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August 1, 2013 4:20 pm
Debate is heating up in Tokyo about the advisability of increasing Japan’s consumption tax. Which should come first – economic growth or fiscal reconstruction? The prime minister must decide in a matter of weeks.
I’m sitting in a Roppongi bar discussing the subject with a knowledgeable Japanese bureaucrat.
“It’s essential to raise taxes,” he says, cradling a well-aged Islay malt. “If we don’t, investors will lose confidence and our bond market will collapse.”
“Aren’t you risking a serious recession?” I asked.
He replied: “A temporary blip, maybe. But the strengthening of public finances will be good for future growth.”
The year was 1997. The Asian crisis was already in full swing. Japan’s own banking system was on the brink of collapse. Yet officials had convinced the prime minister of the day, the popular and dynamic Ryutaro Hashimoto, that raising taxes on consumers was a priority.
In the event, they drove the Japanese economy off a Y10tn ($128bn) fiscal cliff. If you tax something you end up with less of it. So it was with Japanese consumption. In a matter of months outright deflation had appeared and retail sales fell into a protracted slump, from which they have yet to emerge.
Soon afterwards, Hashimoto was forced from office, his reputation for competence in tatters. The story goes that he regretted following the advice of his bureaucrats right up until his untimely death in 2006.
The tax rise failed even in its own terms. Central government tax revenues fell more than 20 per cent over the subsequent 15 years and Japan’s debt-to-GDP ratio – a mere 40 per cent at the time – snowballed to more than 150 per cent.
Meanwhile, Japan’s bond market, far from collapsing, embarked on an astonishing bull run that took 10-year yields to below 0.8 per cent. Even after the recent scare about the US Federal Reserve’s tapering of asset purchases, Japanese bond yields, almost uniquely, are no higher than a year ago.
Sadly Japanese politicians ignored the lessons of this policy disaster. Shinzo Abe’s predecessor as prime minister, the hapless Yoshihiko Noda, had bipartisan support in April last year when he pledged to double the consumption tax in recessionary conditions. Even the charismatic Junichiro Koizumi – he of the Elvis impersonations and world-class haircut – paid lip-service to the necessity of a tax increase.
So it is entirely in character for Japan’s policy-making establishment – including, apparently, Mr Abe’s own finance minister – to clamour for Mr Noda’s fiscal tightening to be implemented as scheduled. This is despite the horrible precedent of 1998; despite the UK example, which shows how contractionary fiscal policy weakens the effects of quantitative easing; despite the fact that post-2008 there has been not a sniff of sovereign debt crisis (in monetary terms the countries of the eurozone periphery are no more sovereign than Detroit).
Not just the establishment is at fault. Japan’s populist press loves to hyperventilate about the country “going bust”, as do some respectable business magazines. In reality, Japan is the world’s largest creditor nation. But such is the power of the narrative that an analyst whose claim to fame is a decade of wrong-headed predictions of bond market apocalypse has just been elected to the Diet.
The idea that Japan has “too much debt” is easy to propagate. The idea that it also has too many assets, in other words that its balance sheet is too large for the scale of the economy, is harder to grasp. The policy implications are very different, too. The right solution is belt-loosening, not belt-tightening; fewer savings and more consumption. Rather than taxing household spending, the government should be targeting the mountains of idle cash lying on corporate balance sheets and promoting higher wages and dividend payouts.
Mr Abe is the first Japanese politician to grasp the overwhelming necessity for reflation, which is why he won a landslide victory in December and triggered the most powerful stock market rally in 50 years. It would be tragic – for himself, for Japan and for the prospects of global reflation – if he were to follow in the footsteps of the late Hashimoto.
Nobody knows the exact formula for leading an economy out of 15 years of deflation, but the probability of success is almost certainly higher if monetary and fiscal policy pull together, rather than in opposite directions. Mr Abe is due to decide in September. Suspending tax rises until nominal gross domestic product growth has reached his target of 3 per cent for three successive years would send a clear signal that reflation is his overriding priority.
Consumers, mortgage holders and job-seekers would surely raise a glass of good cheer to that.
The writer is a Tokyo-based analyst at Arcus Research
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