Monday, August 31, 2009

Japan's Bloodless Coup: Devolution of the Export/Central Planning Model

The ousting of the ruling party in Japan's election spells not just change in politics but the devolution of its entire model of national wealth-building: the export/central planning model.

The news out of Japan will be reverberating for years to come. Here are three cogent summaries:

Rise of a New Era in Japan (

Japan's ruling party suffers major election defeat

The Democratic Party of Japan (DPJ) has vowed to shift the government's focus to boosting domestic demand, rather than the Liberal Democratic Party's (LDP) traditional emphasis on supporting businesses and industry. The DPJ has promised to pay cash allowances of more than $3,000 per child to families, abolish highway tolls, make public high school tuition-free and provide more social programs -- all while postponing a hike in the country's 5% consumption tax even as Japan is struggling to keep its nascent economic recovery on track.
Analyst Christopher Wood of CLSA Asia-Pacific and author of the Greed & Fearnewsletter, courtesy of correspondent Craig M.:

The reason why this election [in Japan] is significant is because the DPJ is running on a manifesto which appears to be the complete opposite of the established LDP policy in place since the end of the Second World War. This is because the DPJ manifesto, which is in fact quite impressively detailed, is all about promoting domestic demand; whereas the LDP has been all about subordinating the interest of the consumer to Japan’s export driven economy where there was tight nexus of interest between the so-called “iron triangle” of big business, the bureaucracy and the long ruling political party.

"One of the most dramatic for GREED & fear is the [DPJ] proposal to introduce a minimum wage of ¥1,000/hour whereas many people are earning ¥800/hour or less. Another interesting policy proposal is a plan to pay a benefit of ¥26,000 per child per month up to the age of 15; a move obviously designed to improve Japan’s depressed birth rate. A third proposal is to ban manufacturing companies from employing temporary labour in factories.

"It is also the case that political funding in Japan is also provided by the government in proportion to the election results. For such reasons, there is even the risk that the LDP, in an incredible disappearing act, literally implodes as an organization on a four year view given its only raison d'ĂȘtre is to exercise power. correspondent Craig M. added this interpretive note:

The impact on the USD as Japan moves away from an export-driven economy to a domestic-driven economy will be significant. A DJP government would most likely stop accumulating US Treasuries and would likely start selling them to fund domestic programs. This is likely USD negative and gold positive.

There will be consequences, and none larger than the devolution of the export/central planning model which Japan pioneered and which many nations have copied.

The export/central planning model is simple: the national means of production are focused on manufacturing goods for export via a public/private partnership in which corporations, banks and central government planners essentially allocate capital and incentives to suppress domestic consumption in favor of export growth. The goal of course is to generate large trade surpluses.

"Free market capitalism" is left to the domestic economy, while a ruthless partnership of crony capitalism and merchantilist government policy conquers global markets and exploits other nations' free-trade policies.

The Japanese perfected this model and reaped the rewards--stupendous growth and trade surpluses/profits, until the export/central planning machine over-reached in the late 1980s and created gigantic bubbles in Japanese real estate and stocks.

Once these bubbles burst, the intrinsic limitations of the export/central planning model became visible. Without true domestic demand unfettered by central planning disincentives and the dead-weight of crony capitalism, export profits remained in the hands of global corporations while the central planners squandered trillions of yen attempting to create domestic demand via building bridges to nowhere.

Like all central planners (i.e. the Federal Reserve and the Treasury), the Japanese ministries believed that a few policy tweaks and some face-saving "adjustments" to mountains of bad debt would do the trick.

Alas, two decades of devolution and falling personal incomes have proven them wrong.

Transparency has no place in central planning. The major banks were crippled with massive bad debts, yet the planners moved glacially to force write-offs and renunciation of impaired debt. Even now, no one really knows how much uncollectable debt remains on the books in Japan, Inc.

One reason is cultural. Declaring a bank insolvent is a major loss of face for everyone involved. Thus the preferred solution was to keep "zombie banks" alive as a face-saving measure.

The tricks used were plentiful and clever. Say a commercial real estate loan went south and the borrower stopped paying. Hmm, that looks bad; why not loan the firm more money, as long as they agreed to use part of it to make some token payments which would allow the bank to keep the loan off the "in default" ledger?

Never mind the additional loans only made matters worse; face was saved and time was bought.

After 20 years of malaise, the citizenry's patience finally ran out. Things are dire for the Japanese economy and nation: the birth rates have fallen dramatically, social security costs on the exploding elderly population are climbing, and an entire generation of younger workers has been relegated to dead-end part-time jobs at 7-11. Like other global manufacturers, to remain competitive Japan's firms moved production to China and other parts of Asia; automation in Japanese factories eliminated many of the remaining domestic jobs.

These structural changes would have occurred even if Japan had moved away from the export model, but the reliance on exports and a sclerotic, crony-capitalist/central ministry oligarchy made the problems much worse.

All nations which have relied on the same export model are suffering the same consequences. China has dodged the recession by spending 30% of its GDP in a gargantuan stimulus program; nonetheless the same structural flaws in the crony capitalist/ central planning model are eroding China's prosperity, too. That devolution is currently being masked by the stimulus but the cracks will start showing by mid-2010 if not sooner.

Export-dependent Germany has also papered over its structural and demographic ills with domestic stimulus, and just as in China the modest "recovery" in global demand as governments spent $5 trillion in borrowed stimulus have boosted the hopes of the exporter/ central planning Plutocracy that exports will climb back to their previous heights and a staggering welfare state will somehow wean itself from enormous deficits.

2010 will see the further devolution of the export/central planning model, in Germany and every other export-dependent economy. Japan, the first exporter to suffer the inevitable consequences of a dependence on exports and trade surpluses, has finally begun the painful process of rebalancing the economy to demographic and financial realities.

There are no easy options. Japan's demographics are unfavorable, and increasing births over the next few years won't resolve that. The same can be said of all developed nations and China as well.

The new party claims it wants to stop relying on deficit spending funded by selling bonds--Japan's national debt is already 185% of GDP, almost three times' the U.S. rate--but it also refuses to raise taxes. It plans on reducing the deficit by cutting bureaucracy and worthless public-works projects. Unfortunately, both of those sacrifical lambs have large constituencies who have what I term asymmetrical stakes in the game: overwhelming incentives to fight to the last breath to retain government spending as is, regardless of the destruction that will wreak on the nation as a whole.

It's fun to govern in expansion--there's more of everything to give away. But governing in devolution and contraction is a lot more difficult and considerably less fun. Let's wish the DPJ well.

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