Thanks to JR for bringing my attention to this important development in the international regulation of the barber industry:

The government has given barbers and beauticians a break in areas affected by the March 11 earthquake, easing laws to allow them to clip and style at shelters or makeshift shops near temporary housing sites. The relaxed regulations will last for about two years beginning this month, according to the government.

The current barbers’ and beauticians’ laws ban the cutting of hair at places other than authorized shops, except for customers who cannot come shops due to illness or hairdressers who provide services at weddings. But the earthquake damaged many hairdressers’ shops and has made transportation to and from authorized shops difficult, leading to many requests from local people for the laws to be changed. This is the first time the rules on cutting hair have been relaxed for any reason.

Something important to note here is that the existing framework already included exemptions for key circumstances in which the regulations would inconvenience people. That’s better than a totally inflexible regulatory framework. But it’s also a bit of a giveaway. If a bride on her wedding day is prepared to roll the dice on getting her hair done someplace that’s not an authorized barber shop then why shouldn’t she be allowed to do so six months later? Why shouldn’t I be allowed to do it whenever I want? Surely the issue isn’t that hairstyle quality is uniquely unimportant during weddings and thus we can afford to loosen the regulation. Let’s regulate polluters and banks whose activities pose meaningful risks to innocent bystanders and let people cut hair in peace.

Given that rich country monetary policy (except in Sweden, Australia, and Canada) has been too tight for years, and it’s been especially too tight in Japan, I can’t but approve of the Bank of Japan’s decision to ease in response to the earthquake/tsunami/meltdown problems hitting the country.

That said, I think this is primarily worth thinking about precisely because of how different this set of problems is from the “normal” ones of a great recession. Japan, after all, just got hit with a series of very real negative shocks. Buildings have fallen down. Buildings that are still standing have been damaged by water. Cars, trucks, and other pieces of useful equipment have been ruined. Roads, docks, and other pieces of transportation infrastructure have been blocked by debris. Several nuclear power reactors aren’t generating electrical power. Tens of thousands of human beings are dead or injured.

These are not problems that can be solved on the demand side. If Japan is producing less two weeks after the earthquake than it was producing two weeks before the earthquake, that will be because the quake and associated traumas have in fact degraded the country’s ability to produce goods and services. This is exactly what didn’t strike the United States and Europe during the financial panic of 2007 and 2008. The United States is producing a low less than it could be producing primarily because a large number of people, the unemployed people, aren’t producing anything at all. And yet we have functioning office buildings they could sit in. We have factories running at below capacity they could work in. We have trucks and cranes and other machines they could operate. We haven’t been hit by an earthquake, our power plants aren’t exploding, our roads aren’t blocked by displaced automobiles, we’re just not putting everyone to work. That’s the very definition of a country with inadequate aggregate demand, and we should be fighting the situation with every tool at our disposal. Instead the debate in congress is about how much short-term spending to cut, and voices slamming the Fed for being too loose continue to be heard louder than those slamming it for being too tight.

One of these news events that seems to demand note, but about which a humble political blogger can say little. Does the fact that an earthquake can serious damage a nuclear power plant without necessarily causing a radiation leak make us more or less sanguine about the idea of building additional nuclear facilities? I’m not sure whether this counts as “see, it’s risky!’ or “see, even in an earthquake it’s not that bad.”

Japanese Defense Minister Toshimi Kitazawa

If you look at the region in very abstract terms, close defense cooperation between South Korea and Japan seems like a no-brainer. In practice, however, the relationship between the two countries is actually quite chilly, as detailed in Chico Harlan’s article about efforts to increase defense and intelligence cooperation between Tokyo and Seoul.

The difficulties are attributed largely to the fact that Koreans, especially older ones, feel “intense bitterness over the 35-year Japanese occupation of Korea that ended in 1945.” That’s quite understandable. It’s also the case, however, that if you look at 20th century Europe, the practical imperative to move forward with defense cooperation served as an important driver of reconciliation between Germany and its neighbors.

The danger here for the United States is that while it’s obviously good for our two main allies in the region to cooperate, especially vis-à-vis the DPRK, I don’t think we really want to become the offshore sponsors of an anti-Chinese military alliance. One can easily imagine some future state of the world in which it does make sense for the US to be the patron of a grouping like that, but one can also easily imagine steps in that direction becoming self-fulfilling. Our main concrete interest in the area is simply that war and destruction in Northeast Asia would be very economically disruptive. We want to be preventing trouble, not starting it.

Felix Salmon writes about the Japanese budget situation and observes that “The lesson here, I think, is that it’s very, very hard for a government to enact a serious fiscal adjustment unless and until the bond market forces its hand.”

