Edward J. Lincoln: What Japan Got Right
[Lincoln is the director of the Center for Japan-U.S. Business and Economic Studies and professor of economics at NYU Stern School of Business.]
Japan's experience dealing with financial crisis in the 1990s has often been used as a cautionary tale for the U.S. The story is fairly well known by now—the collapse of stock-market and real-estate prices in the early 1990s created huge amounts of nonperforming loans in the banking sector and triggered a disappointing decade of only 1 percent average annual economic growth.
The government failed to act quickly, allowing the situation to fester from 1991 to 1998. Only at that point did a serious program of fiscal stimulus and state intervention into the private sector begin.
But what is often forgotten is the fact that once the Japanese government started meddling, it worked. Policy mistakes meant that it took more time than it should have for Japan to return to a healthy (for a developed economy) 2 percent, but without government intervention it might have taken even longer. While a decade of lethargic growth might seem like cold comfort, the fact is that Japan avoided what might have been an incredibly painful depression by nationalizing banks and injecting large amounts of fiscal stimulus into the economy. It's exactly what the U.S. should do now—hard and fast—if it wants to avoid that fate.
Like many Americans today, the Japanese didn't particularly want to nationalize their banks. Deregulation had been a strong political theme in Japan since the 1980s. Indeed, during the troubles of the 1990s, the political push for deregulation actually increased, as many recognized that long-term recovery required a more market-oriented economy. Many sectors, including retailing, transportation and telecommunications, were gradually liberalized.
Therefore, when the Japanese banking sector faced its crisis in the 1990s, the idea of government cleaning up the banks was anathema. But recognizing in 1998 that the entire sector was on the verge of outright collapse, the government put in $100 billion worth of capital into weak but viable banks and nationalized a handful of failed banks. These measures were temporary—not a systemic shift toward state control. Like the United States today, there was no desire to have the government running banks for more than a very short period of time. Capital infusion gave the government more leverage in finally forcing the banks to deal with the large amount of nonperforming loans on their books. Meanwhile, nationalized banks had their toxic assets stripped out and were sold back to the private sector, much like the solution to the American savings-and-loan crisis of the 1980s. The banking sector today is back on its feet, and many Japanese feel their government did the right thing.
But as in the United States, dealing directly with the problems in the financial sector was not a sufficient response to the broad economic malaise that accompanied the crisis. Over the course of the 1990s, the government threw both fiscal and monetary stimulus at the economy. In 1994 the government provided considerable stimulus through both tax cuts and spending increases. In 1995 and 1996 economic growth began to recover, but unfortunately the government raised taxes in 1997, promptly pushing the economy back into recession. Belatedly, fiscal stimulus increased again in 1998, and remained in place for several years. This is one of the most important lessons from the Japan scenario: government must provide a quick, substantial and sustained fiscal shock to the economy, and then gradually back off once the recovery is on solid ground....
Read entire article at Newsweek
Japan's experience dealing with financial crisis in the 1990s has often been used as a cautionary tale for the U.S. The story is fairly well known by now—the collapse of stock-market and real-estate prices in the early 1990s created huge amounts of nonperforming loans in the banking sector and triggered a disappointing decade of only 1 percent average annual economic growth.
The government failed to act quickly, allowing the situation to fester from 1991 to 1998. Only at that point did a serious program of fiscal stimulus and state intervention into the private sector begin.
But what is often forgotten is the fact that once the Japanese government started meddling, it worked. Policy mistakes meant that it took more time than it should have for Japan to return to a healthy (for a developed economy) 2 percent, but without government intervention it might have taken even longer. While a decade of lethargic growth might seem like cold comfort, the fact is that Japan avoided what might have been an incredibly painful depression by nationalizing banks and injecting large amounts of fiscal stimulus into the economy. It's exactly what the U.S. should do now—hard and fast—if it wants to avoid that fate.
Like many Americans today, the Japanese didn't particularly want to nationalize their banks. Deregulation had been a strong political theme in Japan since the 1980s. Indeed, during the troubles of the 1990s, the political push for deregulation actually increased, as many recognized that long-term recovery required a more market-oriented economy. Many sectors, including retailing, transportation and telecommunications, were gradually liberalized.
Therefore, when the Japanese banking sector faced its crisis in the 1990s, the idea of government cleaning up the banks was anathema. But recognizing in 1998 that the entire sector was on the verge of outright collapse, the government put in $100 billion worth of capital into weak but viable banks and nationalized a handful of failed banks. These measures were temporary—not a systemic shift toward state control. Like the United States today, there was no desire to have the government running banks for more than a very short period of time. Capital infusion gave the government more leverage in finally forcing the banks to deal with the large amount of nonperforming loans on their books. Meanwhile, nationalized banks had their toxic assets stripped out and were sold back to the private sector, much like the solution to the American savings-and-loan crisis of the 1980s. The banking sector today is back on its feet, and many Japanese feel their government did the right thing.
But as in the United States, dealing directly with the problems in the financial sector was not a sufficient response to the broad economic malaise that accompanied the crisis. Over the course of the 1990s, the government threw both fiscal and monetary stimulus at the economy. In 1994 the government provided considerable stimulus through both tax cuts and spending increases. In 1995 and 1996 economic growth began to recover, but unfortunately the government raised taxes in 1997, promptly pushing the economy back into recession. Belatedly, fiscal stimulus increased again in 1998, and remained in place for several years. This is one of the most important lessons from the Japan scenario: government must provide a quick, substantial and sustained fiscal shock to the economy, and then gradually back off once the recovery is on solid ground....