Rock and a Hard Place
Japan faces a simple dilemma: tax cuts are what it needs to spur its economy and prevent a recession. But a policy of tax cuts would abandon all hope of the balanced budget and deregulation that Japan needs to prevent a recession. Prime Minister Ryutaro Hashimoto is in an extraordinarily unenviable position.
Japan's media has not shown much sympathy for Hashimoto's plight. Two influential weekly newsmagazines have called for him to resign. One boldly proclaimed that if he quit, the Japanese stock market's Nikkei Average would rise 2,000 points, almost 15%. Norio Ohga, Sony Chairman and respected business pundit, compared Hashimoto to US President Herbert Hoover right before the Great Depression, and argued that a Japanese collapse would trigger a global recession. Japan, he said, "is on the verge of collapsing."
The problem, at its simplest, is a stagnant economy. Folks simply aren't spending any money, and their savings are not being put to productive use. Even at incredibly low interest rates, corporations cannot borrow more money to invest, because banks are unwilling to lend to companies that have little chance of significant growth. Companies cannot grow significantly because government over-regulation and high corporate debts have led to reduced corporate growth, which is fueling unemployment. Tadashi Nakamae, an independent economist and former chief economist for Daiwa Securities, writes in the March 21 Economist that by the end of 1998, unemployment will reach 4.5%, and 7% by the end of 1999. According to the latest tankan survey of businesses, confidence is at a 30-year low. The lack of confidence prompts people to count their yen more carefully, and not spend very much, which brings us back to the beginning of this vicious cycle.
Undergirding this descent into economic misery is a complete lack of faith in government, thanks to recurring corruption scandals, incompetence, and paralysis. But as previously mentioned, the government is caught between two bad choices, trying to decide which is worse. Taxes: to cut or not to cut? (Hashimoto has belatedly chosen to cut taxes; more on that later.)
There is a fairly strong case to be made for both. Most Japanese, American, and even European economists argue for a significant tax cut. Even Japan's central bank governor, Masaru Hayami, has voiced support for tax cuts. "I expect to see permanent income tax cuts, and I hope to see corporate tax cuts and more efficient public spending," he told the Financial Times, saying it was more important to stimulate the economy than to cut the budget deficit. IMF First Deputy Managing Director Stanley Fischer said that the IMF supports Japanese fiscal expansion, largely in the form of a 16 trillion yen tax cut. He said, "Anyone who doubts the effectiveness of tax measures needs only to consider the effectiveness of last year's tax increase in curbing demand."
Last April, the Hashimoto government raised the sales tax from 3% to 5% in an attempt to generate revenue to further deregulation without impacting the rising budget deficit. The impact of the tax hike was apparent even from a simple anecdotal observation. The day before the tax hike, the streets of Akihabara, Tokyo's electronics mecca, were jammed with Japanese getting in their last purchases before the tax hike. The next day, the streets were empty. The 2% might not really have made much of a difference in people's wallets, but it certainly made a difference in their minds.
A reversal of the sales tax hike might make people take to the stores again. An income tax cut might give Japanese extra funds with which to enjoy more spending. And a corporate tax cut might produce some larger bonuses for employees, or prevent some teetering companies from falling over the edge and sacking their workforce. A large-scale tax cut could be just what is necessary to bring Japan bank from the brink of the collapse Ohga fears.
But there is a similarly strong case to be made against tax cuts, both from an objective viewpoint, and from the viewpoint of the government that would have to enact them. Objectively, Japan's budget deficit is increasing rapidly, at its largest for several decades. Tax cuts would bite deeper into the budget, preventing spending on other vital government programs (such as shoring up the pension system, starting to tremble under Japan's graying population). Or, Japan could simply go deeper into debt -- not a choice that inspires much enthusiasm, given the current onerous US debt burden.
