Japanese Capital and Budget Deficits

It is difficult to fathom just how wrong orthodox economists, credit rating agencies, journalists, commentators and other pundits have been concerning Japan. With the economists, it’s understandable. They’ve suffered the handicap of a university education in economics. But I think we all expect better from a pundit.

I can’t pretend to have paid undying attention to the litany of forecasts and policy prescriptions published over the past twenty years in newspapers, magazines and journals, or broadcast on TV, radio or the internet, but by my calculations, if even a fraction of this multimedia blitz had been not completely wrong, Japan should have been torn apart in a cyclone of double-digit interest rates and drowned in a flood of hyperinflation years ago. We could be watching the Hollywood movie of it on the big screen.

But these entertaining fears have not been realized, and some of us are feeling short changed. Now, despite having let us down in the past, without so much as an apology so far as I know, the same pundits, or other pundits who sound quite similar, continue to assert that Japan had better adopt austerity measures quick smart or suffer dire consequences.

Yeah, yeah. We’ve heard it all before.

Here are just a few of the promises that the pundits have made to us over the years:

1. In the early 1990s, Japanese budget deficits were supposedly going to cause high interest rates and inflation. History reveals that this prediction must have been intended as a long-range one. It is still future.

2. In 1997, it was said that austerity measures and fiscal contraction were urgently needed to prevent overheating and inflation. Fiscal contraction was implemented, but instead of overheating, there was recession to close out the century.

3. Quantitative easing was going to bring about a multiplied expansion of broader money, higher inflationary expectations and, through lower real interest rates, an inducement to private investment. The policy was so ineffective that it is now being tried in other parts of the world.

4. For the last ten years, we have been assured that repeated budget deficits and rising public debt mean that hyperinflation is just around the corner.

Well, it’s February 2011, and we’re still waiting …

Needless to say, from the perspective of MMT, the effect of deficit expenditure in the case of Japan was never likely to be inflationary, and certainly not hyperinflationary. A high private saving rate in conjunction with a collapse in private expenditure in the early 1990s following the bursting of the housing-market bubble meant fears of hyperinflation were never realistic. To see this, it was only necessary to understand that:

1. Deficit expenditure applied to an economy operating well below productive capacity is not in itself inflationary.

2. Quantitative easing and the expansion of reserves does nothing to encourage bank lending, which is demand and capital constrained, not reserve constrained, and so likewise is not in itself inflationary.

There is another point that perhaps deserves a little more attention:

3. Japan’s private sector was never likely to revolt in the face of these policies because goods and services provision in the country is overwhelmingly conducted by the private sector. The impact of deficit expenditure under these circumstances is to provide a straightforward boost to profits.

In aggregate, and by definition, Kalecki pointed out that:

P = Cp + I + BD + NX – Sw

In this identity, P is aggregate profit, Cp is consumption out of profit, I is private gross investment, BD is the budget deficit, NX is net exports, and Sw is saving out of wages. (For more discussion of Kalecki’s analysis of the profit identity, see this post.)

Japanese workers, as is well known, have tended to save in the aggregate, and at quite a high rate because of the lack of a Western-style social safety net and demographic factors connected to an aging population. The effect of worker saving is to reduce aggregate profit. Deficit expenditure, in contrast, directly adds to aggregate profit. Under capitalism, all domestic expenditure – whether by private households, private firms or the government – ultimately ends up in the hands of capitalists except to the extent that there is public provision of goods and services. Expenditures other than workers’ consumption end up as profit for the capitalist class as a whole.

Whenever there is excess capacity, deficit expenditure props up the rate of profit, r = P/K, by increasing aggregate profit, P, without impacting on the amount of private fixed capital investment, K, tied up in production. There is little reason to have expected Japanese capital in the real sector to have strongly objected to what has essentially been a public injection of profit into its hands.

The interests of financial capital may be somewhat different. To the extent the government injects profit into the hands of Japanese capital in the real sector, financial capital may feel it misses out on the opportunity of injecting the profit itself along with an interest charge on productive capital. If financial capital had in fact decided to extend more credit itself, there would have been less need for the deficit expenditure. The reason it hasn’t is that prospects for prospective borrowers have looked bleak. Under the circumstances, even for financial capital, it may seem more attractive just to pocket the risk-free interest (albeit at a very low nominal rate) paid on government bonds, especially in the context of deflation.

At the aggregate level, the private banking channel to profit creation in the real sector goes primarily through loans to capital, with any resulting private productive investment having a multiplier effect on household expenditure. Government deficit expenditure, in contrast, can directly impact on final consumption demand for goods and services, improving profitability of real-sector capitalists in the process without going through private finance channels.

Under conditions of pure private provision of goods and services, private investment is not as profitable as deficit expenditure for the capitalist class as a whole because private investment tends to increase K along with P, and as a result tends to limit the average rate of profit (see Fiscal Policy and the Rate of Profit). Nevertheless, private investment can benefit the individual capitalists who undertake the investment at the expense of other capitalists, and so there is a strong impetus to invest provided the prospects for selling the final output seem sufficiently strong. The fact that private investment has been so weak in Japan for so long is a reflection of the weakness in private expenditure levels. That is why government deficit expenditure has been so necessary, on capitalism’s own terms, to prop up demand, and hence profitability.