The Japanese Approach
Nov 18, 2008
Conventional economic wisdom has tended to suggest that, in times of economic difficulty, fiscal prudence and tax reduction are the best means of emerging from financial malaise.
However, Richard Koo, chief economist of Japan’s Nomura Research Institute, argues that the best means of addressing the global financial crisis is to spend and to spend big.
Koo has spent a large part of his career studying how Japan coped with its own financial crisis in the 1990s. Much-criticized, Japan’s tactic of using massive public spending actually worked. Once a minority voice, those with opinions in line with Koo’s are getting a larger audience now that the world is experiencing a situation similar to the one Japan suffered not all that long ago.
Koo’s argument is essentially that, in a significant economic crisis, merely bailing out banks and cutting interest rates to stimulate the economy isn’t enough. What’s required is massive public spending.
In what he refers to as a “balance-sheet recession,” companies focus exclusively on reducing debt, and this serves to act as a barrier to the normal flow of money through an economy. Nobody borrows because everyone is desperately paying off debt.
In Japan’s experience, spending halted this cycle. It took hundreds of billions of dollars, but it worked. That’s not before real estate prices dropped almost 90 percent, and stock prices never climbed back to their pre-downturn levels. And Japan accumulated a crushing national debt because of all the spending.
So why did they do it? Well, basically because they had no other choice. The spending kept Japan’s GDP higher than pre-crisis levels throughout the period of economic stagnation. Mass unemployment – like we’re starting to see in the US – was avoided. The 1990s were a dismal decade for Japan, but they could have been much worse.
Koo sees a similar halt to borrowing a real possibility in the US because households may start paying down debt at greater rates, as was the case in Japan. And the best way of nourishing an economy that is starved of borrowing is to dramatically increase public spending. Whether it’s on infrastructure or health care is of little consequence. The point is to keep the money flowing and not let up.
He also argues that governments should focus on spending rather than tax cuts, because in a downturn like this one, households are much more likely to simply take their tax cut money and apply it to debt, thereby doing nothing to stimulate the economy. The lesson, he says, is that as costly as it is to spend your way out of a crisis of this magnitude, not doing so is far higher.
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Fortunately for provinces like Manitoba, the effects of the global economic downturn will be lesser than those suffered by other provinces. The Conference Board of Canada has recently released economic projections that show Manitoba as having the second-highest economic growth in 2008 and the third highest in 2009. Forecasting a 2.7 percent increase in GDP this year and 2.4 in 2009, the Conference Board cites a strong domestic economy and large construction projects as allowing for sound economic growth in the near term. Manitoba’s diversified economy and steady aerospace sector are also likely factors in this resilience to dramatic economic decline.
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