From Zombie Banks to Zombie Mortgages?
- SEPTEMBER 10, 2010
Japan misallocated capital during its lost decade. How the U.S. can avoid its mistakes.
By Greg Ip
Japan’s recent demotion to world’s third-largest economy, behind China, triggered two distinctly different feelings in the United States.
One was Schadenfreude. At the end of the 1980s Japan was a contender for the No. 1 spot. It was the rich world’s fastest growing big country. Its companies dominated electronics, steel, automobiles and even banking. Its political and business leaders were paragons of long-term strategic thinking, while budget and trade surpluses left it rich with cash. Meanwhile, the U.S. was on the brink of recession, its corporate managers obsessed with short-term profits and its politicians incapable of mustering a coherent industrial strategy. “Japan has created a kind of automatic wealth machine, perhaps the first since King Midas,” Clyde Prestowitz wrote in 1988. The U.S. was “a colony-in-the-making.”
What happened next, of course, is history. Japanese property and stock prices cratered, its banking system seized up, and a decade (actually, two now) of economic stagnation followed.
The second feeling Japan’s misfortunes evoked is dread. The U.S. has gone through its own spectacular property crash and banking crisis and is now mired in a painfully weak recovery. Does it face a long period of stagnation as Japan did?
Much of the U.S. policy response to the crisis has been driven by a determination to learn from Japan: the Troubled Asset Relief Program and bank stress tests were designed to keep credit flowing. The Federal Reserve’s near-zero interest rates and bond purchases, and both the Bush and Obama administrations’ fiscal stimulus plans, were meant to sustain demand while the private sector pays down debt.
These have been the right actions. Yet they too narrowly focus on the role of inadequate demand in Japan’s reversal of fortune. Japan has just as important a lesson about supply.
Supply depends on three things: population, the source of labor; capital, the source of investment; and ideas, the means by which capital and labor are recombined to make new or better products. Because of a low birth rate, an aging population and virtually nonexistent immigration, Japan’s working-age population has shrunk 0.4% per year since 1994; America’s has grown 1.2%. Japan’s postwar economic miracle was driven in great part by adapting the Western world’s best ideas. By the 1990s, though, it had largely caught up. Inevitably, a country at the technological frontier grows more slowly than one catching up to the frontier. Japanese productivity grew far faster than that of the U.S. throughout the 1970s and 1980s, but it slowed to U.S. rates in the 1990s and 2000s.
Once a country has run out of existing ideas to adapt, it must develop new ones. Creative destruction is essential to this process as companies with new ideas grow and old companies die. Japan has never been as comfortable with creative destruction as the U.S. Only 43% of Japanese have positive views of free markets, compared to 68% of Americans, according to the Pew Global Attitudes Project. In the U.S., companies start up and die at the rate of 10% to 12% per year, Toshihiko Mukoyama at the University of Virginia notes, while in Japan the share is a little over 4%. In the last decade Japan has eased some of its obstacles to creative destruction, such as restrictions on the opening of large retail stores. Yet starting a business in Japan still costs 10 times as much as in the U.S. As Masaaki Shirakawa, the governor of the Bank of Japan, put it in January: “Japan’s economic metabolism is low.”
Demographics can reinforce productivity trends, for better or for worse. As Japan’s population ages, it may have become more risk averse. By contrast, a remarkable share of Silicon Valley companies are founded by immigrants or their children. Immigration is also one reason U.S. fertility and population growth rates are among the rich world’s highest.
The U.S. shouldn’t be smug. Prolonged economic distress could undermine the attitudes responsible for U.S. economic dynamism. For example, the political winds are shifting against immigration even as labor-force growth slows because of an aging population and the leveling out of women’s participation in the work force. The crisis has demonstrated that too much U.S. wealth is tied up in houses. The mortgages that financed them now clog financial institutions’ balance sheets, starving new businesses of credit, much as Japanese banks kept lending to “zombie” companies at the expense of more promising firms. The U.S. risks perpetuating this misallocation of capital by maintaining extensive federal support for mortgages.
Fortunately, American faith in free enterprise and tolerance of creative destruction appears intact. In April 2009, at the depths of the worst recession and bear market in memory, Pew found that 90% of Americans admired people who get rich by working hard. The Obama administration has rattled business with its regulatory impulses and occasional blasts of populist rhetoric. But unlike many governments, it has tried not to stand in the way of creative destruction. Yes, it propped up General Motors, but to get the money GM had to go through bankruptcy and shear off 30% of its U.S. work force. By contrast, France lent money to Peugeot-Citroen and Renault only after they promised to preserve French jobs.
The U.S. has many of the problems Japan had two decades ago. If it’s careful, stunted supply won’t be one of them.
Mr. Ip is U.S. economics editor of The Economist. This article is adapted from his book “The Little Book of Economics: How the Economy Works in the Real World,” published by John Wiley & Sons this month.
The original article is linked here.