In the 1960s through the 1980s, the former World War II Axis countries of Japan and Germany were the engines of world economic growth. Since 1990, both countries have endured lengthy recessions, their economic systems sneered at by U.S. commentators. Both countries face crucial elections in September amid signs of economic revival. Should we remove their economic models from the trash can?
Both elections are pivotal. If they go wrong not only should you leave the countries’ economic models in the trash can, but you might as well set fire to the trash can. In Germany, Chancellor Gerhard Schroeder has maneuvered an early election, because he believes he can no longer continue a public sector “reform” process that appears essential if Germany’s social costs are to be contained as the population ages. He has huge opposition within his own party, a new party to the left that is doing well in the opinion polls, and a center-right Christian Democrat opposition, feebly led by ex-East German Angela Merkel, that is only marginally capitalist.
The opposition had been expected to win an overall majority, but this is no longer certain. Should they fail to do so, there is still the option of a Grand Coalition between the Christian Democrats, the reformist wing of Schroeder’s Social Democrats and possibly the pro-market Free Democrats. However previous experience in 1966-69 demonstrated that such a coalition has a huge downside risk: if it pursues unpopular, economically reformist policies dissent becomes concentrated in parties of the extreme, either of the left or the nationalist right. Thus any result short of an outright Christian Democrat majority will indicate economic danger ahead, certainly in the long term and very possibly in the short term.
In Japan, prime minister Junichiro Koizumi has pursued a policy of cautious reform, reining back public spending, particularly on infrastructure, which had been allowed to spiral out of control under previous governments. At its peak Japanese public sector infrastructure spending was 7 percent of Gross Domestic Product, twice the level of the next most spendthrift country, France. In a Western political system, Koizumi, still fairly popular, would have been allowed to remain in power for a decade or more, renewing his electoral mandate every few years. Thereby his cautious but reformist approach would by the end of the decade have paid such clear economic dividends that there would be no possibility of a return to former follies – just as Margaret Thatcher’s policies, even though they suffered heavy blows from her 1990 ousting and the Tories’ 1997 defeat, live on in many ways under Tony Blair.
In Japan, the political system does not work that way. Koizumi is forced by the internal rules of his Liberal Democrat Party to retire in autumn 2006, after only 5 years in office. The party’s obscurantist pork-barreling barons will then have the opportunity to regain power, wholly or partially, and thereby reverse the progress Koizumi has made, spending the “fiscal dividend” from Japan’s renewed economic growth on yet more rural bridges to nowhere. Seeing his political mortality, Koizumi pushed forward the privatization of the Japanese postal system (which funds much of the wasteful public spending), after the defeat of which he called an election, in the hope that reform elements in both the LDP and the opposition Democratic Justice Party will together achieve enough strength for postal privatization to proceed.
Should Koizumi win the election and push through postal privatization, a major part of the public sector’s funny money system will be cut off. A victory should also give him enough political strength to ensure that his successor is a follower of approximately his own policies (or even possibly enough strength to carry on as prime minister after 2006, though the forces of convention opposing that are very strong.) His main problem is that the term “win” is ill-defined to say the least: does he want lots of new LDP members of the Diet, many of whom may well be anti-reformist, or a stronger DJP, which will be out of his control and owe him no allegiance?
September will thus show in both Japan and Germany whether economic recovery can continue, with benign electoral outcomes being possible but by no means certain in both cases. However it’s worth asking: what are the characteristics of the Japanese and German economies that (outside lengthy recessions caused by bad public policies) make them work so effectively? Given their success, why are the German and Japanese economies subject to such disparagement by economists from the Anglo-American free market school, particularly those who support the easy money policies of the Alan Greenspan Federal Reserve and the tax-cutting, fiscally lax George W. Bush administration?
Fiscal discipline is certainly not part of the German success story, or of the Japanese. According to figures published by the Organization for Economic Cooperation and Development, general government outlays (central and local) were flat at around 35 percent of GDP in the United States in the two decades 1985-2005, and declined from 46 percent of GDP to 43 percent in Britain. In Germany they increased from 45 percent of GDP to over 50 percent in 1985-95, and have declined only slightly, to 48 percent of GDP, since then. In Japan, public spending increased steadily from 31 percent of GDP to 38 percent in 1985-2002, then declined marginally to around 37 percent over the next 3 years. The reasons for this lack of discipline – the lengthy 1990s Japanese recession and the post-1990 German reunification — are well known. Certainly the economic drag of resources transfer to their less productive public sectors explains to a considerable degree the sluggish behavior of both economies until recently.
