The Recession Buzz ... in Japan

By WILLIAM PESEK
January 10, 2008

As economists buzz about a Japanese recession, officials in Tokyo are racing to assign blame.

An unfolding global slowdown is the most mentioned excuse. Fallout from the American subprime debacle is a close second. Surging oil prices also are being held up as an ominous force imperiling Japanese prosperity.

Yet if the second-biggest economy contracts this year, it will have only itself to blame. The list of self-inflicted wounds includes clumsy policies that over the last 12 months slammed Japan's construction and consumer-lending industries and a pension scandal that dented household confidence.

Those missteps, as damaging as they were, pale in comparison with the biggest failing: Complacency. Officials in Tokyo have done little to make this recovery self-reinforcing, leaving Japan highly vulnerable to slowing global growth.

Japan is hardly alone in shooting its economy in the foot. Ten years after the Asian crisis, for example, the region remains too reliant on exports for growth. From Seoul to Bangkok, Asia is awash in instances of policy failures that may imperil the region's ability to withstand a global recession.

Take the generals who ousted the prime minister of Taiwan, Thaksin Shinawatra, in a September 2006 coup and then spooked investors with unsteady policies. In South Korea, attempts to restrain surging property prices and redistribute national wealth drove away foreign investment.

Malaysia isn't using today's good times to tweak a 37-year-old affirmative action policy that gives preferential treatment to ethnic Malays and hobbles the economy's competitiveness. The Philippines isn't doing enough to attack corruption, Indonesia isn't upgrading infrastructure, and Taiwan's leaders are mired in political squabbling.

China put off slowing its economy to avoid overheating and has been slow to address a worsening pollution problem. India hasn't reduced its staggering bureaucracy or altered its restrictive labor laws.

These are but a few examples of how Asia hasn't used strong growth in recent years to remove the headwinds holding back living standards. Policy makers will regret not acting more boldly as America loses speed.

America doesn't get a pass from responsibility. A decade ago, it lectured Asia on strengthening financial systems and becoming more transparent. Troubles in credit markets exposed cracks in American-style capitalism, sending contagion Asia's way.

Yet for all its efforts to shore up its economies, Asia hasn't prepared for this day. While the region has come a long way since the late 1990s, it has much further to go.

Japan's woes will come as a disappointment to investors expecting big things from the longest post-war recovery.

While global growth gets most of the credit, the upgrades championed by Junichiro Koizumi, prime minister between 2001 and 2006, helped turn things around. As growth returned, though, reform fatigue set in and Mr. Koizumi's drive to get the government out of the economy and boost Japan's competitiveness lost momentum.

The one-year tenure of Mr. Koizumi's successor, Shinzo Abe, accelerated the return of Japan Inc. By the time Mr. Abe resigned amid scandals and general incompetence, the old practice of cross-shareholdings between companies and takeover defenses were back in vogue.

Many of the needed reforms have been sidelined, from boosting productivity and importing foreign labor to increasing entrepreneurship. The same is true of efforts to scrap Japan's dependence on near-zero interest rates, massive public borrowing, and a weak currency. The current prime minister, Yasuo Fukuda, is too preoccupied with halting the drop in the ruling-Liberal Democratic Party's popularity to tend to the economy.

A return to the crisis days of the late 1990s is unlikely. Japan's banking system is stable and companies have done considerable restructuring. Still, Japan has yet to defeat deflation at a time when options are limited.

"Unlike the three major business-cycle downturns that preceded this one, neither fiscal nor monetary policy are available to soften or shorten the decline," says Carl Weinberg, chief economist at High Frequency Economics Ltd. in Valhalla, N.Y.

Crude oil prices near $100 per barrel pose an additional challenge. "The nature of the latest threat to the cycle is particularly problematic for the Bank of Japan, as it faces the risk of input cost-driven inflation, while real demand is under downward pressure," says Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo.

Japan failed to use five years of decent growth to rein in a public debt the government says will reach 147% of gross domestic product by March 2009. BOJ Governor Toshihiko Fukui failed to normalize monetary policy. Japan's benchmark lending rate is 0.5%, by far the lowest among major economies.

That might be fine if consumers were responding to growth as hoped. The key to making Japan's recovery self-reinforcing is getting households to spend more. Elected officials are offering households little confidence that their economy won't be eclipsed by China and India in the decades ahead. Nor are workers convinced that companies will share more of their profits. Wages slid 0.2% in October from a year earlier.

Such failings will become more obvious if the storm on Asia's periphery closes in. That would have Asia wishing it had fixed its leaky roof when the sun was shining.

Mr. Pesek is a columnist for Bloomberg News.

Correction from January 11, 2008:

Thailand is the country of which Thaksin Shinawatra was prime minister before being ousted in a September 2006 coup. The country was misstated in an article on page 9 of yesterday's Sun.

The Recession Buzz ... in Japan

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