@ 2018 Annunziata + Desai Advisors, LLC

  • Marco Annunziata

Are They Mad? Japan's Austerity Lessons


They say insanity is doing the same thing over and over, but expecting different results.

Judging from recent media reports, you would have to conclude that Japanese governments are insane—or are they?


While trying to boost growth and inflation, in 2014 Japan raised its consumption tax from 5% to 8%; the economy tipped into recession. Last October, while trying to boost growth and inflation, it raised its consumption tax to 10%; the economy contracted by 6.3% in Q4.


Prominent commentators promptly accused Japan of suicidal fiscal impulse. Paul Krugman, who in a year-end New York Times OpEd, characterized the 2010s as a decade of misguided global austerity, took to Twitter to accuse Japan of “destructive austerity policies”.


According to this narrative, Japan chooses to tighten the belt and wallow in economic misery, “lost decade” after lost decade, when looser fiscal policy could boost prosperity.

This sounds insane.


But let’s take a step back.


First: How bad has Japan’s economic performance been?


Japan’s per capita GDP growth underperformed both the US and Germany during the 1990s and 2000s, but caught up with them in the last decade:



In terms of living standards, Japan has lost ground to the US; but so have other countries. The two charts below show real per capita GDP (purchasing power basis, IMF data) for the G7 countries as a percentage of US per capita GDP, in 1990 and 2019.



Between 1990 and 2019, Japan’s per capita income fell from 83% of US levels to 70%; but France lost almost as much ground (from 82% to 73%) and Italy fared a lot worse (from 84% to a mere 62%). Japan is still in the same league as France and the UK, just as before the start of its “lost decades”. Yet we don’t talk about “lost decades” for either France or the UK (Italy is a separate, sadder story.)


Second: How brutal has Japan’s austerity been?


Japan’s government deficit has averaged 6% of GDP for the past two decades. By comparison, the much-maligned Maastricht benchmark for Eurozone members is 3% of GDP; and the current 5-6% of GDP level in the US has already raised concern.



The debate on government deficits has become politically charged almost everywhere; The same fiscal deficit can be “reckless policy” or “responsible stimulus” depending on whether your favorite party is in government or at the opposition. But regardless of political views, if you’ve been running an average fiscal deficit of 6% of GDP for twenty years, “destructive austerity” is unlikely to be your gravest sin.


And when you run a large fiscal deficit for two decades, your debt piles up:



Japan’s public debt now nears 240% of GDP, far higher than any of its G7 peers (even Greece’s is lower, at a mere 177%):



The high debt ratio is the main reason why Japan is so desperately trying to lift inflation.

We have seen above that Japan’s real per capita growth, while somewhat disappointing, has not been an outlier. Given the adverse demographics, however, overall real GDP growth has underperformed:



And because of deflation, overall nominal GDP growth has lagged far behind everyone else:




Over the last quarter century, US real GDP has grown on average 2.5 times faster than Japan’s; US nominal GDP has grown nine times faster. Japan is finding it extremely hard to reduce its debt ratio by boosting the denominator.


Does it matter if the debt to GDP ratio is so high? Japan’s debt is largely held by domestic investors, traditionally a stable demand base. Moreover, a growing number of economists argue that interest rates will likely remain very low for a very long time, and that countries should take advantage of this to borrow even more.


Of course, in 2007 a large number of economists believed we had achieved the “great moderation” and the global economy would never again experience a deep recession.

It’s prudent to admit the possibility that economists might be wrong again—however shocking the thought might be.


Japan’s aging population will cause pension and healthcare costs to rise. Should debt servicing costs start rising, it could put debt sustainability at risk. Reducing the debt ratio therefore seems like a good idea. The best way to do it would be faster growth, and under Prime Minister Abe, Japan has boosted its efforts on structural reforms. These have helped, but they have not been enough yet. This is why the government has been striving to reduce its fiscal deficit.


Japan’s lesson is not that austerity kills growth; it’s that even twenty years of loose fiscal policy are not enough to sustainably boost an economy. For all the populist rhetoric against austerity, you can’t rely on loose fiscal policy forever—the bills eventually come due.

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