Krugman: The Anti-Liquidationist Manifesto

Michael Pollak mpollak at panix.com
Wed Apr 25 04:45:18 PDT 2001


April 25, 2001

Purging the Rottenness

By PAUL KRUGMAN

T he world's second-largest economy has its next prime minister, and

hope is in the air. Junichiro Koizumi doesn't look or sound like a

conventional Japanese politician. He could turn out to be Japan's

Franklin Roosevelt. Alas, judging from his platform he seems more

likely to be Japan's Herbert Hoover.

Mr. Koizumi has not given many specifics. But what he has said amounts

to a promise of blood, toil, tears and sweat or anyway their financial

equivalents. "There will be companies going bankrupt and increased

unemployment," he has admitted. "But if we are fearful of

unemployment, we will never see the recovery of the Japanese economy."

It's a hard-headed and courageous position. It is also reminiscent of

the disastrous advice given by Andrew Mellon, Hoover's Treasury

secretary: "Liquidate labor, liquidate stocks, liquidate the farmers,

liquidate real estate. . . . It will purge the rottenness out of the

system. . . . Values will be adjusted, and enterprising people will

pick up the wrecks. . . .."

What was wrong with Mellon's advice, aside from its callousness? He

confused supply with demand.

When an economy's production is limited by its capacity to produce the

normal state of affairs it is important to make sure that scarce

resources like capital are used efficiently, put to work where they

yield the highest return. Japan's postal savings system, which

channels money into public works projects that have little if any

social payoff, is monumentally inefficient; so is the practice of

rolling over the debts of companies that will never regain

profitability and hence keeping capital employed producing goods

nobody wants. So if Japan's production were limited by its capacity,

Mr. Koizumi's proposals to privatize postal savings and force banks to

write off bad loans would be right on target.

But Japan isn't limited by its capacity. It is plagued by chronic

insufficiency of demand that is, consumers and businesses are

unwilling to buy as much as the economy is already capable of

producing. And in such an economy, attempts to increase efficiency

often do more harm than good. Freeing capital by reducing the budget

deficit and closing down unprofitable businesses sounds great but if

that freed capital is simply put under the mattress (or stored in a

bank vault), the result is not faster growth but a deeper slump.

Now there are many pundits who claim that such a slump is exactly what

Japan needs, that purging the system will create the conditions for a

future surge in demand. But why? If the economy remains depressed, why

should either consumers or businesses start spending? Banks, in

particular, are already awash in cash, but cannot find good new loans

to make. Why would forcing them to write off bad old loans make any

difference?

Nonetheless, Mr. Koizumi is right about one thing: Japan cannot go on

like this. Swelling public debt will eventually threaten the

government's solvency; the festering financial problems of the banks

will soon require a government bailout that will swell that debt even

further. Something must be done. But the actions Mr. Koizumi has

proposed could tip Japan into full-blown depression.

There is an answer to this dilemma, one that has become almost

orthodoxy among economists who have tried to think seriously about

Japan's plight. This answer involves unconventional monetary

expansion, with the Bank of Japan buying dollars, euros and long-term

government bonds; it also involves accepting and indeed promoting mild

inflation and a weak yen. I could explain why this would probably

work, but what's the point? It's not about to happen.

For the real tragedy right now is that however innovative and open-

minded Mr. Koizumi may be, he will fail unless other important players

mainly the Bank of Japan, but also the U.S. Treasury Department are

prepared to learn from Andrew Mellon's mistake. And all the evidence

is that they are not. The head of the Bank of Japan insists that the

country's continuing slump is the result of inadequate reform that is,

insufficient purging of the rottenness. And although the details are

in dispute, the U.S. Treasury secretary, Paul O'Neill, appears to have

warned Japan not to let the yen weaken too much.

Poor Japan. It is the victim of those who refuse to learn from the

past, and thereby condemn others to repeat it.

Copyright 2001 The New York Times Company



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