Thursday, November 6, 2008


A government repeatedly lowers lending rates, develops a cozy relationship with banks, and tolerates the hiding of bad loans.

A real estate bubble collapses, and banks start to buckle.

Everyone panics and government bails out the banks, spends massively on public projects, and raises taxes to pay for the new spending.

The U.S. today? No, Japan in the 1990s.

Tokyo’s mishandling of the economic crisis led to long-term stagnation, from which Japan has yet to recover, and to the loss of its place as a global economic leader. This - or worse - could be America’s fate if we get our reaction to the current crisis wrong.

While there is a veritable cottage industry of economists debating the causes and meaning of Japan’s “lost decade,” one thing is clear: It lasted much longer than it should have.

From 1976 to 1991, Japan’s gross domestic product (GDP) increased at an average annual rate of 6.5 percent. But from 1992 to 2007, it averaged only 0.6 percent per year.

There are many differences between Japan’s and America’s economic crises, but there are also several applicable lessons that we can take from Tokyo’s experience.

• First, allow the market to clear. Bailouts, subsidies and other rescue packages may ameliorate the problem in the short term, but slow economic recovery in the long run.

That’s what happened in Japan. Politicians, fearing recession, propped up banks and shielded investors from the consequences of bad decisions. Asset prices stayed artificially high, depriving investors of new opportunities. New regulations and taxes to pay for the additional spending froze the low-performing economy.

• Second, don’t hide the problem. The collapse of commercial property values in Japan left firms with huge debt that they hid from shareholders; they were still paying it down a decade after the bubble burst.

As we work to solve our crisis, we need much more transparency not only from government in whatever interventions it undertakes, but also from banks and firms in their accounting.

This won’t require intrusive new regulations. Instead, firms and banks should follow existing disclosure requirements while government is fully transparent about how its expensive programs are serving the public.

• Third, don’t expect “stimulus packages” or massive spending to “grow” our way out of the crisis. Tokyo spent on a historical scale. At one point in the 1990s, its budget deficit approached 10 percent of GDP, the equivalent here to more than the trillion-dollar deficit we expect for this fiscal year.

No matter how much Japan spent on public works or subsidized the weakest links in finance and industry, its economy refused to grow. All that spending couldn’t make up for a paucity of investment opportunity and capital frozen by high taxes, new regulations and an extremely high aversion to risk bred by the lack of transparency

• Fourth, don’t raise taxes. Japan, after spending piles of money it didn’t have, tried to deal with the budget imbalance by raising consumption taxes, which triggered another downturn.

• Fifth, keep interest rates as low as you want, but recognize that this alone will never bring the economy back. For most of the 1990s, the Bank of Japan’s discount rate was below 1 percent; so was growth.

Federal Reserve Chairman Ben S. Bernanke, like Alan Greenspan before him, may think low interest rates will provide the liquidity to grow our way out of a recession, but this likely won’t happen if high taxes, runaway spending, and frozen asset markets convince investors that the future will be worse than the present.

• Lastly, avoid the political stagnation that prevented Japan from correcting its problems. A tyranny of consensus killed any attempt at leadership in Japan. Short-term political expediency ruled the day; and when government did act, the only thing politicians could agree on was to throw more money at the problem. It didn’t work.

Notwithstanding the differences between Japan’s economic crises and our own, we are in danger of repeating some of their mistakes. Republicans and Democrats - the White House and Congress - seem to be suffering from a tyranny of consensus of their own. They believe a recession is politically unacceptable. They may do anything, regardless of long-term consequences, to stop or at least relieve short-term pain.

This is precisely when the long-term fate of an economy is most in peril. Decisions are made or not made for short-term political and economic gain, and the future health of the economy is scarcely debated.

This mentality is what brought Japan’s once mighty economy down. It could be our fate, too, if we allow our politicians to abdicate their leadership responsibilities.

Kim Holmes is vice president for foreign policy at the Heritage Foundation ( and author of “Liberty’s Best Hope: American Leadership for the 21st Century” (2008).

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