Well, I agree. But I’m less depressed about the whole thing than Salmon is. I mean, really, why would it be the case that governments enact serious fiscal adjustments when the bond markets aren’t forcing their hand? What I actually find remarkable is the quantity of media and political whining that goes on about the fact that countries don’t do this. Normally, though, we expect human beings and the organizations they run to respond to incentives. If people cease wanting to buy Japanese debt, then the Japanese government will find ways to issue less debt. But demand for Japanese debt is high, so why wouldn’t the government keep issuing more?

That’s not to say these endless debts are optimal policy for Japan. What they ought to be doing is trying to have more economic growth. Finance their government with a bit less debt and a bit more printing of yen. That’ll create elevated inflation expectations and spur growth. More immigrants wouldn’t hurt either. I think the real mystery is why unconstrained governments are so reluctant to really put the pedal to the metal.

(cc photo by LateNightTaskForce)

One remarkable aspect of the recent conservative assault on QE2 is that the conventional wisdom on the American right is now well to the right of where Milton Friedman was ten years ago. Take these remarks on Japan from 2000:

In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”

It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.

According to Mike Pence and Paul Ryan, this is left-wing lunacy. The only solution to any economic problems is tax cuts for rich people.

Ethan Devine has a very good article in Foreign Policy sketching out Japan’s economic problems as a cautionary tale for China:

When China’s working-age population peaks in 2015, it will be 20 years after Japan’s crested the wave, but it will do so at a much lower level of prosperity than was Japan’s at that time. The harsh reality is this: Japan got rich before it grew old, and China will grow old before it gets rich. [...]

History has given China this moment to do what Japan could not. The Japanese did not seriously attempt to rebalance until their economy was well-developed, ossified, and allergic to change. So when the jig was up on their longstanding economic model, rather than rebalance, Japan unraveled. In this sense, the global financial crisis was serendipitous for China. By reminding China’s leadership that relying on exports means depending on unreliable foreigners, the crisis put the pain of rebalancing in perspective. It is not out of altruism that we have seen renminbi appreciation accompanying Chinese wage hikes and other rebalancing measures. A slight loosening of controls over media and finance could be in the offing. Deregulating the service sector might be a frightening political proposition, but perhaps less so than not having one when the exports dry up.

It is worth saying, however, that from a different perspective I can see how Japan just looks like a success story to many people. After all, Japan’s PPP-adjusted per capita GDP is about level with France and higher than Spain, Israel, or Italy. Most people around the world, in other words, are poorer than the Japanese. So “you’re going to end up like Japan” isn’t necessarily much of a nightmare scenario to leaders in the developing world. Devine’s point is that China won’t end up like Japan, but instead risks seeing its economic growth stall out at a much lower level of development. But making that argument stick requires at least as much attention to the significant differences between the economies as to the similarities.

One of the oddities of the current crisis is that throughout the 1990s it was absolutely conventional wisdom in the United States of America that Japan, though suffering from some real structural issues, was making things much worse for itself than necessary by failing to coordinate fiscal and monetary policy to stimulate adequate demand. The extent of that conventional wisdom is why many of us thought the same thing couldn’t happen in the United States. And yet as soon as the USA experienced a big crash, suddenly the conventional wisdom started looking like old-timey Japanese conventional wisdom—”nothing can be done, the problems are structural, blah blah blah.”

In that light, it’s interesting to see that western media coverage of Japan still adheres to the old western orthodoxy about the desirability of stimulative policies. Here’s the NYT:

Prime Minister Naoto Kan proposed new stimulus steps, while the central bank, under pressure from the government, eased its already easy monetary policy. But analysts called the measures too timid in the face of the problems facing Japan’s export-oriented economy. A yen that has paradoxically surged to 15-year highs despite weaknesses in the country’s economy, coupled with the damaging phenomenon of falling prices known as deflation, continues to hinder hopes of a strong recovery, analysts said.

“There seems to be a sense of fatalism. The B.O.J. continues to play the same old game of making incremental, but ultimately meaningless, policy changes in response to political pressure,” said Richard Jerram, economist for Japan at the global investment bank, Macquarie.

And here’s the Washington Post:

Both analysts and the markets were underwhelmed by the central bank’s measures. Following the announcement, the yen actually strengthened – rising to 85.12 on the dollar. The Nikkei index, meanwhile, lost its early morning gains following the central bank’s announcement. For the day it rose 1.76 percent.

“The BOJ measures were pretty much as expected,” said Edwin Merner, president of Tokyo’s Atlantis Investment Research. “It helps a little bit – if it’s followed by government action. The government could be adding measures that don’t cost anything. Cutting taxes. Guaranteeing loans for overseas contracts. They could do those things. But they’re not.”

