Issues Facing the Japanese Economy in 2012 (January 2012)

What Must Be Done in 2012

ONO Goro
Senior Fellow, RIETI

Diversification of geographical sources of global economic growth

Although disruption occurred last year due to events such as the Great East Japan Earthquake, the fundamental proposition remains unchanged: we should candidly acknowledge that even the United States no longer has the power it did in its heyday, thus we should immediately start constructing an economic society commensurate within our means. Uncertainty in the euro, a stronger yen, etc., are nothing but the manifestation of what was anticipated. In 2012, we thus have no choice but to "act up to the market principle and aim at prompt financial reconstruction, while keeping the minimal safety net, in view of the next two decades at least, and being prepared to accept frictions accompanying a reduction in the scale of the economy," as I pointed out in my column, "What Must Be Done in 2011."

What have we learned from the Fukushima Daiichi Nuclear Power Plant accident?

First of all, what needs to be newly addressed then is "what have we learned from the Fukushima Daiichi Nuclear Power Plant accident?" We should bear in mind, when facing irreversible propositions such as huge systems or structural issues, the statement made by the Environment Agency in its report on four major pollution cases that "post-factum measures can cost from 5 to 100 times as much as prior prevention." The Fukushima Daiichi Nuclear Power Plant accident and the "lost two decades" are the results of making overly optimistic assumptions without utilizing the internationally acclaimed valuable lessons from the report, which are "proactive measures constitute the pivotal point of a policy" and "addressing a problem must not be postponed." If you make excuses and say that something was "beyond expectations," it presupposes that you must not repeat that excuse for the same mistake.

As a matter of fact, an important precedent from the Great Hanshin-Awaji Earthquake was overlooked as attention was paid only to its direct damage. Namely, a blast furnace of Kobe Steel Group became out of control due to total power loss, causing an abnormal rise in the pressure inside the furnace. Since there were no means to release the pressure as the entire system was automated, the furnace was on the verge of a huge explosion. The situation was similar to that at the Fukushima Daiichi Nuclear Power Plant in the recent earthquake, but a retired Kobe Steel Group engineer remembered the procedure conducted for the previously used manual system control and helped manage to reduce the pressure. Perhaps because this was an event in a "different area," there are no signs that a lesson was learned by those in the electric power industry. Although the Kobe Steel Group case was not a failure, a catastrophe caused by large systems would be repeated endlessly unless we learn from this kind of experience.

In short, for every large system, risks "beyond expectations" in a narrow sense which are not taken into account by the system in advance should be listed, and methods should be prepared for addressing them outside the system to reduce these risks in a broad sense as much as possible. This applies particularly to new and advanced systems with no past track records.

Although this may appear unrelated to the "economy," it is essential to regard the market mechanism as a large system, and to take a similar approach without overestimating its auto-adjusting function. The oil crisis, which I describe as an "industrial policy in emergency" is the precedent, and its warning—to restore Japan's fiscal health in preparation for an emergency—remains significant. The collapse of the financial markets has also demonstrated that details should be thoroughly checked in adopting unproven new systems such as new markets based on financial engineering, high-speed trading technology, etc.

Reconstructing the minimum safety net and the fundamental social framework

Second, let me point out the futility of a debate on "Keynes or Hayek," which re-emerged in debates among scholars and journalists. If both were alive, Keynes would refuse to adopt a Keynesian policy, and Hayek would prefer the reconstruction of market rules over laissez-faire.

Current phenomena—including the villain known as casino capitalism revealed by the collapse of Lehman Brothers, advanced countries' loose financial policy exposed by the euro crisis, maturity (a loss of growth potential) of leading advanced countries, including Japan which "lost two decades," and demand saturation (a "wall of demand" emerging every time a new area of demand is created) which I pointed out around 1990—are not circulation problems that can be covered up by superficial measures but instead are structural problems which cannot be postponed.

Therefore, a Keynesian policy response which emphasizes the artificial contraction of the time axis in cyclical phenomena from a macro overview is not desirable but instead is useless as it delays and distorts structural reforms. It is thus clear that the economy should be left free, except for reconstructing the minimum safety net and the fundamental social framework, until it settles down to a new steady state. This, however, is not a problem that can be left to a Hayekian market process which emphasizes trial and error and auto-adjusting from a micro point of view.

From Adam Smith to the contemporary American economic theories, economics has only been a theoretical support for tools to realize national interests and is not "value-neutral." A steady state, presupposed by contemporary theories, describes that of an old generation and not of a new one to which we are heading, and what exists in human society is not "wild freedom" but instead is "controlled freedom." In addition to this, strain was caused by directly applying a reasoning originally developed in the goods market to the production factor market. The protection of intellectual property of the type opportune to the United States thus conflicted with hackers who sought complete liberalism, and an argument for tax reform without changing perspectives, a mercantile idea of "taxing those easy to tax," e.g., raising consumption and income taxes, becomes ineffective in the Internet community.

In a policy argument, economic utility is merely an element of total utilities, and satisfying all desires, each of which is desirable individually, results in the "fallacy of composition," in which no desire is satisfied due to a financial collapse. Consequently, it should not be allowed for "desires" to be replaced by "goals" and fabricating values, formulas, and theories that fit them. Although there are opinions regarding the issue of fiscal reconstruction such as "reducing effective debt via inflation does not affect the national economy as it only entails asset transfer among domestic households," "the government should exchange yen-denominated debt and foreign currency-denominated assets to prepare for the current rise and the future decline of the yen value," etc., any of these is only a fraudulent argument which treats a complex entity having diverse elements such as "national economy" or "foreign currency" as a simple entity.

Breaking out of inertia is required

Now, all we have to do is to attempt a paradigm shift to a "greater emphasis on spiritual values," which I advocated in the paper "Cultural Industry" during the 1970s, under a "complementary relationship between the market and the government," which I advocated in the Jissenteki-sangyoseisaku-ron [Theory on Practical Industrial Policy] in 1992 and which Stiglitz and others have developed, to design the fundamental structure of a new society, and devote all policy tools leading there.

Participation in the Trans-Pacific Partnership (TPP) is also necessary for the "conversion of the social structure to one suitable to a mature society" and not for "internationalizationism" or "free market fundamentalism." Since it is natural for agriculture protectionists to oppose the latter, they should be persuaded by the argument that "the potential for protecting the areas which should be protected will be lost without an effort to improve productivity as a country by structural reform." Since this kind of regional economic open door policy is merely the industrial policy of the United States and other participating countries, Japan should naturally make use of it as "an industrial policy in light of the entire national interests" apart from "pros and cons of a protectionist policy." Globalization necessarily leads to a disaster due to an increase in entropy unless it entails diversification instead of Western-type unification.

Now, "breaking out of inertia," which I argued for in the early 1990s, is required for solving new problems with which we are confronted. This includes not only overthrowing vested interests and the old regime—"let it fail even if too big"—but also the shift of the paradigm itself on which the current theory is based.

Conclusion: In 2012, I hope people will listen to my warning from the RIETI column in 2011, and proceed assuredly with carrying them out along with additional agenda. The top priority should be put on fiscal reconstruction: there is no choice but to accept a mercantile way of thinking as the second best policy, and it should be recognized that expanding welfare, education, etc., can be fully dealt with by scrapping and building vested interests and wasteful expenditures instead of increasing budget for them.

December 28, 2011

December 28, 2011

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