One notable difference between the German/Japanese model and the Anglo-American model has been monetary policy. Germany has traditionally feared inflation, since the Weimar Republic monetary collapse of 1923, so its monetary policy has always been relatively tight. Since the euro came into being in 1999, not only has Germany been a force for monetary discipline, but also its inflation rate, lower than in southern Europe because of its previously stronger monetary discipline, has resulted in Euro monetary policy being relatively tight for the deflationary German economy, bringing short term and long term interest rates higher than those in the English speaking world. This resulted in a rash of bad debts in the commercial property sector in 1998-2001; it has also resulted in a total absence of a British or U.S.-style housing bubble in 2001-05. Consequently, as world real interest rates increase in 2006 and thereafter, German economic performance is likely to be relatively benign compared with others.
In Japan, the collapse of the real estate market in the early 1990s brought a period of deflation, which was approached by the Bank of Japan with the utmost caution. Only in 2003 did the BoJ begin to expand the monetary base at a rate that permitted reflation, while nominal interest rates near zero still resulted in sizeable real interest rates until late 2004. Japanese price inflation now appears near zero; with an independent monetary policy available, Japan is likely to maintain an even keel as world interest rates rise.
More plausible as a source of Japanese and German economic success since World War II are the national cultures. In both cases, in contrast to Anglo-American culture, these emphasize saving over consumption, the long term over the short term and job satisfaction through product quality over financial reward. Both countries are notable, like Britain and the United States but in contrast to Latin America or Southern Europe, for a high level of probity in their business dealings.
Middle class savings in particular are central to the long term German and Japanese economic success stories. The German “savings rate” in 2004 was lower than in recent years at 9.4 percent, but that is still several times the U.S. rate. More broadly, including corporate cash flow (but excluding depreciation) in 2002 Gross National Savings as a percentage of Gross National Income was 20.31 percent in Germany, 27.24 percent in Japan (down from 33.24 percent 10 years earlier) but only 14.41 percent in the United States and 14.48 percent in Britain.
Contrary to Anglo-American sneers, both Germany and Japan have seen considerable entrepreneurship over the past half century, but the goals of entrepreneurs are different to those in the U.S. or Britain. Anglo-American entrepreneurs, particularly since 1980 have sought primarily to achieve wealth, through growing the business rapidly and selling a substantial portion of it to public investors at a high price. While in the bubbles of the late 1980s in Japan and the late 1990s in the German Neuer Markt there was a certain amount of this, the majority of entrepreneurs in both countries have sought to create stable and long lasting family businesses, raising expansion capital if needed through a bank with which they maintain a stable relationship. In both countries’ business cultures, the claims of dynastic succession are important, and profits are reinvested in the business, not to produce a juggernaut but to increase and deepen the business’s long term market niche.
Owing to the longer time horizons of both countries’ businesses, top management is less highly rewarded than in Britain or the United States, while even in 2005 both countries’ workforces are employed on a longer term basis, and are rewarded through some form of collective bargaining. In consequence, both countries today have much lower levels of inequality than the United States and Britain.
Immigration of unskilled labor is also lower; in Germany primarily because of the natural barrier of the German language, which deters immigrants from countries outside Eastern Europe, while in Japan explicit policies discourage immigration. The result is labor forces that are much less flexible than those of the United States or Britain, which proved a handicap when both economies operated well below their potential. Before 1990, the labor management systems in both countries worked well, and it would seem likely that in a period when their economies are once again expanding the countries’ labor practices will prove a help to stable expansion rather than a deterrent to it.
In summary, Germany and Japan combine a high level of inefficiency and populism in their political structures with a considerable devotion to hard work, saving and the long term in their cultures. Without the probity and hard work, the model is dysfunctional, as evidenced by the current economic troubles of the third member of the World War II Axis, Italy. In Italy’s case, the Germanic business culture of northern Italy, which produced huge economic progress after World War II, appears to be increasingly smothered by the corruption that pervades the culture, and the endemic chaos of the political system, whose public finances combine high German levels of public spending (currently 49 percent of GDP) with high Japanese levels of public debt.
Germany and Japan are likely to see only moderate economic growth in 2006 and thereafter, but their fate may still be pleasanter than that awaiting the rest of us. Even Greenspan struck a note of caution Friday, perhaps beginning to realize that the monetary policy chalice he will hand to his successor in January 2006 is poisoned beyond redemption. Ten years of cheap money, and the accompanying stock market bubble, housing bubble, consumption bubble and government spending bubble must all now be paid for, and the process is likely to be exceptionally unpleasant.
Just as Germany and Japan became economically ossified after 1990, and needed to learn from the United States’ less restrictive labor laws and more active financial system, so in 2006 and after the United States and Britain will have much to learn from Germany and Japan. Particularly useful lessons will be the need for a much higher savings rate, the reorientation of the business system from the short term to the long term, and the reduction of excesses at both ends of the economic spectrum by tightening shareholder control of management remuneration at the top end and by restricting employment of illegal immigrants at the bottom end.
Flexibility and quick wealth aren’t everything; savings, stability, quality and the long term are important too.
-0-
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.