Nothing wrong with any of this coverage. Indeed, I agree with it wholeheartedly. But the exact same basic principles apply to the United States. Economies facing low and declining inflation combined with high unemployment and massive excess capacity benefit from expansionary monetary policy. Monetary policy that merely aims at preventing further collapse is timid and inadequate. Policy should aim at rapidly bringing as much of that excess capacity as possible back into use.

I would highly recommend that you take a look at Adam Pozen’s talk “The Realities and Relevance of Japan’s Great Recession – Neither Ran nor Rashomon“. His point is that poor Japanese economic performance, though of course not unrelated to the bursting of asset bubbles, was fundamentally caused by policy errors and that when better policies were implemented growth became strong:

What was necessary was the clean-up and recapitalization of the banking system, the further loosening of monetary policy (to the extent possible given that interest rates were at zero), and the avoidance of any further premature fiscal tightening, as I set out in Posen (1998, 1999a, and 2001b). This was obviously not a simple list, economically or politically. Yet, it was also not a list of the impossible, it emphasized demand side factors, and was a list that seemed all the more plausible when Japanese policymakers recognized that Japan was not doomed to a permanently low trend growth rate – a belief that had bedevilled both fiscal and monetary policy decisions in Japan for much of the 1990s.

Japan’s new economic leadership in the early 2000s, Prime Minister Junichiro Koizumi, Cabinet Office and later Financial Services Minister Heizo Takenaka, and Bank of Japan Governor Toshihiko Fukui, turned matters around. They reversed monetary policies that contributed to deflation, turned the fiscal impulse to average net zero (see figure 5), and forced bad loan write- offs and recapitalization by the Japanese banks (figure 6).10 What few seem to appreciate, either inside or outside of Japan, is just how strong the resulting Japanese recovery from 2002-2008 was. It was the longest unbroken recovery of Japan’s postwar history, and, while not as strong as pre-bubble Japanese performance, was in fact stronger than the growth in comparable economies even when fuelled by their own bubbles.

People can get confused about Koizumi-era Japan’s economic performance because demographics were driving a pretty rapid reduction in the number of workers. That drags down overall output. But even though China’s GDP is much larger than Switzerland, Switzerland is still much richer and its workers are much more productive.

Posen’s piece is important, because I fear that historical evidence of poor economic performance in the wake of asset price bubbles bursting is creating a mood of dangerous complacency. You can read that as evidence that we’re destined to experience an extended period of poor growth, but you can also read it as evidence that what normally happens after a bust is that policymakers implement an ineffective response. And as Posen argues, accepting the view that slow growth is inevitable is a major cause of ineffective policy and becomes self-fulfilling. Japan started growing once it got some policymakers who believed it was possible for Japan to grow, and thus that they would try pro-growth things and try them on a large scale.

In a lot of ways, I feel like Chinese people would be better off if instead of one giant country they lived in 15 medium-sized ones. The current situation leads, I think, to some accurate facts that produce misleading ways of thinking:

After three decades of spectacular growth, China passed Japan in the second quarter to become the world’s second-largest economy behind the United States, according to government figures released early Monday. [...] The recognition came early Monday, when Tokyo said that Japan’s economy was valued at about $1.28 trillion in the second quarter, slightly below China’s $1.33 trillion. Japan’s economy grew 0.4 percent in the quarter, Tokyo said, substantially less than forecast. That weakness suggests that China’s economy will race past Japan’s for the full year.

Spectacular growth has certainly been key here, but the other thing is that China has a large economy because so many people live there:

With a population of that size, China would have to have a far, far, far larger overall economy than Japan’s in order to provide people with half Japan’s standard of living. Under the circumstances, I find this sort of commentary puzzling:

“This has enormous significance,” said Nicholas R. Lardy, an economist at the Peterson Institute for International Economics. “It reconfirms what’s been happening for the better part of a decade: China has been eclipsing Japan economically. For everyone in China’s region, they’re now the biggest trading partner rather than the U.S. or Japan.”

As best I can tell, this is just false. Despite twenty years of very strong Chinese growth and twenty years of very weak Japanese growth, China is still nowhere near “eclipsing” Japan as a prosperous center of high-skill, high-wage work where people enjoy a high standard of living. In East Asia it’s Singapore that now leads the pack in prosperity, and Japan is about tied with Taiwan. China is still well behind Malaysia, to say nothing of South Korea or those three. The recent growth has been spectacular and a hugely important event, but people shouldn’t let illusions of pure scale confuse them about how far China’s come.