Believe those who are seeking the truth. Doubt those who find it. Andre Gide


Wednesday, September 25, 2013

Another look at the Koizumi boom

In my previous post, I reported on the remarkably different trajectories that consumption and investment have taken in Japan since the Asian financial crisis. Consumption has boomed at the expense of investment.
Junichiro Koizumi conducting the Japanese economy orchestra
The aggregate investment series I reported earlier included both private and government investment expenditure. The government component of investment in Japan is sizeable. In 1980, it comprised over 30% of gross fixed capital formation. (It's relative size has diminished since then.)

But as Mark Sadowski has pointed out to me, private and public investment in Japan have behaved quite differently over the past couple of decades. I want to explore this property of the data in a little more detail today.

In case you missed it, the Japanese economy experienced a sort of "boom" that roughly corresponded with the time Koizumi was prime minister of Japan. Here is a plot of real GDP in Japan from 1980 to present:


OK, so it wasn't much of a boom relative to what Japan experienced in the 1980s, but it's definitely there.

The boom started shortly after Koizumi took office and lasted for a couple of years after he left -- up until the 2008 crisis. What factors were responsible for this period of relative prosperity? Noah Smith, in a very fine post that I encourage you to read, argues that the episode constitutes a bit of a macroeconomic puzzle.

Keiichiro Kobayashi argues that the root of Japan's lacklustre performance prior to the Koizumi boom was the bad debt problem. The bad debt problem was finally dealt with by two government-backed agencies -- the Resolution and Collection Corp. (RCC) and the Industrial Revitalization Corp. of Japan (IRCJ) -- which were established to dispose of soured loans and restructure troubled corporate borrowers. Kobayashi, who was writing in 2009, also warned against "wishful thinking" on fiscal stimulus.

This latter remark drew the attention of Paul Krugman here. According to Krugman, the Koizumi boom was nothing special--it was driven by an export boom. And, of course, in a world recession, one cannot export one's way out of trouble...unless. In any case, I think Krugman is wrong in his assertion. Take a look at the first figure here. Yes, it is true that exports boomed--but so did imports. And the last time I checked, only net exports constitute contributions to GDP.

In response to Kobayashi's column, Krugman writes:
But it’s true that I’m a bit puzzled by the attribution of Japan’s recovery to bank reform. If the bank-reform story were central, you’d expect to see some “signature” in the data — in particular, I’d expect to see an investment-led boom as firms found themselves able to borrow again. That’s not at all what one actually sees.

The reason Krugman does not see the signature investment boom in the data is the same reason I did not see it in my earlier post, where I obscured the boom by lumping private and government investment together. The following figure shows a rather robust boom in private investment during the Koizumi era:



It is interesting to note that this boom took place despite the era of "fiscal austerity" over the Koizumi boom period. In particular, note the significant reduction in public sector investment and the noticeable slowdown in the growth of public sector consumption during that episode. I might add that the boom took place despite the moderate deflation  (and relatively slow growth in nominal GDP).

Moreover, the evidence does point to a resolution of Japan's bad debt problem over this period; see here:


What role did Koizumi's administration have to play in this? Read this press statement, dated September 27, 2001: Bad Loans Gone by 2004: Koizumi. Remarkable.

Addressing the bad loan problem was only a small (but important) part of the "structural reforms" implemented by the Koizumi administration; see here. Among other reforms listed here include significant cuts to public investment. Note that these cuts were presumably motivated by the belief that public investment had gone too far -- this is arguably not the right policy now in the U.S. where public investment seems to have been underfunded in recent years. Nevertheless, the experiment shows that "austerity" does not necessarily induce economic contraction and, indeed, may be consistent with helping to foster an economic boom.

PS. For academic economists, I came across this interesting paper explaining how government delay in resolving a debt crisis can prolong a slump: Nonperforming Loans, Prospective Bailouts, and Japan's Slowdown, by Levon Barseghyan.

8 comments:

  1. Great post. And thanks for the kind words.

    My guess, actually, is that Japan in 2001 had far more than the optimal level of public investment, so austerity really was expansionary.

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    1. Sounds plausible, Noah. Would be good to dig deeper in the data to find more clues. It is also not clear how expansionary that public investment boom was; the data above suggests a considerable degree of crowding out of private investment. Again, more work is needed to find out.

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  2. David Andolfatto:
    "According to Krugman, the Koizumi boom was nothing special--it was driven by an export boom. And, of course, in a world recession, one cannot export one's way out of trouble...unless. In any case, I think Krugman is wrong in his assertion. Take a look at the first figure here. Yes, it is true that exports boomed--but so did imports. And the last time I checked, only net exports constitute contributions to GDP."

    In my opinion there's evidence that exchange rates may have played a role in the export boom.

    When comparing changes in relative exchange rates one obviously wants to take into account different rates of inflation. This is especially the case with a country as unusual as Japan, where there has been virtually persistent deflation since 1995 as measured by the GDP implicit price deflator, as this almost guarantees that the yen will appreciate in nominal terms over time relative to other currencies. The following is a graph of the BOJ’s estimate of Japan’s real effective exchange rate which is trade weighted with respect to 16 different currencies and takes into account their relative inflation rates:

    http://thefaintofheart.files.wordpress.com/2013/06/sadowski2b_1.png

    Note that the real effective exchange rate increased sharply from the second half of 1998 through 1999. It plateaued in 2000 and began to noticeably drop in December 2000. Japan’s original ryōteki kin’yū kanwa (QE) was officially announced in March 2001, although there wasn’t a noticeable increase in the monetary base until December 2001.