The current government is resistant to the idea of widening the budget deficit. The Liberal Democratic Party was elected on a platform of deregulating the economy, which is vital to economic growth. As the March 21 Economist points out, "in tables comparing the extent to which different countries' economies are subject to regulation, Japan ranks 35th (below even Russia) with 30% of its economy still tied up in tape, compared with America's 7%." But without extra cash in the kitty, financial reform will have to wait. The government cannot afford to allow bad businesses to fail when it cannot pay for a safety net for newly unemployed workers.
Finance Minister Hikaru Matsunaga has said that the government must maintain "the spirit of fiscal reform," which means that deregulation shouldn't be pushed aside for a tax cut. His publicly stated reasons are similar to the ones mentioned previously. But there are "selfish" reasons for this policy, as well. As a Los Angeles Times editorial from April 9 says, "the embarrassment this necessary but abrupt reversal of policy would bring to Hashimoto and his party is a key reason they have resisted acting."
Lastly, the tax cuts would only work if people spent their extra money. Recent polls by the Kyodo News Service indicate that only 32 percent of respondents would spend the money, with the rest saving it or repaying debts. Given that Japan's savings rates, although still high, are well below their average for the last few decades, it is likely that much of the tax cut would simply go directly into savings accounts. Although this might help shore up sick banks, it would not help desperate industries such as construction.
There have been some suggestions for other solutions, but most of them are not viable. One such idea is a large-scale government spending package. Such a package would inspire the economic demand that Japan needs, but it would also damage the budget deficit. Furthermore, it would be unlikely to work. Past spending packages have been depressingly pork barrel in nature, paving river beds and building unneeded bridges in the districts of influential lawmakers. Since 1992, the Japanese government has spent over 75 trillion yen on attempting to boost its economy, with little positive result.
Another potential solution is a full frontal thrust into deregulation, with the aim of rejuvenating the economy so that successful companies could pick up the massive unemployment slack that the failing companies would leave in their wake. But there is no will for true deregulation in the powerful government ministries, because of the loss of influence deregulation would bring. The ministries have fought such deregulations in the past, settling instead for compromise deregulations in which the ministries ironically gained more influence. Hashimoto, who famously promised upon his appointment to deregulate the economy or "explode into a ball of fire," favors deregulation, but is powerless to further it right now.
There are no easy ways out. And the rest of the world should take notice, because if Japan, the world's second-largest economy, fails, the potential impact to the global economy is mind-boggling. As the LA Times stated, "If other Asian countries are to climb out of recession, they need a receptive Japanese market for their exports. If they can't sell in Japan they will try to sell even more in the United States. That threatens to bloat the U.S. trade deficit, fuel protectionist inclinations and weaken the profits of American companies."
The problem may go further. Although Japanese markets are famously closed to foreign investment and trade, a Japanese depression would harm the profits of those American companies who do big business in Japan, such as McDonald's, Coke, IBM, Apple, 7-11, and many others. Although the Japanese market is not the feather in any of these companies' caps, losing money is a bad thing for a corporation in more ways than just the immediate financial impact. Wall Street, flying to record highs, may be severely overvalued, and one strong blow to American investor confidence could end the bull run. In Japan, there is plenty of doom and gloom to lend out.
On April 10, Hashimoto made the decision. He announced a proposal for 2 trillion yen in tax cuts for individuals in 1998, another 2 trillion yen in 1999, and a 16 trillion dollar stimulus package, to include at least 10 trillion in ma-mizu (literally "real water," meaning actual spending by central and local governments). The plan calls for a reform to the fiscal reform law Hashimoto pushed through a few months ago. This law requires the government to gradually reduce and phase out the issuance of deficit-financing bonds, a law that would be mutually exclusive with the increase in the deficit that the tax cuts will produce.
After choosing tax cuts over a balanced budget and deregulation to save his nation's economy, Hashimoto announced that there was no need for him to "bear responsibility" for the economic downturn by resigning, and the better way to bear responsibility would be to stay on and oversee his emergency bailout package. We shall see if the nation agrees.