Japan shows the limits of pump-priming

Hamish McRae is one of the few economic commentators to have come out of this crisis in credit. His column today on how to avoid the stagnation that has gripped the Japanese economy for the past twenty years is well worth reading. Here’s the key section but do read the whole piece:

“During the early 1990s the country escaped recession, unlike for example the UK, but the economy was flat and when the recession did come, in 1997, it was a biggie. Then until a couple of years ago it was back to stagnation. So while cheap money will help, and some increase in government borrowing is inevitable, they will not on their own fix things. Wasting money on ill-conceived public spending (which Japan did) is damaging in the medium-term.

A further mistake of the Japanese authorities was that they tried to prop up depreciating asset prices, including the stock market. They had a plan called the price keeping operation or PKO, which used public money to buy shares on the market and so stabilise the price. The joke at time was that it should not be called the PKO but the PLO, or price lifting operation.

The other major failure of Japan was to sort out its banking system. The banks were so full of bad debts, in many cases concealed, that they were unable to lend to new and more creditworthy customers. Banks have to be realistic about their bad debts and then, having opened the books, they have to get new capital so they can get back into business. The UK model of optional partial nationalisation looks a better bet than the US plan to take the bad debts off the banks into a publicly-funded pot.

So from a British perspective, we are on the right track in forcing the banks to disclose their rubbish loans and then replace their capital, if necessary by getting it from the state. But we are in danger of making the same mistake as Japan if we boost public spending to try to pump-prime the economy with a big spending programme.
The deficit will rise anyway as a result of falling tax receipts; the government has to be careful about increasing it yet further. These stories that the Prime Minister wants to try and borrow its way out of recession have a nasty ring to them, given Japanese experience.”