Tuesday, February 10, 2009

The accounting reaper cometh (Noah Smith)

A specter is haunting East Asia. Consumption is falling in the world's "deficit" countries, as American and British consumers rebuild their balance sheets. The global current-account and capital-account imbalances are thus coming under immense strain. An accounting identity states that for the imbalances to vanish, one of two things must happen in the "surplus" countries: either consumption must rise, or production must fall. In layman's terms, Japan has for at least a decade been making more stuff than was efficient for it to make. Now either Japanese people must buy more of the stuff, or make less of it. As one of the two big rich "surplus" countries (the other being Germany — the Axis of Overproduction?), Japan will not be able to escape the adjustment. It is too big to continue to overproduce and hope that some other overproducer will start overconsuming.

The optimal solution, as most international economists have stated, is for China, Germany, and Japan to boost their fiscal sending by huge amounts — much more than America — to increase domestic consumption. China is already doing this. Germany, for reasons that I won't go into, is not. That leaves Japan.

The smartest way for Japan to raise consumption would be to expand social security and unemployment benefits. People plan for the future (they base much of their consumption on their "permanent income"), so government spending that is guaranteed in perpetuity is more effective at getting people to spend now — otherwise they may just squirrel their money away to guard against future tax increases. But thanks to its massive debt overhang and low birthrate, Japan will find it had to do either of these. The dead hand of the 90s reaches up from the grave to throttle our best hope of escape.

So what will happen in Japan? Gravity. Japan will fall to something closer to an efficient long-term production level. This means jobs lost, whether it's the cushy full-time type or the hand-to-mouth Dickensian temp type. It will mean big losses and industry consolidation — farewell to a few more of the corporate baronies of Japan's old entrepreneurial families. It will mean more angry street protests from the laid-off temps and more lonely suicides from the laid-off lifers. More divorces, fewer children. A spiral of lower consumption and higher unemployment. Empty apartment buildings, higher petty crime. Yakuza and foreign mafias taking over more neighborhoods. More teenage girls and married women turning to prostitution in the soaplands and deri-heru services, sometimes pushed by their parents and husbands. Families squatting together in cramped conditions. Rural ghost towns. Heat shut off in buildings in winter, people accidentally dying of malnutrition from eating cup ramen too many days in a row.

Accounting looks pretty ugly in real life.

And the thing is, there is very little Japan's government can do about this. For too long, Japan has pretended to be a richer country than it is, not unlike how American consumers used easy credit to pretend they were richer than they were. In fact, that same American deficit spending, funneled through exports or through China, was what kept Japanese wages and profits above what production-efficiency dictated. The bill has now come due; Japan must wash off its makeup, take off its go-go boots, and stagger out the back of the dance club. And this is a sad thing. Those whimsical economists who have studied the phenomenon of "happiness" — myself included — have generally found that happiness comes to people who are coming up in the world. Someone who makes $50,000 when last year they made $40,000 is more likely to be happy than someone who makes $100,000 but who last year made $110,000.

Japan, sadly, chose the short-term illusion of wealth over the chance to climb higher in the future. They chose it when they pulled the lever for the LDP.

But I'd like to end this dreary litany with a little hope. Falling back to an efficient level of income will be painful for today's Japanese people, but it had to happen. After this crash — the recession Japan should have had in the 90s — Japan will have nowhere to go but up. Leaner, more profit-driven companies will start looking for hires — hopefully something between the full-time and part-time positions of today. Women will find themselves on a more level playing field. There will be room for new industries, new entrepreneurs who are not the first sons of old entrepreneurs. Researchers will invent new technologies, and start companies to sell them — the nerds will win out. And if Japan changes its political system now...if it lays the pipes for a workng social safety net...if it dramatically cuts bureaucratic meddling...if it modernizes its corporate governance and legal system...then the rebound will be deep and lasting.

That is why right now, in the depths of Japan's despair, is the most important time to elect new politicians who focus more on building the future than preserving the past. Accounting says nothing about the day after tomorrow.

— Noah Smith


David said...

And I thought it was hard to find anyone more pessimistic than me concerning the huge problem now imminent---or here--for Japan.

I have to say that I hope you are wrong, but I suspect that you aren't too far off.

Bryce said...

Nice, but are Japanese savings rates really that high these days. I thought the tenet that "Japanese people save more than everybody" really only applied to the high-growth period.

Noah said...

Bryce - You're right, Japan's household savings are not that high anymore (though still much higher than those of Americans and many other net importers of Japanese goods). But Japanese businesses have been sitting on a lot of cash, and a lot of households have been doing their saving by buying foreign assets (the carry trade). Japan's government also bought a ton of foreign assets in 2004 to hold the yen down.