More than five years after the financial crisis hit its peak, the world is still far from recovering the ground lost. Tens of millions of people in the wealthy countries of North America and Europe remain unemployed or underemployed as a result of the collapse of the housing bubbles that drove their economies before the crisis.
This downturn has robbed workers of the opportunity to have a decent job and the income necessary to raise their children. It has also resulted in trillions of dollars of lost output. Millions of workers who could have been employed improving our infrastructure, making our homes and businesses more energy efficient or better educating our children have instead been left idle.
According to the dominant strand of economic thinking in policy circles, if not also academia, this suffering was necessary because of the sins associated with the inflation of credit bubbles in the lead-up to the crisis. Their bursting threw budgets out of whack, causing large government deficits. The conventional wisdom in Brussels, London and Washington is that governments must focus on reducing their budgets in order to reduce their debt to more normal levels and lay the basis for renewed growth.
Fortunately this position is not universally shared. Japan’s new prime minister, Shinzo Abe, has taken the opposite tack. Abe became prime minister at the end of 2012 and quickly embarked on a program of aggressive government stimulus. He pushed through spending measures focused on improving Japan’s infrastructure, child care and health care, plus other measures anticipated to provide long-term benefits.
This commitment to additional spending, which means raising Japan’s deficit, is especially striking because Japan is by far the world’s leader in its debt-to-GDP ratio — an allegedly key metric for determining whether a government should cut spending for the sake of economic growth. In a widely cited but later debunked paper, economists Kenneth Rogoff and Carmen Reinhart claimed that when a country’s debt-to-GDP ratio breached 90 percent, it could expect reduced economic growth. Japan’s ratio of gross government debt to GDP is over 240 percent. This is more than twice as high as the United States’ and more than 100 percentage points above that of Italy, which ranks second in this category among major economies.
Abe also got Japan’s central bank to commit itself to increasing the inflation rate, ending two decades in which Japan has seen a modest bout of deflation. This meant setting a 2 percent inflation target, with the commitment to buy as much government debt as necessary to reach the target. A higher inflation rate will reduce debt burdens on the population and lower the real interest rate, giving firms more incentive to invest.
In addition, Abe promised to remove a number of structural obstacles to growth. These barriers take a wide variety of forms, including strong protections for agriculture that raise the price of food and limit the availability of land for other purposes. However, the most important barriers targeted by Abe are the obstacles that prevent women from being full and equal participants in the labor force.
"Japan’s policy of larger budget deficits and a higher inflation rate has not led to any crisis of confidence from financial markets. "
Although it is early to judge, since Abe’s program has been in place for less than a year, the initial results look overwhelmingly positive. After being nearly stagnant in 2012, Japan’s economy grew at more than a 3.0 percent annualized rate in the first three quarters of 2013.
This growth rate, which is more than a percentage point higher than growth in the U.S. or any of the major European economies, is more impressive than direct comparison suggests. Japan’s population is shrinking at the rate of 0.1 percent annually. By contrast, the U.S. population is growing at the rate of 0.9 percent annually. This difference in population growth rates adds a full percentage to the difference in per capita GDP growth, which is what matters for improving people’s living standards.
Japan’s renewed growth has had a clear impact on the labor market, with the employment-to-population rate (EPOP) for workers ages 15 to 64 rising by 0.9 percentage point in the first three quarters of the year. By contrast, job growth in the U.S. has been sufficient to raise the EPOP by only 0.1 percentage point. The EPOP for prime-age women (25 to 54) in Japan rose by 1.2 percentage points in this period, bringing it to 70.7 percent. That is 1.2 percentage points above the current rate in the United States.
Japan’s central bank’s efforts to boost inflation, which began only after Abe took control of the bank in March, seem to have already put an end to deflation. After three years of modest deflation, Japan’s price levels have stabilized on a year-over-year basis, with recent months showing modest rates of inflation. Of course, there is still a way to go before reaching the 2.0 percent inflation target.
Strikingly, this policy of larger budget deficits and deliberately raising the inflation rate has not led to any crisis of confidence from financial markets. The interest rate on long-term Japanese government debt is less than 0.7 percent. Japan’s stock market has risen by more than 70 percent over the last year.
If Japan’s economy can continue its recent trajectory, despite a debt-to-GDP ratio of more than 240 percent, it should push both Europe and the U.S. in the direction of more stimulus policies. It is hard to argue that the U.S. and the European Union are more constrained than Japan, since they have much lower debt-to-GDP ratios.
The United States, Great Britain and the euro-zone countries have been testing contractionary fiscal policies for the last three years. They have led to slow growth and high unemployment everywhere. In addition, this prolonged period of economic weakness is likely to have lasting effects as workers lose skills and firms put off investment. In short, political leaders in Europe and the U.S. have enough evidence to conclude that short-term pain from cutting government spending begets only greater long-term pain.
Fortunately, Abe has shown them that there is an alternative.
Source: AlJazeera America
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