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Wednesday, May 13, 2009

Going back to Mr. Keynes


James M. Buchanan, a renowned anti-Keynesian economist, has attributed the fall of the legendary city of Camelot associated with King Arthur to gross intellectual errors. Camelot is an ideal city that appears in a chivalric tale. But legend has it that it collapsed because the inherent nature of human beings is not good.

In his 1979 book titled "The Consequences of Mr. Keynes," Buchanan criticized not only politicians but also Keynesian economists. Like Camelot, during the late 1970s when Keynesian economics was wielding a strong influence, the advanced capitalist nations were forced into huge fiscal deficits. Buchanan says the plight of the British government can be traced to its blind following of the Keynesian fantasies. Buchanan said that the British government was ruled by an intellectual elite who utilized "persuasion" as they wished.

During the past few months, however, after the bankruptcy of Lehman Brothers led to a credit crunch and a drastic fall in demand for goods and services on a global scale, the predominant view of economists the world over has started moving in a direction that is diametrically opposed to what had been taught by Buchanan.

A notable example of this shift is found in the agreement reached among the leaders of 20 industrialized and developing nations in London on April 2, calling for implementation of the Keynesian principle of drastically boosting government spending to prevent the recession from expanding into a global depression.

Those economists who had taken negative views on the effectiveness of increased fiscal spending have started saying, though somewhat inarticulately, that there is no choice but to rely on increased government spending at a time when the financial system is paralyzed. In my view, however, restoring the sound financial system should be given priority.

John Maynard Keynes wrote in his 1936 book "The General Theory of Employment, Interest and Money" that even though businessmen think they are free from intellectual influence of any kind, they are normally slaves of a certain economist of the past. Similarly, the politicians, bureaucrats, businessmen and journalists during the administration of former Prime Minister Junichiro Koizumi were slaves of Milton Friedman. Today, however, these same people have become slaves of Keynes.

The resolution of problems related to nonperforming loans held by many banks in the days of the Koizumi administration and the five years and nine months of economic boom from February 2002 to October 2007 were hailed as results of the Koizumi's structural reform and market-oriented reform.

In reality, however, the economic boom was brought about primarily by direct actions taken by the government, such as the near-zero interest rate policy, the injection of huge sums of public money into banks, and the large-scale intervention in the foreign exchange market in 2004 to lower the value of the yen currency vis-a-vis other major currencies. Nonetheless, those who follow the market principles heaped praise on what they called market-oriented reform policies.

During that period, public works spending decreased and it appeared that the Keynesian formula of boosting the economy through increased government spending had become a thing of the past. The drop in public works projects added to the economic predicaments of local economies that had relied heavily on such undertakings, widening the economic disparities between metropolitan and rural regions. Moreover, the number of "nonregular" workers shot up drastically following the easing of regulations governing the dispatch of temporary workers in March 2004. All these have contributed to making the expression "society with economic gaps" popular throughout the country.

Market fundamentalists have responded to all this by asserting that the income disparity among individuals motivates people to work hard. On that basis, they call for easing the progressive income tax rates and lowering the minimum taxable income level. These arguments were played up by the mass media and accepted by a majority of citizens until the summer of last year.

Japan was particularly hard hit, however, by the global economic crisis triggered by the collapse of Lehman Brothers. During the final quarter of calendar 2008, its economy recorded an annualized negative growth of 2.1 percent, the worst since the oil crisis of the 1970s. The outlook for 2009 is also dismal as the national economy is forecast to contract by more than 3 percent.

Why is it that Japan, which had been regarded as suffering least from the subprime loan crisis, has ended up with suffering more than any other country? The answer is simple: Japan has been too dependent on exports.

Faced with "the most serious crisis in a century," all that economists could do was call for stepped-up government spending and easy money. Government spending is typically related to public works projects like road and bridge construction and land reclamation. I strongly hope, however, that any such projects, which inevitably involve the pain of additional fiscal deficits, will not be a source of regret. In spending more, the government must avoid projects that serve no practical purpose or that would be detrimental to the environment. Otherwise it would be just like digging holes and then filling them. The money should be used for such purposes as promoting power generation using solar, wind or biomass energy sources, and popularizing low pollution automobiles.

Even if government spending for these purposes, including offering tax incentives through tax cuts, does not immediately help boost gross domestic product, achieve a higher economic growth rate or create employment opportunities, the projects will not be a source of regret. They will at least contribute to reducing carbon dioxide emissions and help mitigate global warming.

From this viewpoint, the Green New Deal policy pushed by U.S. President Barack Obama should be praised. From that perspective, I believe the supplementary budget bill introduced by the Japanese government to the Diet is also worthy of praise because it earmarks sizable sums of money for the environment-related projects.

In affluent industrialized countries where durable consumer goods are already nearing their respective saturation points, people who are provided jobs through public works projects would see no need to replace their electrical appliances. Instead, they are likely to save all of their incremental income to prepare for the future. The Green New Deal policy's effect of boosting domestic consumption may not be very big. However, if solar batteries, stationary fuel cells and electric automobiles spread to 10 percent of the nations' households, compared with a mere 1 percent at present, that would result in a considerable increase in domestic consumption.

In China and other emerging economies, public works projects are still major factors in shoring up the domestic consumption. If Japan provides those nations with ¥1 trillion in economic aid, it would partially lead to the purchase of products from subsidiaries of Japanese firms within those countries and this would lead to increased export of products and parts from Japan. The effect of such Japanese economic aid increasing domestic demand in Japan is likely to be greater than the effect of the same amount of government money spent inside Japan.

All this leads me to believe that the Keynesian fiscal policies of the future must be pursued on a global scale.

Takamitsu Sawa is professor at Ritsumeikan University's Graduate School of Policy Science and specially appointed professor at Kyoto University's Institute of Economic Research.


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