    There was also a foreign exchange intervention that involved only U.S. dollars and ran from January 2003 through March 2004. The real effective exchange rate (which has a 25.82% dollar weight) actually rose from 104.75 in December 2002 to 106.77 in March 2004. Although the 35 trillion yen that the Ministry of Finance, (through the BOJ) spent buying dollars (and which were subsequently converted to U.S. Treasuries) was an extremely large foreign currency intervention in absolute terms (Japan is an important economy after all), it was approximately 40% unsterilized, and so was also effectively an important part of the 48 trillion yen expansion of Japan’s monetary base from March 2001 and January 2006 under QE. For those interested in the interrelationship between Japan’s QE and what John Taylor has termed the “Great Intervention” I recommend reading Tsutomu Watanabe and Tomoyoshi Yabu’s “The great intervention and massive money injection: The Japanese experience 2003-2004” (Journal of International Money and Finance, Vol. 32, February 2013, pp. 428–443) who conclude, among other things, that the unsterilized interventions during this time period had a greater effect on the yen-dollar rate than the sterilized ones.

    In any case the real effective exchange rate fell from 116.25 in February 2001 to 91.09 by March 2006, when the BOJ announced the completion of QE, a decline of 21.6%. Although the monetary base was reduced by about 24.4% between January and November 2006, the real effective exchange rate continued to fall until July 2007, but later surged dramatically towards the end of 2008 as the global Great Recession set in.

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    1. In my opinion there's evidence that exchange rates may have played a role in the export boom.

      What export boom? Take a look at the first diagram here: http://andolfatto.blogspot.com/2013/09/whats-up-with-japan-g-evidently.html

      Maybe the scale of the diagram obscures the boom. I do see what appears to be modest trade balance surpluses. Imports boomed as well.

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    2. David,
      Calm down! It wasn't my intention to disagree with you.

      Yes, I agree there was no *net* export boom.

      Exports rose from 10.2% of nominal GDP in 2001Q4 to 19.3% of GDP in 2008Q3. Imports rose from 9.4% of GDP in 2001Q4 to 19.5% of GDP in 2008Q3. From 2002Q1 to 2008Q3 real (adjusted by the GDP implicit price deflator) grew at an average annual rate of 11.0%. Real imports grew at an average annual rate of 12.1%.

      So there was boom in both exports and imports. But imports grew faster than exports, and net exports actually moved from surplus (0.8% of GDP) to deficit (-0.2% of GDP) between 2002Q1 and 2008Q1.

      So Krugman is clearly wrong when he claims the Koizumi Boom can be explained by net exports.

      P.S. This post is obviously not the post I would have written about the Koizumi Boom, but there's nothing here that I disagree with, and you have succeeded in finding still more important evidence (all new to me) helping to explain the "puzzle" of the boom. I especially enjoyed the Paul Krugman smackdown. Krugman clearly made a series of errors in his analysis (in particular when he measured net exports in real terms). It's really nice to know I'm not the only one who dared to disagree with a Nobel Prize winner on this issue.

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  3. David Andolfatto:
    "It is interesting to note that this boom took place despite the era of "fiscal austerity" over the Koizumi boom period. In particular, note the significant reduction in public sector investment and the noticeable slowdown in the growth of public sector consumption during that episode."

    In my opinion the most objective way of judging fiscal policy stance is the change in the general government structural balance. The structural balance is adjusted for the business cycle and thus any changes should represent policy rather than the state of the economy. The IMF provides estimates of Japan’s general government structural balance from 1994 on so we can compute the changes from 1995 on:

    http://thefaintofheart.files.wordpress.com/2013/06/sadowski2b_4.png

    With the exception of calendar years 1997 and 2001 fiscal policy was expansionary during 1995-2003. Do we know anything about the fiscal policy stance prior to 1995? An excellent summary of the Japanese discretionary fiscal stimuli programs is Anita Tuladhar and Marcus Bruckner’s “Public Investment as a Fiscal Stimulus: Evidence from Japan’s Regional Spending during the 1990s” (IMF Working Paper No. 10/110, April 2010). Appendix Table 8 lists two fiscal stimuli for 1993 and one each for 1992 and 1994, so fiscal policy was obviously expansionary for the entire 1992-96 period. It also lists nine fiscal stimuli and three tax cuts during 1995-2002, but none during 2003-07. The fiscal tightening in 1997 is explained by the fact that Japan raised its consumption tax from 3% to 5% on April 1, 1997. The fiscal tightening in 2001 seems to have been passive. The expansionary fiscal policy of 2003 represents a carryover of the effects of the 2002 fiscal year, which ended on March 31, 2003.

    Considering that the BOJ’s call rate wasn’t lowered below 1% until July 1995 and didn’t get below 0.25% until November 1998, Japan’s fiscal policy seems a bit backwards. Away from the zero lower bound there’s absolutely no rationale for doing fiscal stimulus unless one wants to see the spectacle of competing policy levers cancel each other out, and yet Japan did eight fiscal stimuli and three tax cuts during 1992-98. On the other hand, if one truly believes in the Keynesian concept of the liquidity trap, then one would want to do fiscal stimuli when the policy rate is pinned to the zero lower bound, and yet Japan practiced five consecutive years of consolidation during fiscal years 2003-07, a time when the policy rate was never as high as 0.5%.

    David Andolfatto:
    "I might add that the boom took place despite the moderate deflation (and relatively slow growth in nominal GDP)."

    To be specific, annual NGDP growth averaged 0.5% from 2002Q1 through 2008Q1, compared with (-0.1%) from 1996Q1 through 2002Q1. So despite the fact fiscal policy went from being on balance expansionary, to being persistently contractionary, the rate of NGDP growth increased. So there was a positive if modest increase in aggregate demand (AD).

    Deflation, as measured by the GDP implicit price deflator increased from (-0.8%) to (-1.4%). The combination of increasing AD and further disinflation suggests that there was also an increase in aggregate supply (AS).

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