Is the world at risk of the "Japan disease"?

Author:Roach, Stephen S.
Position::A SYMPOSIUM OF VIEWS - Report
 
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Scholars and experts are wrestling to define the nature of globalization in the twenty-first century. To what extent can the global picture of 2017 be described in one sentence: Significant parts of the world are at risk of becoming more like Japan. In other words, the world's public and private debt today is approaching 300 percent of GDP. Yet despite an extraordinary degree of monetary expansion and relatively tight labor mrfrkets, a number of central bankers are finding it tough to meet their inflation targets. Meanwhile, wage growth remains modest. Productivity growth gains are disappointing. As Japan has done in recent years, some central bank authorities, including those in China, are purchasing equities to stabilize stock markets. Has the world been afflicted with a kind of "Japan disease"? Or is the current global environment a temporary development? Or is Japan doing better economically than advertised? If a negative Japan-like scenario is a risk for significant parts of the world, what policy steps would potentially lead to the avoidance of such a scenario?

Twenty international observers offer their thoughts.

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STEPHEN S. ROACH Senior Lecturer, Yale University, former Chairman, Morgan Stanley Asia, and author, Unbalanced: The Codependency of America and China (2014)

For the past seven years, I have taught a very popular seminar at Yale, "The Lessons of Japan." The first half of the course is a deep dive into the rise and fall of the modern Japanese economy, with an aim toward distilling key lessons from a stunning collapse. The second half of the seminar uses the tools of forensic macro to ascertain the relevance of those lessons to other major economies in the world--especially Europe, China, and the United States.

The short answer to the question of whether the world is at risk of the "Japan disease" and the major conclusion of this seminar is that there are, indeed, significant risks of Japan-like outcomes--namely stagnant growth and deflation--in other major economies of the world.

The lessons of Japan are many--from a dysfunctional mercantilist growth model and the toxic zaitech of financial engineering to condoning asset bubbles and productivity-inhibiting zombie corporates. But the most salient lesson pertains to the insidious sequencing of policy gambits that stem from what can be called the political economy of false prosperity. Convinced that the (lifetime) employment guarantees of what Chalmers Johnson dubbed a "plan-rational development state" were all that ultimately mattered, Japan, in effect, succumbed to the alchemy of a failed growth experiment.

A similar temptation can certainly be detected elsewhere. The political economy of growth imperatives is a common thread that runs through the policy and regulatory blunders that have given rise to Europe's dysfunctional currency union, China's unbalanced state-directed producer model, and America's property- and credit-distorted bubble economy that culminated in the Great Financial Crisis.

In all of these cases, there is strong insistence in policy circles that the lessons of Japan have been heeded and that, as a result, similar outcomes are unlikely. That's especially the case in the United States, where Fed Chairmen Alan Greenspan and Ben Bernanke argued that a quick policy response was all that was needed to forestall a Japan-like outcome.

It is also the case in China, where there continues to be active debate over the possibility of the Japan syndrome; the now famous "authoritative person" interview featured in China's People's Daily in May 2016 is a particularly prominent case in point, where a senior Chinese official warned of the Japan-like perils of debt-intensive, bubble-distorted economic growth. Having given several presentations in China on the lessons of Japan, I can personally attest to avid Chinese interest in this topic.

In the end, however, it's not enough simply to recognize the risks. It is delusional to think that the interplay between real economies, asset markets, and financial systems can be pushed to excess without severe and lasting consequences.

Similarly, it is ludicrous to believe that the "big bazooka" of massive monetary and fiscal policy responses can successfully address post-bubble carnages. The persistence of sharp growth slowdowns and below-target inflation outcomes in most major economies in the world today is prima facie evidence of lessons unlearned.

That gets to the toughest lesson of all--the misplaced notion that a reactive policy function is a substitute for a proactive growth sacrifice. Bubble-induced prosperity is a recipe for systemic failure.

Yet political economy pressures have led to a succession of misplaced growth gambits and the related contagion of the Japanese disease. As Japan's third lost decade underscores, the cure remains as elusive as ever. And at Yale there continues to be a long waiting list for my seminar on the lessons of Japan.

