Download Discretionary Fiscal Policy in Japan

Discretionary Fiscal Policy in Japan
Trying to jumpstart the economy
1991–6
After experiencing an average annual economic growth rate of nearly 4 per cent from 1980 to
1991, it was a shock for the Japanese when the growth rate plummeted to 1 per cent in 1992,
followed by a mere 0.2 per cent in 1993.
In response to the slowdown, the Japanese government injected into the economy a sequence
of five public spending packages over the period 1992–6 totalling ¥59 500 billion (£330
billion): an average increase in government spending of 7 per cent a year in real terms. There
were also substantial cuts in taxes. This, combined with the economic slowdown, moved the
public-sector finances massively into deficit. A general government surplus of 0.8 per cent of
GDP in 1992 was transformed into a deficit of over 5 per cent of GDP by 1996 (see the table
below). Japan’s general government debt rose from 68.7 per cent of GDP in 1992 to 93.9 per
cent by 1996.
In addition to this fiscal stimulus, the government reduced interest rates nine times, to a
record low of 0.5 per cent by 1996. It also pursued a policy of business deregulation,
especially within the service and financial sectors. Yet despite all these measures, it was not
until 1996 that significant economic growth resumed (see the table).
Why did such an expansionary fiscal (and monetary) policy prove to be so ineffective? The
answer can be found in the behaviour of the other components of aggregate demand.
In previous decades, the prosperity of Japanese business was built upon an export-led growth
strategy. If there was a lack of demand at home, surplus capacity in the economy could
simply be exported. But this option was no longer so easy. Since 1985 there had been a
massive appreciation of the exchange rate: the yen rose by over 150 per cent against the US
dollar in the ten years up to 1995. This, plus growing competition from other Asian exporters,
meant that Japanese firms were finding it harder to export.
As far as investment was concerned, the slowdown in the economy and sluggish export sales,
plus high levels of debt from the expansion of the late 1980s, reduced profits to near record
lows and created a climate of business pessimism. After increases in investment averaging 10
per cent per year from 1987 to 1990, investment fell for three successive years after 1991.
Japanese macroeconomic indicators: 1980–2006
1980–91 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
% Annual growth
in real GDP
General government
budget balance: % of GDP
3.8
–1.1
General government debt:
% of GDP
Inflation
Exchange rate index
(2000 = 100)
2.1
32.9
1.0
0.2
1.1
1.9
2.6
1.4 –1.8 –0.2
2.9
0.4
0.1
1.8
2.3
2.7
2.8
0.8 –2.4 –4.2 –5.1 –5.1 –4.1 –5.9 –7.5 –7.7 –6.4 –8.2 –8.0 –6.3 –5.2 –5.2
69
75
80
88
1.7
1.3
0.7 –0.1
95 102 115 129 137 145 154 160 168 172 175
0.0
1.7
0.7 –0.3 –0.8 –0.8 –0.9 –0.3
0.0 –0.3
0.7
60.1 74.3 86.4 92.5 80.6 77.1 80.0 91.9 100.0 92.3 88.4 91.4 95.3 92.4 86.8
Consumers too were in a pessimistic mood. Even with a ¥5000 billion cut in taxation in 1994,
consumer spending on domestic goods and services grew only marginally, whereas saving
increased sharply, as did imports.
Even though the total fiscal stimulus over the period was large, the incremental nature of the
government’s action failed on each occasion to stimulate business and consumer activity to
any significant degree.
1997–
The recovery of 1996 was short lived. With other countries, such as Thailand and Indonesia,
experiencing a large economic downturn in 1997, and with a growing mood of pessimism
across the region, the Japanese economy plunged into recession. By 1998, amidst bank
failures and speculative outflows of money from the country, the Japanese economy was in a
state of crisis. The government’s response was once more to resort to fiscal policy.
A ¥16 000 billion (£80 billion) expansionary fiscal package in April 1998, was followed six
months later by another package worth ¥24 000 billion (£120 billion). This second package
included over ¥8000 billion on public works projects and cuts in the maximum rate of income
tax from 65 per cent to 50 per cent (worth ¥4200 billion) and substantial cuts in corporate
taxes. One novel feature of the package was the distribution of shopping vouchers to 35
million citizens: the elderly and families with young children. These free vouchers were
worth ¥700 billion (£3.5 billion).
One of the biggest problems in stimulating the economy was the very high marginal
propensity to save. Given the continuing pessimism of workers about the security of their
jobs, many people responded to tax cuts by saving more, especially given that prices were
stable or falling and hence the value of money saved would not be eroded by inflation. Even
the shopping voucher scheme had limited success, as people used them to replace existing
expenditure and saved the money that they no longer needed to use.
Another problem was the mood of businesses. With banks collapsing under the weight of bad
debt, with loans to industry consequently cut, with Japanese companies eager to cut costs,
and with business pessimism about consumer and export demand, investment was being cut
back. Reductions in business taxes were not enough to reverse this.
A modest recovery was under way in 2000 (see the table), but in 2001, with the USA slipping
into recession and with the European economy slowing down, Japanese exports began to fall
and a mood of pessimism rapidly returned. The government had hoped that supply-side
reforms to make the economy more competitive would work, but these are long-term policies
and the problem was immediate.
So what could be done? The answer was very little. With interest rates of virtually zero, there
was little scope for an expansionary monetary policy, and with a general government deficit
of over 6 per cent and a national debt of over 140 per cent of GDP and rising, there was now
little scope for fiscal policy either. All that could be done was to wait for the recovery in the
world economy and for the supply-side reforms to begin to work to make Japanese industry
more competitive.
By 2003, the Japanese economy at last seemed to be recovering and for the next three years
managed to achieve moderate economic growth (but with a decline in output in the last half
of 2004). But consumer spending remained hesitant and a persistently high value of the yen
curbed a growth in exports. Nevertheless, the growth in the economy, and signs at last of a
positive rate of inflation, persuaded the Bank of Japan to raise interest rates from 0% to
0.25% in July 2006 (see also).
Question
If tax cuts are largely saved, should an expansionary fiscal policy be confined to
increases in government spending?