Friday, December 1, 2000

U.S.-Japan Relations in the Next Administration

In a speech delivered on December 1, 2000, the future director of the National Economic Council, Lawrence Lindsey, argued that the results of the 2000 Presidential Election mattered a great deal to Japan, as Republicans had a much more favorable policy towards the country than the Democrats did. As evidence of this, he noted that the Japanese stock market rose 450 points when Florida certified that George Bush won the election. Lindsey referred to the way the Clinton administration handled Japan as “a period of neglect verging on abuse.”

Lindsey accused the Clinton administration of being hypocritical. On the one hand, the administration demanded that Japan increase its government spending to stimulate its economy. On the other hand, the administration had claimed that economic growth in America had been due to its low level of budget deficits. Actually, according to Lindsey, the Clinton administration had it reversed – the high rate of economic growth in America decreased the budget deficit, as higher growth means higher government tax revenue. Higher tax revenue means lower deficits.

According to Lindsey, during the Clinton administration, the relationship between Japan and America had “been reduced to a single concept: gaiatsu, or foreign pressure on Japan.” While admitting that gaiatsu had been an important part of the relationship ever since Admiral Perry visited Japan in 1853, Lindsey argued that the Clinton administration had gone too far.

“Lectures by U.S. government officials are both loud and very public,” said Lindsey.

During the Clinton administration, much of the focus had been on the fiscal and monetary policies of Japan. Lindsey hoped that the next administration would deal with these economic issues quietly.

In contrast to what the Clinton administration wanted, Lindsey argued that Japan should reduce its government spending. Lindsey believed that Japan had suffered from large fiscal deficits because its economic growth rate had been too low. If Japan were able to increase its growth rate, that would also increase its government tax revenue which would lower its deficit.

When deciding on the proper amount of government spending, Lindsey argued that the government should spend money only if it could generate a higher rate of return on its investment than the private sector. Otherwise, the government would be diverting money from a better investment in the private sector. According to Lindsey, Japan had run out of high return investments in the public sector, and thus, it should reduce government spending which would allow the private sector to use that money.

Unfortunately, this assumes that there is no limit to the demand for funds in the private sector, and that is not true. In an economy that suffers from excess production capacity, as the Japanese economy does, reducing government spending will not cause an increase in private spending. The private sector will not spend that money because it already has more than enough factories to meet the current level of demand set by the public.

In fact, reducing government spending may result in lower private sector investment. If the government reduces its spending, that will result in the loss of public sector jobs which means that the public will have less money to spend. As consumption goes down, the private sector will get saddled with an even higher amount of excess production capacity. With a higher level of excess production capacity, the need for private sector investment drops even further.

In his speech, Lindsey admitted that a country should not run a budget surplus while in an economic slump and he admitted that reducing government spending in Japan would lead to some amount of short term economic pain. But he did have a way out of the doomsday scenario that I outlined. If Japan took the money it saved on government spending and loaned that money to America, then America could use that money to buy Japanese goods. In this scenario, overall demand for Japanese goods would not decline because America would increase its imports of those items. Unfortunately, this would hurt the American manufacturing industry. However, Lindsey believed that America would have to continue to rely on foreign capital “for the foreseeable future.” After all, foreign money had driven the expansion of the U.S. economy in the 90s.

“The current American expansion is being financed by a record setting inflow of foreign capital,” said Lindsey.

Lindsey argued that America should not use gaiatsu to get Japan to agree to his plan.

“American gaiatsu sets America up as the scapegoat for the pain, which is sure to be associated with such reform,” said Lindsey. “Our current outspoken position therefore allows Japanese politicians hostile to good Japanese-American relations to run on anti-American platforms, and do so with some credibility.”

So there you have it. America expanded its trade deficit on purpose.

Whoops.

This all works out fine until the countries who loaned us the money figure out that we don’t have the means to pay it back. Then they won’t loan us any more money. Then our economy goes down the tubes.

Whoops.

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