Wednesday, February 6, 2013

Global Ecomomy: Japan and the race to the bottom

by Michael Roberts

There are three tools of pro-capitalist macroeconomic policy: fiscal, monetary and currency.  There is total confusion among mainstream economic advisers on which of these policy tools is best to use to get capitalism out of its depression.  Monetarists like Ben Bernanke are wedded to cutting interest rates and ‘printing’ piles of money.  Keynesians want to go further: they want to reverse neo-liberal fiscal austerity measures and let the government spending ‘multiplier’ work its magic.  And some, less vocal, advocate the benefits of devaluing the currency to boost exports. 

Well, the newly elected Japanese government has gone for all three ‘solutions’ at once! Japanese economic growth has been stalling. The government’s answer is to add yet more fiscal stimulus to the economy, to pump in yet more liquidity and now to drive down the value of the yen against the currencies of its major trading rivals.   That’s particularly important for Japanese capitalism, which relies on exports and investment for any marginal improvement in growth. 

In just two months, the yen has depreciated by as much as 20% against the dollar from its peak.  This was necessary, in the minds of the Japanese, because the yen had been left behind in a ‘race to the bottom’ for the major currencies since the Great Recession began.   At one point, the yen had appreciated in real terms (taking into account relative inflation rates) against the currencies of its trading rivals by 30-40% since the Great Recession started.  Over the same period, the UK pound had dropped 25% and the euro by 10-15%.  Even the currencies of faster-growing emerging capitalist economies had not moved up.

Are these Japanese measures likely to work?  Keynesian guru, Paul Krugman, is doubtful (  For him, Japan’s problem is a monetary one, namely that Japan is in a classic Keynesian ‘liquidity trap’ where near zero interest rates do not restore investment or spending because ‘debt deflation’ is in operation.  What’s needed is a huge fiscal stimulus.  “Here’s my take. Japan has pretty much spent the past 20 years in a liquidity trap; as I’ve been explaining for years, one way to understand such traps is that they happen when, even at a zero real interest rate, the amount that people would want to save at full employment exceeds the amount they would be willing to invest, also at full employment…  What you need in this situation is a negative real interest rate — which means that you need some expected inflation, because nominal rates face the zero lower bound. “

So the answer is more fiscal spending and monetisation to increase inflation deliberately.  Indeed, that’s what the US government should be doing as  well.  “Oh, and what about the US relevance? We are, for the time being, in the same situation. What I think you can argue is that because we don’t share Japan’s demographic challenge, our liquidity trap is probably temporary, the product of an episode of deleveraging. So in our case fiscal stimulus is much more likely to serve as a bridge to a revived era of normal macroeconomics. That said, I welcome efforts by the Fed to modestly raise inflation expectations, and would like to see more.  … it’s a tale of fiscal and monetary policy that have been too cautious, not of stimulus that failed.”   And it seems that outgoing chairman of the UK’s Financial Services Authority has also adopted a more Keynesian/Krugman turn, when he advocated in an FT interview that there were occasions (like now) when central banks should ‘monetise’ government debt by ‘printing money’ in order to boost an economy.

Interestingly, another Keynesian who would usually agree with Krugman seems to reject this explanation of Japan’s stagnation and Krugman/Adair solution.  Martin Wolf, the FT columnist, points out that Japan has had plenty of ‘fiscal stimulus’ over the years and it has done little to get Japan’s economy going ( 

And monetary stimulus and yen devaluation to cause inflation won’t work either because the problem is not deflation, as Krugman argues, “The persistent fiscal deficits and deflation are a puzzle. A standard explanation is that they are due to a mistake in monetary policy. If the central bank had avoided deflation, real interest rates could have been negative, making private investment and consumption stronger. I agree that this would have been helpful. But I disagree that deflation is the underlying cause of Japan’s ailment.”

So what’s the problem, according to Wolf.  Well it’s that Japanese industry is profitable but unwilling to invest.  “So what is that underlying cause? “Excess private savings” is the answer or, more precisely, a huge structural excess of corporate gross retained earnings over investment”.   There is some truth in Wolf’s view.   Over the last two decades, Japanese industry has not been investing nearly as much of its rising cash flow back into the real economy.  So the economy has struggled.

Japan’s capitalist sector, just as in other major capitalist economies, is not stepping up to the plate and investing in plant, equipment and employment to restore economic growth.  But the explanation for this also lies in the profitability of the Japanese corporate sector.  From 2002, Japan’s rate of profit rose 60% (blue line, left-hand scale below) while investment stayed pretty flat (red line, right-hand scale).  In the Great Recession,  profitability plunged and along with it, investment.  Profitability has now recovered, but it remains below the 2007 peak, so investment remains very much in the doldrums.

Wolf calls for these ‘excess savings’ (i.e. profits) to be taken away from the corporate  ‘oligopolies’ and used for the greater good: “the key to a better-balanced economy is taking the vast surplus profits away from a corporate oligopoly that has proved unable to use them. Corporate financial surpluses that end up in vast fiscal liabilities must be trimmed.  Let the public enjoy the income instead.”  How is this to be done?  Wolf proposes to raise corporate taxes, not cut them, shift profits into dividends for shareholders to spend and raise wages.  But these proposals would be anathema to the capitalist sector and will therefore fall on deaf ears.  And they would not work because profitability would fall back again.

Instead, the Japanese government is now looking to devalue its currency and inject inflation into the economy as a way of restoring growth.  This is very much in the tradition of the ‘beggar-thy-neighbour’ policies of the 1930s as it is of any Keynesian alternative.  The aim is to steal back world market share by making Japanese exports cheaper in world markets.  That’s why French prime minister Francois Hollande piped up yesterday to say that the Eurozone “must have an exchange-rate policy.  If not, it will be subject to an exchange rate that does not reflect the real state of the economy… we need to act on an international level to protect our own interests.” French capital is worried by the strength of the euro because French exporters are not performing as well in world export markets as German capital.  Thus, the response of Germany’s economy minister, Philipp Rostler was that the aim should be “strengthening competitiveness rather than weakening the currency”.

Historically, devaluation does not work for long as it leads to other governments adopting the same policy in a race to the bottom.    And there is little evidence that a weaker currency will help get better growth.  Look at the record of the last five years since the Great Recession.   The biggest depreciation in currency value since 2007 has been with the pound and the euro, but average real GDP growth has been negative over that period for them. The US dollar has appreciated and yet the US economy recorded a slightly positive growth rate in the period.  The yen appreciated dramatically, but Japan still had a better growth rate than the Eurozone or the UK.
What about in the period of global economic recovery since mid-2009?  Has devaluation helped?  All major economies have grown a little since the trough.  The US dollar has depreciated and growth has been over 2% a year.  But the euro has depreciated even more and growth has been less than half the US rate. The yen and the currencies of emerging economies have appreciated but real GDP growth has been passable.
Fiscal austerity has not worked; indeed, it has made the situation worse.  But neither has fiscal stimulus where it has been applied, as in Japan (I refer you to my post, The smugness multiplier for the evidence on that,

The Keynesians say that it has not been applied hard enough and needs to be combined with a depreciation of the currency and even a boost to inflation with monetary injections.  In other words, try all three tools of capitalist economic policy at once.  That is what Japan is now doing.  We shall see if it succeeds.

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