TOKYO – For almost two decades, Japan has been held up as a cautionary tale, an object lesson on how not to run an advanced economy. After all, the island nation is the rising superpower that stumbled. One day, it seemed, it was on the road to high-tech domination of the world economy; the next it was suffering from seemingly endless stagnation and deflation. And Western economists were scathing in their criticisms of Japanese policy.
I was one of those critics; Ben Bernanke, who went on to become chairman of the Federal Reserve, was another. And these days, I often find myself thinking that we ought to apologize.
Now, I’m not saying that our economic analysis was wrong. The paper I published in 1998 about Japan’s “liquidity trap,” or the paper Bernanke published in 2000 urging Japanese policymakers to show “Rooseveltian resolve” in confronting their problems, have aged fairly well. In fact, in some ways they look more relevant than ever now that much of the West has fallen into a prolonged slump very similar to Japan’s experience.
The point, however, is that the West has, in fact, fallen into a slump similar to Japan’s – but worse. And that wasn’t supposed to happen. In the 1990s, we assumed that if the United States and Western Europe found themselves facing anything like Japan’s problems, we would respond much more effectively than the Japanese had. But we didn’t, even though we had Japan’s experience to guide us. On the contrary, Western policies since 2008 have been so inadequate if not actively counterproductive that Japan’s failings seem minor in comparison. And Western workers have experienced a level of suffering that Japan has managed to avoid.
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What policy failures am I talking about? Start with government spending. Everyone knows that in the early 1990s Japan tried to boost its economy with a surge in public investment; it’s less well-known that public investment fell rapidly after 1996 even as the government raised taxes, undermining progress toward recovery. This was a big mistake, but it pales by comparison with Europe’s hugely destructive austerity policies or the collapse in infrastructure spending in the United States after 2010. Japanese fiscal policy didn’t do enough to help growth; Western fiscal policy actively destroyed growth.
Or consider monetary policy. The Bank of Japan, Japan’s equivalent of the Federal Reserve, has received a lot of criticism for reacting too slowly to the slide into deflation and then for being too eager to raise interest rates at the first hint of recovery. That criticism is fair, but Japan’s central bank never did anything as wrongheaded as the European Central Bank’s decision to raise rates in 2011, helping to send Europe back into recession. And even that mistake is trivial compared with the awesomely wrongheaded behavior of the Riksbank, Sweden’s central bank, which raised rates despite below-target inflation and relatively high unemployment and appears, at this point, to have pushed Sweden into outright deflation.
The Swedish case is especially striking because the Riksbank chose to ignore one of its own deputy governors: Lars Svensson, a world-class monetary economist who had worked extensively on Japan and who had warned his colleagues that premature rate increases would have exactly the effects they did, in fact, have.
So there are really two questions here. First, why has everyone seemed to get this so wrong? Second, why has the West, with all its famous economists – not to mention the ability to learn from Japan’s woe – made an even worse mess than Japan did?
The answer to the first question, I think, is that responding effectively to depression conditions requires abandoning conventional respectability. Policies that would ordinarily be prudent and virtuous, like balancing the budget or taking a firm stand against inflation, become recipes for a deeper slump. And it’s very hard to persuade influential people to make that adjustment – just look at the Washington establishment’s inability to give up on its deficit obsession.
As for why the West has done even worse than Japan, I suspect that it’s about the deep divisions within our societies. In America, conservatives have blocked efforts to fight unemployment out of a general hostility to government, especially a government that does anything to help Those People. In Europe, Germany has insisted on hard money and austerity largely because the German public is intensely hostile to anything that could be called a bailout of southern Europe.
I’ll be writing more soon about what’s happening in Japan now, and the new lessons the West should be learning. For now, here’s what you should know: Japan used to be a cautionary tale, but the rest of us have messed up so badly that it almost looks like a role model instead.