The Japan Syndrome
Japan was in trouble long before anyone even imagined that the words Asia and crisis could be used in the same sentence. And the good news that has recently started to come in from its neighbors has no counterpart in the island nation, where the best that can be said is that last year's economic plunge has leveled off. If developing Asia suffered from an acute, potentially lethal, but short-lived fever, Japan suffers from a slow wasting disease, one that shows no sign of going into remission.
What is wrong with Japan, the nation that not so long ago seemed to be the heir-apparent to world economic leadership? The inefficiency of Japan's service sector is legendary. Although the country remains a formidable exporter, it has been slow to adopt some new technologies. And like its poorer neighbors, Japan has troubled banks and has been too slow to fix them. But the clear and present constraint on Japan's economy is something that would normally be regarded as a virtue: the caution and thriftiness of its consumers. Japanese households simply save more than the country's businesses can be persuaded to invest, even at near-zero interest rates. The result is that, for the first time since the 1930s, a major economy finds itself in the dreaded "liquidity trap," in which the private sector as a whole is in effect trying to accumulate cash. Since this is collectively impossible--there cannot be sales without purchases--the attempted flight to cash produces a persistently depressed economy, one that every year falls further below its productive potential.
Why is Japan in this predicament? Maybe the economy has never recovered from the bursting of the late-'80s financial bubble; maybe Japan's dismal demography (the working-age population peaked in 1997 and is expected to decline steadily for decades to come) is the key. What is clear is that policymakers have not yet found a solution.
The classic prescription for curing a liquidity trap is a fiscal jump-start: use deficit spending to get the economy moving, and hope that this gets investors investing and consumers consuming. But after years of ever-widening deficits--this year Japan will run far and away the largest peacetime budget deficit ever recorded--the economic engine shows no sign of catching, while the government's debt has risen to worrisome levels. Some economists (most obnoxiously, yours truly) have argued that Japan needs to stand the normal rules of monetary policy on their head, abandoning the goal of price stability and actually committing to a moderate rate of inflation (which would make borrowing more attractive, and holding cash less so). But the Bank of Japan remains obdurately orthodox.
At this point the Japanese government still seems to hope that somehow the situation will right itself. Massive public works programs have slowed the rapid economic decline of last year--and helped push growth in this year's first quarter to a surprisingly high annualized rate of 7.9%. But there is no sign of a genuine, self-sustaining recovery, and it is all too easy to see how things could get considerably worse. Indeed, it is alarmingly easy to see how Japan could plunge into a nasty deflationary spiral. Here's that scenario: Japanese companies finally begin "rationalizing," that is, laying off large numbers of unneeded workers; fear of unemployment makes cautious consumers even more nervous; declining spending leads to still more unemployment; and a depressed economy leads to falling prices, worsening the debt burden on corporations and making cash an even more attractive asset. And if this nightmare chain of events starts to unfold, it is unclear what Japanese officials could or would do about it. With interest rates near zero, conventional monetary policy is already as expansionary as it can get; with huge government debt and deficits, there isn't much room for another fiscal boost.
Inevitably, worries about Japan color the prospects of the whole region. This is partly because Japan is a major export market, partly because bad news from Japan would surely affect market perceptions of the whole region. But it may also be an omen, for the Japan syndrome need not be confined to Japan.
One might have expected China's economic problems to bear more resemblance to those of other low-wage economies like Indonesia than to those of its far richer and more developed neighbor. But China never caught the Asian flu, because foreign-exchange regulations prevented hot money from leaving and deterred it from coming in the first place. (Although those regulations have also fostered inefficiency and corruption.) If growth has slowed, it is because Chinese consumers--worried about unemployment as Beijing continues to reform the state sector, and about saving for retirement in an aging society (an unanticipated side-effect of the one-child policy)--are not keeping up with productive capacity. Incredibly for a developing country, China is now experiencing pronounced deflation--and is fighting it, Japanese-style, with deficit spending.
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The Asian Scorecard
The good news and bad news on the region's economies (click to open a pop-up window)
• Japan
• Singapore
• South Korea
• The Philippines
• Thailand
• Hong Kong
• Indonesia
• Malaysia
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