Bank fix no panacea for Japan

The issue of what exactly Japan’s problem is has consumed the thoughts of analysts and commentators for some considerable time now.

The various fiscal and financial stimuli that have been applied have been miserably inadequate, with none of the money generated from the stimuli actually finding its way back to the economy.

The problems in Japan are not confined to just what happens there, with the nation’s fortunes being bestowed on the rest of the world. So what is the problem?

When Japan’s economy is examined, the following characteristics are evident — a politically stable nation with a history of responsible macroeconomic policy, a massive net international creditor and no foreign currency debt.

Yet the plight of the nation is serious. Of recent times, there has been a thought that the problem is simply a banking one.

Any attempt to fix the banks will fix the more fundamental issue of the economy. The recent passage of a large bank rescue package was seen as the turning point in its recovery process.

Paul Krugman, well recognised as the bad boy of economics and professor of economics at the Massachusetts Institute of Technology, has taken the view that this is blatantly wrong.

The problem, as he sees it, is “even at a near-zero interest rate, aggregate demand is inadequate to employ the country’s productive capacity. Or, to put the same point differently, at full employment Japanese savings would exceed Japanese investment by more than the country’s current account surplus”.

As Krugman said: “To believe that banking reform will heal the Japanese economy, you must believe that it will sharply reduce this savings-investment gap. Call it the ‘clogged pipe’ theory. It says that the weakness of Japan’s banks depresses investment, because it prevents liquidity from getting through to credit-constrained firms.”

Krugman doesn’t believe injecting capital into the banks is the answer to Japan’s woes.

He calls for “something radical, something that would normally be unsound policy, as the only way out. The real significance of the fixation on banks as the be-all and end-all of the problem then, is that it means that Japan, and those who advise it, are not prepared to rethink their ideas of what constitutes sound policy. And that, I fear, means that there is not yet even a glimmer of light at the end of the tunnel”.

It is hoped the stimulus that has been provided to the banking system does work.

Our historical perspective is that it won’t. If it doesn’t we can look forward to continued depression in Japan.

This is a scenario the world can tolerate for only so much longer. Given the size of Japan’s economy and the importance of its trading position in the world, we can not continue to stand by and watch the demise of the nation’s economy.

It is hoped the policy makers in Japan will see it the way that Krugman does and takes a bold position on its economy.