Japan – a success story
This is not perhaps a
headline to be expected. After all, government debt is
over twice GDP, and Japan has a rapidly aging
population. After her stock market crash, which started
in December 1989, she has been in a bear market for over
twenty years with the Nikkei 225 Index falling over 80%
at its worst. Since then she has just managed to avoid
outright deflation, with GDP having shown virtually no
growth between 1990 and 2008, and only showing some
recovery in 2009, aided by global industrial investment.
This apparent stagnation
is the nightmare the West is trying to avoid. But all
those economists who gave their free advice to Japan
over the years have generally given up, because there
are now more interesting disasters to analyse closer to
home; yet for an aging stockbroker Japan is interesting
precisely because no one else is interested.
There is one key
difference between Japan and those countries where her
critics reside, and that is her propensity to save. Her
critics reside in countries that are driven by credit
and not savings. So to understand the Japanese
condition, we need to briefly consider her post-war
economic history from a non-Keynesian and non-monetarist
perspective.
Post-war recovery
After her defeat in WW2
the Japanese economy was rebuilt from nothing. Even
though the initial burden on the authorities was
immense, tax policy at the outset was designed to
protect savings at the expense of consumption, which
ensured the finance for rebuilding the economy would
become available. The pre-war samurai zaibatsu
had been disbanded by the Allies, but they lived on in
the groupings of businesses known as keiretsu. These
keiretsu were organised into industrial and financial
groups with cross-shareholdings, capable of re-investing
profits across a wide range of manufacturing businesses.
The eight major keiretsu were Mitsubishi, Mitsui,
Sumitomo, Fuyo, Dai-ichi Kangyo, Sanwa, Tokai and IBJ,
and they formed the commercial houses with which we are
familiar today. Japan therefore had the finance from
saving and an organised business structure for recovery.
The Americans, who ran
the country under General MacArthur, had a large
military presence in Okinawa and elsewhere in Japan, and
in the early fifties used Japan as a base for the war in
Korea. This presence helped kick-start the recovery. The
keiretsu re-invested the profits from supplying the
military, into manufacturing businesses, initially
manufacturing quick and easy products – low quality
cheap consumer goods.
Japan rapidly began to
be associated with cheap low-quality products. It was
time to move on, and at this stage two Americans who
were the world’s leading advocates of quality and
quality control, William Deming and Joseph Juran,
persuaded Japan’s business leaders to switch production
to high quality, reliable goods. This became the
hall-mark of Japan’s post-war miracle, and by the late
fifties she was setting quality control standards far
higher than many of her foreign competitors.
While a number of events
contributed to the post-war miracle, by far the most
important was the propensity to save. Peter Drucker, the
American management guru, recalled that a military
officer deputed by General MacArthur to advise the
post-war government on economic policy insisted that
savings should be exempt from tax. The advice was taken,
with taxes only applying on savings accounts for very
large deposits. However, it was the account that was
taxed, rather than the individual, so a saver could open
further accounts to keep all his savings under the tax
threshold.
The propensity to save
reduced income available for consumption, ensuring that
competition in consumer goods was intense. The keiretsu
were able to respond rapidly to improve their products
and reduce costs through capital investment, since the
savings to finance it was available at low, stable
interest rates. The Western consumer initially became
aware of these advances through items such as transistor
radios in the late fifties, and 35mm format reflex
cameras at about the same time.
With competition at home
for reluctant consumers intense, the keiretsu found
export markets lucrative. Thanks to the advice of
William Deming and Joseph Juran, Japanese products were
better and cheaper than their Western equivalents, and
exports expanded rapidly. The economic effect in Japan
was to increase the value of wages, which allowed
workers to save yet more, and so the cycle went on with
savings and capital investment growing at an increasing
pace. In the absence of inflation, these savings grew in
value with interest rates of only two or three per cent.
This strong and growing
savings flow allowed the keiretsu to expand their ranges
of products and by the mid-seventies Japan was the
largest shipbuilder, the largest car exporter, the
largest exporter of electronic goods and the global
leader in the commercial application of advanced
technologies. In little more than twenty years she had
achieved what had taken Britain seventy or so after the
Napoleonic War. In both these cases the economy had
developed without government intervention, relying only
on sound money and a propensity to save. Japan’s
development was quicker due to the pace of technological
change, a factor that had also benefited America in the
1920s.
Japan was also helped by
the monetary policies of foreign governments. By
discouraging savings by taxing them, they had ensured
their economies were driven almost entirely by
consumption. Furthermore, by generating credit-driven
boom-bust cycles of increasing magnitude, these
governments crippled their own industrial capability,
making home-produced consumer goods inferior and more
expensive. So stark was the difference between Japan and
her client countries that Japanese business was forced
to invest in manufacturing capacity in these client
countries, or face trade sanctions.
In the early eighties,
car plants and electronics manufacturing were
established in the UK for access to European markets, to
be followed by factories in America and elsewhere. The
capital investment was funded by Japanese savers through
keiretsus’ in-house banks and by reinvesting profits, as
was their custom. The workforces were properly trained,
given the latest tools and probably for the first time
in their lives had job satisfaction: a notable contrast
to labour relations in indigenous businesses.
On the back of their
in-house commercial lending, the keiretsu banks expanded
into financial services during the eighties. Foreign
speculators were keen to invest in Japan’s success, and
for the keiretsu it was such easy money - taking it off
the gaijin and investing it into associated
entities - that the inevitable stock market bubble
formed, followed by the equally inevitable collapse in
1990.
