Pushing on a corpse


Economists are used to thinking that monetary and fiscal policy failures are important causes of economic fluctuations and weak economic growth. But in the long run sustained economic growth is driven by sound economic fundamentals, and there is nothing that fiscal or monetary policy can do to hide general economic weakness. To see that this is the case it is instructive to examine the failure of Japan’s economy over the past two decades.

 There is little doubt that fiscal and monetary policy could have been looser after Japan’s economy initially fell into recession in 1990 following the collapse of equity and property prices. Paul Krugman and others argued that the Bank of Japan’s cutting of interest rates was too slow, so that by the time deflation hit real interest rates hadn’t dropped enough to stimulate growth – the classic liquidity trap. From there conventional monetary policy is like “pushing on a string” and it is surprising how unwilling the BoJ has been to pursue unconventional policies. The Fed learned the lesson from these mistakes, cutting interest rates very aggressively in 2001 to avoid seeing that economy go into recession and deflation (before being too slow to raise rates subsequently). [DDET Read more]

 Fiscal policy too suffered from reversals in policy direction, most famously with the government assuming that the economy had recovered and raising taxes in 1997, before subsequently reversing direction. And in the early 1990s public sector net debt was not a constraint, being about the same level as in Australia and below 20 percent of GDP in 1992. Currently Japan is again discussing increasing consumption taxes, and a major worry is that this will again stifle any recovery.

 But the real issue in Japan is its weak corporate sector. The simplest number to put on this is private investment. The level of private investment in Japan in 2008 was 89 percent of 1990 levels – by comparison in Australia private investment is 267 percent over 1990 levels. Caballero, Hoshi, and Kashyap in the American Economic Review in 2008 and elsewhere describe the problem of “Zombie lending” that explains this very weak corporate performance.  I have described the basic story before, but here is an example as I described it in a piece I wrote in late 2008…

 A typical example of a Zombie Japanese firm was the retailer Daiei. Daiei is one of  Japans’ largest retailers, but it’s businesses also include real estate, finance, and leisure. After the bubble burst Daiei consistently posted large losses, and it was given two multi-billion dollar public funded bailouts in 2001 and 2002. Despite Daiei’s weak performance they enjoyed a very cosy relationship with their bank, UFJ, who continued to lend to them despite a huge build-up in non-performing loans to Daiei. These NPLs eventually forced UFJ into difficulty, though they managed to avoid restructuring until 2005, when they were forced to merge with Mitsubishi Tokyo Financial Group. It was only during this restructure that the full extent of Daiei’s bad loans were revealed, and it too was forced to restructure.

 The existence of zombie firms like Daiei makes it very difficult for more competitive firms to thrive and prosper. How can you compete against a firm that is consistently being fed public handouts? In the banking sector the giant Postal Savings bank was public owned until late last year, and was able to offer above market deposit rates because of tax exemptions and deposit guarantees that it enjoyed. As a result competition in the banking sector was reduced.

 Importantly, Caballero et. al. find that the existence of zombie firms weakens employment growth and investment in non-zombie firms as well as zombies, explaining Japan’s overall weak investment and GDP growth performance. The Koizumi government managed to finally clean up many of Japan’s Zombies, so that by the time of the GFC Japan’s banks and many corporates were in reasonable shape. In the retail sector Walmart and Carrefour entered in the early 2000s, and have in recent years started to make profits. But reform has been very slow. A prominent example of a zombie still being fed is Japan Airlines.

 How to deal with zombies depends on the particular causes of zombie difficulties and the balance sheet positions of relevant firms. Good examples of how to restructure banks and corporate sectors suffering from zombie like problems are described in an IMF working paper describing restructuring in Asian crisis countries in 1998 and 1999. In countries like Korea  corporate and banking sector balance sheets were decimated by the Asian crisis, and the issue was how to clean up those balance sheets – slowly, a la Japan, or much more quickly.

Are the zombies relevant to Europe or the US, or are they a purely Japanese affliction? The US airline industry and autosector, and agriculture and elsewise in Europe would suggest not. The appropriate stance for fiscal policy in Europe and the US is a valid question, but to focus on fiscal policy as the answer to long term growth ills is to ignore the fact that it is the corporate sector that drives growth at that horizon. I’m sure that some will comment that the issue in Japan was that its deficits weren’t,  and still are not big enough, but leaving aside the size of the multiplier required to explain Japan’s insipid private sector contribution to growth, the real question is what is the mechanism whereby looser fiscal policy will lead to stronger corporate investment in zombie affected industries? If monetary policy doesn’t work because it is like pushing on a string, then fiscal policy without corporate reform won’t work because its like pushing on a zombie. Hard work and won’t get you far. [/DDET]

5 Responses to "Pushing on a corpse"
  1. Are you seriously suggesting that we should take lessons (other than “don’t do this”) from the IMF’s actions in the Asian currency crisis?

  2. Andre the Australian auto sector was the example that I used in a longer piece on this. Not exactly a new economy industry. James it is an IMF working paper on reform in Korea etc. It is about what Korea did not what the IMF advised. I guess if you’re convinced that everything the IMF does is wrong then you won’t like it, but I have a more nuanced view of the IMF role in the Asian financial crisis – initially mistakes but subsequent assistance in rolling over short term debts eventually stabilised the crisis…but again, that is not what the WP is about.

  3. An interesting way to paraphrase your first sentence:

    “Macroeconomic policymakers really should have little to do when the business cycle is following its normal path. Fine tuning is unnecessary, although obviously some ongoing unobtrusive monitoring of the situation is useful. When a clear, large negative shock threatens to pull the cycle down into severe contraction, central bankers and (to the extent feasible) fiscal authorities have to intervene, and do so proactively.”

    Given we currently are experiencing a clear, large negative shock what is your policy perscription?

    PS: The exerpt is from an excellant speech by Adam Posen (member of the external member, monetary policy committee, Bank of England). He concludes “my main analytic point is for people to stop thinking of ‘turning Japanese’ as a syndrome… we should think of Japan’s Great Recession as largely demonstrating the validity of much textbook, even old fashioned Keynesian, macroeconomics – and thus amenable both to comprehension and, within limits, avoidance, or at least amelioration.”



  4. I don’t buy that. If macroeconomics is JUST about bog standard monetary and fiscal policy then it is OK. But the point is that macroeconomics should be about understanding the overall performance (or non-performance) of the macroeconomy. As I argue above this has little to do with fiscal and monetary policy and is instead mostly to do with productivity, competition, and corporate balance sheets in Japan. If for reasons related to these issues the economy is malfunctioning then surely macroeconomic advice ought to be to fix it. Not to just assume that monetary and fiscal policy is the whole story. I’m reading Michael Porters book on the “Competitive Advantage of Nations” at the moment which takes quite a different perspective from the conventional macro/growth perspective on economic growth. He starts from a competitive/strategic/productivity based approach and spends a lot of time looking at industries, rather than the whole macroeconomy. I think that this is something that macroeconomists spend far too little time thinking about.

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