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SCOTT BESSENT CIO and Founder, Key Square Capital Management

The question of whether the world is at risk of the "Japan disease" mirrors the difficulties that an infectious disease specialist would have in identifying a pathosis that should have devastated any other patient years, if not decades, ago. Japan is what is known in medical jargon as Patient Zero, the first case of a condition or syndrome to be described in the medical literature. That patient usually has the most basic, least mutated form of the disease, which may either make them invaluable to medical efforts or completely useless.

Indeed, if we continue the medical analogy, the patient is extraordinarily healthy as measured by many metrics. Recent OECD Economic Survey data show the probability of becoming unemployed as a Japanese citizen is the lowest in the developed world. Net household wealth ranks among the world's highest. Japan's net external financial position is the largest of any country. Literacy and personal safety also score the highest, and World Health Organization statistics show Japanese citizens enjoying the longest life expectancy.

So what are the symptoms of the Japan disease and why do we care about this malady emanating from Tokyo? In a seminal 2016 paper, "Japanization: Is It Endemic or Epidemic?" Columbia University Professor Takatoshi Ito, an early critic of the Bank of Japan's policies and an advisor to the Abe government, defines "Japanization" as a combination of the following four economic conditions:

* The actual growth rate is lower than the potential growth rate for an extended period;

* The natural real interest rate is below zero and also below the actual real interest rate;

* The nominal policy rate is zero;

* The inflation rate is negative (that is, deflation).

Based on this rubric, some of the symptoms of the Japan disease do appear to be spreading around the world. The European Union and the United States have been struggling with weak inflation, below-trend GDP growth, and nominal policy rates that are only now starting to move away from zero.

However, two factors unique to Japan made the duration, depth, and durability of the Japan disease possible.

First, the structure of Japan's bond market and the country's persistent current account surplus during the deflationary decades has allowed the government to grow its gross debt-to-GDP ratio nearly four times since the early 1990s. Historically, less than 10 percent of Japanese government bonds are held by foreigners, giving the Ministry of Finance a committed domestic pool for its issuance.

Second, the tradition of social cohesion in Japan has not spurred the government to radical policies. Despite stagnant wages, there has been little widespread labor unrest or punitive policies aimed at Japanese corporates. Contrast this with the rise of populist parties and politicians in the United States and Europe.

Given these Japan-specific factors, what lessons can other advanced economies learn from Patient Zero? First and foremost, countries diagnosed with Japan disease should pursue monetary easing in an aggressive and timely manner. As Ito and Frederic Mishkin (2006) describe, Japan's inability to escape the most pernicious symptom, deflation, was ultimately "a failure of monetary policy."

As evidence of this failure, GDP growth in Japan had been consistently lower than nominal JGB yields from the bursting of the bubble in 1992 to the beginning of Abenomics in 2013. With risk-free interest rates higher than nominal growth, monetary policy had been incentivizing the private sector to deleverage for two decades. Naturally, this deleveraging led to weak inflation outcomes and embedded deflationary expectations among Japanese citizens.

Indeed, as Financial Times Japan noted in their "Deflated Generation" piece last year, the current cohort of Japanese twenty-year-olds is "the first to have lived its entire life with the economy in a broad state of deflation." As Tokyo University Professor Hiroshi Ishida explains, "economic factors have stripped away the incentives for young Japanese to leave home, buy cars, marry, have children, take risks, and generally grow up."

Thankfully, the European Union and the United States appear to have taken the lessons learned from Patient Zero to heart. Since the financial crisis, monetary authorities have been far more proactive than during Japan's two lost decades, with the European Central Bank and the U.S. Federal Reserve intervening in bond markets via aggressive quantitative easing.

Thus far, this has largely forestalled widespread deleveraging and prevented deflationary expectations from taking hold. This offers some hope that the United States and the European Union can avoid Japan's costly mistakes.

Finally, lost in the myriad of ex post working papers, academic articles, and monetary and fiscal policy advice is what economists, historians, and policymakers should properly define as the real "Japan disease"--the negligent asset bubble that was allowed...

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