It is worth emphasising
that the bubble arose not from Japanese credit creation,
but from the importation of speculative Western capital.
The Bank of Japan made the subsequent mistake of
lowering interest rates to stop the yen from rising,
which had the effect of spreading the asset bubble into
the domestic property market.
The 1990 collapse in
share and property prices hit the Japanese consumer
hard, with unemployment rising from zero to five per
cent. Margins on consumer goods were squeezed as a
result of a further increase in the propensity to save,
which was the natural response of individuals to the
stock market and property crashes. Japanese
manufacturers reacted by investing in new factories
abroad, this time benefitting from the cheap and
plentiful labour in South East Asia. The miracle
continued from abroad, with the keiretsu building
commercial empires in South East Asia.
Insights
This then is Japan’s
post-war economic history as it perhaps should be
understood, and there are some valuable insights to be
gained. By far the most important is the role of real
savings in driving an economy, compared with the
Keynesian approach, which relies on credit. The detailed
reasons behind why savings are so important and credit
is so destructive to the capital investment process were
covered in my article on
capital theory
dated 1 July. It is a lesson that has now been learned
by China, which has almost certainly analysed the
reasons for Japans’ success for her own benefit. While
times are different, there are similarities in China’s
strategy: she is now spreading her production beyond her
borders as Japan did in the 1990s.
The Japanese
savings-driven model is suitable for just about any
other Asian country which shares aptitudes for hard work
and thrift. It is the availability of capital investment
driven by purely commercial factors that can rapidly
turn a community from bare subsistence into a
competitive modern workforce manufacturing advanced
products. And for commercial factors to be the sole
determinants of capital investment, the role of the
state in the economy has to be minimised.
This has certainly been
true of Japan, and fortunately her government has
generally resisted many of the more hysterical Keynesian
calls to action. The Japanese government has made policy
errors, but none of them have been bad enough to
destabilise her economy. It has avoided the inflation
trap of printing money, with M2 more or less unchanged
since 1990. Furthermore, once strong flows of capital
investment are taken into account, her economy has grown
more than the GDP numbers suggest. This is because much
of her economic activity is not captured by the GDP
statistic. GDP is the net domestic output of goods and
services, and therefore does not capture the gross
values which reflect expanding production activities.
And now that so much of Japan’s manufacturing capacity
is located elsewhere this is not captured in the
statistics. By looking at the domestic statistics we
forget the empire; taking these factors into account,
Japan has actually grown significantly.
The land of the
setting sun?
Those budget deficits,
so keenly advocated by Keynesian economists are
beginning to catch up with Japan. The cost of financing
them has remained low, varying between one and two per
cent, because there is no monetary and credit inflation.
Nevertheless, the expansion of government debt has
diverted savings from the private sector, corrupting the
savings/investment cycle.
The rate of savings has
been declining since the late 1990s as a result of
several factors. Japan is burdened with an increasing
population of retirees and a low birth rate, and these
demographics are deteriorating and are expected to
deteriorate more rapidly than in other countries, such
as the US and UK. Improvements in state pensions and
welfare have also reduced the incentive to save, and the
general westernisation of society has increased
allocation of personal income to consumption at the
expense of savings.
This is something
Western commentators fret over, but there are
differences. Western governments actually have three
separate pension problems. The first is the one most of
us know about and which is shared with Japan: the ratio
of retirees to those of working age is increasing.
Second, the long-term effect of monetary inflation has
effectively wiped out the value of bank and bond
savings, replacing them with pensions funded
substantially by asset speculation. Before the dot-com
crash of 2000/03 and then the credit crunch of 2007/08
no one saw any risk in this investment strategy. Now
that private pensions have substantial shortfalls and
face further risks in current asset market conditions,
the consumer-driven economies face a severe pensions
crisis in the private sector. And lastly, the inflation
protection offered to public sector employees in
unfunded state schemes is extremely expensive,
escalating in cost due to inflation and likely to become
socially divisive.
So the consumer-driven
economies have far greater pension problems than Japan,
and the root cause of the difference has been monetary
and credit inflation in the former compared with sound
money policies of the latter. Government deficits in
Japan have actually been funded by savings and not
through the printing press, so the outlook for the
public sector must be one of substantial cut-backs due
to the fall in savings. The private sector, the
keiretsu, also faces difficulties ahead. Economic growth
for the last four quarters has been strong, averaging
4.2% fuelled by strong exports and one-off domestic
subsidies for cars and home appliances. Export growth is
driven by demand for capital goods at a level unlikely
to be sustained in the months ahead.
The sun may be setting
for Japan’s commercial empire, but her legacy today is a
far stronger economy than those of the consumer-driven
nations. She is also on China’s doorstep and has
substantial investments within that sphere of influence.
All she needs to do is unwind the Keynesian-inspired
errors of economic policy: cut government spending and
give savings more encouragement. So yes, her stock
market is good value, on the basis there will be good
reasons for the gaijin to buy again. Japan
certainly was successful, and probably still is, at
least compared with the West.
A cartoonist might draw
an old man sitting in his rocking chair on his porch,
smoking contentedly and at peace with himself. Younger
men in their sharp suits observe him with pity, thinking
he hasn’t got much. What they don’t know is he has lots
more than they have.
The old man is Japan and
the youngsters are smart-arsed economists.
15 July 2010
