LONDON (Reuters) - U.S. and euro zone governments drowning in debt should look no further than Japan to learn what happens when political deadlock stifles decisive policy-making.
As Japan prepares to usher in its sixth prime minister in five years, Moody’s this week cited the political revolving door in Tokyo as one reason for cutting the country’s credit rating, to AA3, for the first time since 2002.
The conclusions to be drawn from Japan’s two decades of anemic growth come with caveats: its parties are not as ideologically divided as Democrats and Republicans in the United States; and political stasis has not led to the sort of bond market attack that felled Greece, Ireland and Portugal.
But the downgrade, which followed America’s loss of its totemic AAA rating from Standard and Poor’s, chimes with the view that the current travails of mature industrial democracies are due as much to poor leadership as they are to too much debt.
Marcus Noland, deputy director of the Peterson Institute for International Economics in Washington, traced Japan’s stagnation to an incapacity to forge the political coalitions needed to overcome entrenched interests opposed to reform.
“In that sense, the challenge that Japan has in large part failed to address over the last 20 years resembles the challenges that both the United States and parts of Europe are beginning to face,” Noland said. “The Japanese example stands as a very cautionary tale about the long-run costs of not getting it right.”
Back in 2002, Ben Bernanke argued that Japan’s losing battle with deflation was a special case, a by-product of a protracted failure by politicians, businessmen and the public to agree on how to spread the costs of writing off debt and enacting reforms.
“In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve,” said Bernanke, then a Federal Reserve governor and now its chairman.
Stephen King, chief global economist at HSBC in London, said that, with political leaders increasingly in denial and hoping that something will turn up, Bernanke’s analysis now extended more widely.
“What we are now discovering is that there are similarities between political discord in Japan and what we’re beginning to see in the States and in Europe,” King said. “If that’s the view Bernanke had back in 2002, he ought to be really worried now.”
The conventional wisdom is that Japan relaxed monetary policy too slowly to counter deflationary forces after sky-high property and share prices started tumbling back to earth in the early 1990s.
Nominal gross domestic product in Japan is back to 1991 levels, noted Paul Sheard, Nomura’s chief economist. That weighs on wages, increases the burden of repaying debt and corrodes confidence.
Western policymakers have taken much more aggressive action than Japan since the collapse of Lehman Brothers in 2008 threatened to drag down the global financial system.
U.S. banks wrote off more than $1 trillion in net assets in 2008/2009; Japan, by contrast, dragged its feet, said David Hale, who runs an international economic consulting firm in Chicago.
“Here we recognized the losses in our banking system very quickly,” Hale said. “The Japanese knew in 1992 that they had a massive problem, but it wasn’t acknowledged until 1998.”
Despite the swifter response, economic recovery in the West has been fitful. Fears of a new recession are mounting.
In King’s view, this shows that Japan’s malaise is only partly down to indecisiveness in the 1990s; it was also a result of its failure to prevent the bubble in asset prices in the first place — much as U.S. and European policymakers allowed their own bubble in housing and credit to inflate.
Seen in this light, America and Europe are in the same pickle as Japan: with current and future economic activity no longer strong enough to allow all financial claims to be settled, a way has to be found to share out the ensuing losses.
“There has to be a process of deleveraging and burden-sharing, and the problem with burden-sharing is that it’s an inherently political process,” King said.
And, as in Japan, political leaders in the United States and Europe are offering few answers. With indecision breeding uncertainty, investors have been seeking refuge in gold, the Swiss franc and, ironically, government bonds.
The risk for all three economies is that, without a clear strategy for reducing deficits over time, bond market investors will lose confidence and demand a growth-sapping premium to roll over debt — as governments on the euro zone’s periphery have discovered.
In the case of Japan, the leadership needed to rise to the challenge appears nowhere in sight, said Peter Drysdale, emeritus professor at Australian National University in Canberra.
“What could be carried in the way of economic and administrative inefficiencies in a country whose population was young and still growing, and in which the opportunities for catching up to the industrial world were palpable, now are huge dead weight burdens in a mature industrial economy with a declining workforce and population,” Drysdale wrote on the East Asia Forum website.
The 2012 presidential election might break the U.S. political impasse. Euro zone leaders might put aside their differences and thrash out a long-term plan to underpin their single currency. In Japan, a more dynamic leader might emerge in the mold of Junichiro Koizumi, prime minister from 2001-2006.
But Wendy Dobson at the University of Toronto expects instead a prolonged period of uncertainty. Global shifts in comparative advantage are worsening the distribution of incomes and wealth in major economies, prompting strong political pushback from the losers.
“Smart politics and policies will help the transitions. Strong leadership too. But with many democracies able only to produce unstable coalitions, strong leadership seems to be in short supply,” Dobson said in an email.
Reporting by Alan Wheatley