How Not to Fix Japan
Jude Wanniski
April 27, 1998


Memo To: Chairman Bill Roth, Senate Finance Committee
From: Jude Wanniski
Re: Japan’s Economy

First, I have to again congratulate you on the ingenious design of the Roth IRA, which I think is partly responsible for the boom on Wall Street. It is clearly in the tradition of Kemp-Roth in its supply-side design, essentially eliminating all taxation on the fruits of after-tax investments. I’m not sure who helped you in its legislative design -- although I hear it may have been Gary and Aldonna Robbins, both of whom came out of the Reagan Treasury Department. They are both super supply-siders.

Alas, I read the recent speech you made on the Asian economy, which you inserted in the Congressional Record of March 20. It clearly came from someone on your staff whose economics are closer to Jimmy Carter’s than Ronald Reagan’s. I, of course, agree with the general thrust of the speech, which is that Japan’s economic stagnation over the past seven years has been a drag on the Asian and world economy. I’d love to see an expansion. The four recommendations you make, though, would do very little to bring that about, and might do more harm than good.

First, you say “Tokyo must deliver a significant package of tax cuts coupled with a campaign to induce the Japanese public to use those tax cuts for consumption rather than savings.” You go so far as to suggest “a [tax] rebate in the first year to get money into the hands of the public so that they’ll be encouraged to spend rather than save.” With all due respect, Bill, this comes right out of the demand-side textbook of John Maynard Keynes.” The $50 tax rebate was President Ford’s contribution to Keynesian economics. President Carter also proposed a tax rebate. Because there is no connection with a rebate and PRODUCTION, it is exactly the equivalent of giving people money to “dig holes and fill them up,” which Keynes actually proposed at one point.

If the Tokyo government were to float bonds in order to hand out cash, the net result would be the same as in the Ford administration -- the money people used to buy the bonds would be diverted from production and the economy would get worse. There is no single idea further from Kemp-Roth or the Roth IRA than a tax rebate. Whoever gave you this idea should be given a stern lecture and a copy of The Way the World Works.

Second, you say “Japan should more quickly open its markets to foreign imports.” Because you don’t specify how they should do this, I’m not sure what your complaint is. My observation is that the Japanese economy is as open as ours to foreign imports -- but because the economy has been so weak for seven years, the people of Japan have become poorer, and thus buy less from each other and from foreign markets. In other words, Senator, it does no good for you to instruct poor people who are feeling poor to buy more from other people. The idea is also associated with the “demand-side” model that puts consumption ahead of production. Any advice you give should be aimed at making them more productive and richer, which will cause them to buy more from each other, their neighbors in Asia, and from us.

Third, you exhort Japan to “finally come to terms with its enormous, festering bad loan problem.” Your advice on this count seems to be that the Ministry of Finance should simply let “the bad banks fail,” which “deals forthrightly with the massive bad loan problem.” This is, of course, the purest “free market” solution to a bank that is theoretically bankrupt if it were to mark its assets to market. I don’t see how this would encourage the Japanese economy to become more productive. With massive bank failures, it would take several years before the people of Japan would be able to rebuild on the rubble of its crippled financial system. In 1981, when President Reagan was inaugurated, a majority of the banks in the country would have gone down if they had to mark their loans to market value. Most of the pensions of corporations and state and local governments were similarly under water, I’m sure you recall, Bill. Simply declaring massive bankruptcies from coast to coast is not what Reagan did, and if the Japanese who were then riding high recommended we let our “bad banks fail,” you would have been sorely offended.

Fourth, you say “Tokyo needs speedier -- and real -- deregulation.” Well, I can see what you mean when you talk about having them have a bigger “Big Bang” in deregulation of their financial markets than they are now scheduling. This is not going to do much for their economic prospects, Bill, anymore than our Big Bang was able to lift us out of our doldrums in the early 1970s. It was a good thing to do, and Japan should move along in that direction, but if they had the biggest bang they could manage, it would not get their economy moving.

What should they do? The Japanese economy is the equivalent of a log jam, where the removal of one log will get the other logs moving and soon break the jam up. The “bad log” is the capital gains tax on real estate. It can go as high as 57% if you sell a property held less than five years, 17% if held more than ten. Indeed, the so-called “bubble” that burst in 1990 occurred when the Japanese government raised the holding period of real property to ten years from five in order to get the lower rate. Because Japanese corporations have vast holdings of real property which they bought years ago and never marked to market, the high capgains rate caused a steady erosion of after-tax property values in these last eight years. This was reflected in the collapse of the Tokyo stock market, as the underlying values in real property declined.

The property market is now as immobile as a log jam. An enormous part of the wealth of the country is smothered by the silly capital gains tax, which produces no revenue to the government, because nobody can afford to sell when faced with high rates of taxation and nobody will buy because the economy is in a deflation. I hope you can see my reasoning here and with a little reflection will agree that none of the four things your staff suggested as remedies will have any effect on the economy. Simply eliminating the tax on capital gains would send the Nikkei up 5000 points, and the economy would be almost instantly liquefied.

I’ve discussed this with your old supply-side partner, Jack Kemp. If you’d like me to go through it with you, or your Keynesian staffer, whomever it may be, I would be happy as always to be of  help.