harmful as they lead to politicized meddling in the economy, with arguably worse consequences for everybody than if we simply let the market regulate itself.  In order to avoid the pain of bankrupt banks and auto companies, we’ve spent billions in bailouts so far and we can expect more to come; this will cause prolonged pain in the form of higher taxes, a lengthy period of low (or no) growth, and an increasingly intrusive government.  It would be better to let the big companies fail and deal with a period of possibly VERY bad times rather than have a long (perhaps endless) period of raiding the treasury to prop up zombies and pay an ever-increasing army of regulators and “czars”.

  • There is some perspective comparing the current times to the depression.  For a good read, try Misha’s economic analysis of the 1 st Quarter report (4-22-09).  The fact is that the crisis may have started as early as 1987.  The government (the Fed) discovered then that it no longer had interest rate pricing without severe consequences to the economy.  With politicians scared of the consequences, each successive increase in interest rates was followed by a disastrous crash, causing the money velocity to increase.  Money Velocity peaked in 1997.  It has come down as a result of banking deregulation, but at the transference of huge amounts of risk from the banking system to the government.  This is the crux of the problem now, in order for growth to return, money velocity much crash from the present 1.8 to around 1.2 an implied crash in GDP of  34%.  If you reflate by printing money, you can make the crash less painful, however, that has not been tried successfully.  That is the present Japanese approach, as well as, the Roosevelt/Hoover Depression era approach. 
    Could it be that the Fed of 1929-1932 actually got it right (by raising nominal interest rates and allowing banks to fail!) and everybody else goofed?  That is the question for this generation to answer and figure out.  The next question we need to answer, is why the government was left with so much risk on their books?  The answer to that one is easy, as long as marginal tax rates on the rich remain high, the only way they’re willing to pay these rates is by passing risk to the government.