Does Japan Still Matter?

In the last issue of The International Economy, respected Washington journalist Owen Ullmann wrote that Treasury Secretary Lawrence Summers has been less strident than his predecessor Robert Rubin in pressuring Japan to grow its economy: "Rubin worried that Japan's prolonged slump jeopardized the global economy, and he became increasingly frustrated by Tokyo's lack of action.... Now that he's in charge, Summers has occasionally lectured Tokyo officials on ways to improve their economy, but he doesn't harangue them to change because he does not share Rubin's belief that a vibrant Japan is essential to the world's economy." How important is a full Japanese recovery to the health of the global economic system ? Or has the Japan macroeconomic card been overplayed?

We've been mesmerized by Japan for too long.

SAMUEL BRITTAN Principal Economic Commentator, Financial Times, London.

No one country is "essential" to the health of the world economy. The USA most nearly meets the bill. Japan does not do so at all. Japan makes up less than 18 percent of the OECD GDP and just over 14 percent of world GDP.

It is also a much more self-sufficient economy than generally realized. Japanese imports are less than 8 percent of OECD imports and only 5 percent of world imports. These are WTO estimates. Other ways of compiling the figures might lead to slightly different results, but are unlikely to change orders of magnitude.

Perhaps the most important ratio is that of Japanese imports to world GDP, which comes to one percent. It is changes in this relatively modest total that could add or subtract from world demand and thus worsen a world recession or sustain a world upturn.

There is another aspect. The U.S. punches above its weight because it is the world's most important financial center. Wall Street movements have a powerful effect on equity prices throughout the world and thus on the whole climate of confidence and investment. This is not the case with Japan.

The problem with the Japanese economy is not that output and demand are falling, but merely that they are not rising as fast as they could and that a negative output gap has appeared. Since 1991 Japan has had a sizeable increase in its output in only one year, 1996, when GDP grew by just over five percent. In 1998 it fell by nearly three percent; but in nearly every other year it grew by small amounts, typically just over or just under one percent. So the problem is not that Japan is precipitating a recession, but that it is not playing its part in the present world upturn. This may be as well for the moment, given that, according to most estimates, world output as a whole is now growing faster than productive capacity, leading to potential inflationary strains -- which can be seen from the upward trend in world interest rates in almost all financial centers.

There is a broader comment to make. The Western business establishment and the U.S. political establishment have been mesmerized by Japan for too long. For many years, when Japan was simply catching up with the U.S. economy, Japan was both demonized and admired. It was demonized because of a ridiculous fear that its rapid expansion and penetration in export markets could lead to the burial of American and European business. It was worshipped because Western leaders of an authoritarian disposition preferred its managed capitalism to the uncertainties and excitements of the more market-driven Anglo-Saxon variety. These obsessions were then followed by a period of hysteria about the opposite problem, that of a weak Japanese economy preventing the world from ever seeing prosperity again.

If I were writing for a European audience I would suggest putting Japan on the back burner. The reason why I cannot say this to Americans is that the policy of successive administrations has contributed to that country's difficulties. A durable Japanese recovery probably requires export-led growth, possibly with currency depreciation, but above all with some assurance that the yen will not be allowed to appreciate to the highs seen in the last few years. U.S. administrations have been too pre-occupied with a supposed threat from Japanese export competition to agree to any such concord -- the case for which has been powerfully argued by Ronald McKinnon of Stanford.

The combination of exhortation to expand the economy, and resistance to the currency conditions which would facilitate that expansion, is reminiscent of the contradictory stimuli used in torturing prisoners to obtain confessions. If I were U.S. Treasury secretary I would stop exhorting Japan to expand but co-operate in a sensible currency concord. And this is one of the many reasons why I do not occupy that position.

If Japan fails, the global impact would be formidable. That's why the time for supply-side reforms is now.

RUDI DORNBUSCH Ford Professor of Economics and International Management, MIT.

Yes, Japan does matter as an important part of the world economy and an all-important pillar for continued growth in Asia. What has been done to bring Japan back on its feet was all for the good. But much more needs to happen, especially from the supply side. If everything is done right, Japan may be back to strong growth a decade from now. It might even escape from an all-out fiscal crisis. But if supply-side measures are postponed and any incipient upswing is met by renewed taxes, kiss Japan good-bye.

Since the collapse of its asset bubble in 1990, Japan has been attempting to get back on its feet. There was a brief success in 1996, but that was soon undone by a mindless tax increase. A move to the very edge of a depression followed. Deepening recession and the risk of pervasive failure of banks and insurance companies -- their balance sheets being far below water -- were thwarted by a dramatic set of measures: huge construction spending and a wholesale guarantee for finance and no-questions-asked loan programs for small- and medium-sized firms. The upshot was a stabilization of sorts -- moderate growth and a return to some normality.

So far, unfortunately, we have only that. Investment and consumption spending are not piggybacking on the public works programs. And as long as they do not, Japan is far from a significant upswing. If and when an upswing does get underway, moreover, the Ministry of Finance will want its pound of flesh -- tax increases and a cutback on public works to reduce the huge budget deficits. But if that is done overeagerly, as in 1997, everything will unravel once again, and worse.

Japan's desperate strategy of the past two years was correct: Keynesian policies and pervasive guarantees were essential to avoid depression. They worked because they were huge and comprehensive. Unfortunately, the story stopped there. Rightly, the Bank of Japan (BO J) supported recovery by a zero-interest rate strategy. Rightly, the BOJ refused to engage in a misconceived notion of "making inflation." Wrongly, there has been no aggressive drive for deregulation and reform. Japan's supply side is even worse than Europe's. Without dramatic supply-side reform, a high growth-led fiscal stabilization will not happen. In fact, the anemic growth of the present will be hard to maintain. And if growth does not come, make no mistake, the pressure of huge deficits, huge debt burdens, and demographics will mean Japan's debt will become junk bonds. The Japanese public may be in love with JGBs, the only asset that has never disappointed them. But let them understand how bad the fiscal situation is and even they will return to offshore investment.

A few signs of optimism can be discerned outside the public policy arena. First, Japanese companies are furiously restructuring, far more than in Europe. The macro fall-out is unpleasant, but this route is the only option. Restructuring will contribute to growth over time, more so as it translates into a return of investment.

Another important development will contribute to confidence and medium-term employment: Japan is outstanding in technology, and technology is the hot stuff around the world. In communications, Japan is tops, far ahead of the United States. That should both increase confidence, which is all-important to spending, as well as help to establish a new industry that can undermine the entrenched old economy.

If Japan fails, the impact on the world economy will be formidable. Its debts will go bust, restrictions on capital flows would be likely, and a currency collapse will translate into trade problems. Asia will lose a much needed export market and, given their failure to reform much after the crisis, will be right back to volatility if not recession. Steady prodding of Japan on the public reform and restructuring effort is all important. The risk lies with the politicians not getting the message: Public works might make for a wonderful pork-barrel and corruption business, but it has no future. Earth to Japan: Get moving on reform!

The truth is that Tokyo had better get to work.

NORBERT WALTER Managing Director, Deutsche Bank Research and Chief Economist, Deutsche Bank Group.

Treasury Secretary Larry Summers needs nobody's education. Nobody needs to remind him that Japan is the world's second largest economy, still generating almost 10 percent of global GDP. And he is certainly not unaware of the fact that Japan is home to the second largest national capital market, with all the rest of us as counterparties.

As I know from private conversation -- already half a...