Kannomics

If the DPJ takes control of the government, the basic policy of the Cabinet will be to change all bureaucracy-directed governance. We will create the strongest Cabinet and strongest Kantei to achieve that. Of course, there will be no room for the bureaucracy or the zokugiin to enter.
- Kan Naoto, Soridaijin no Utsuwa (The Caliber of the Prime Minister) 2003

The politicians should absolutely never decide things by themselves. The bureaucracy (consists of) professionals with many years of experience in dealing with policies and issues.
- Kan Naoto’s first news conference as prime minister last week

THE LATE American humorist Will Rogers was famous for a stage routine in which he would draw laughs from the audience by reading aloud from a newspaper and making comments on each article.

Imagine how much money he could make today.

Take all the reports about Japan’s new prime minister, Kan Naoto, for example.

He was the deputy prime minister when Hatoyama Yukio formed a Cabinet last September and took on the additional role of finance minister on 7 January. The day before, Bloomberg reported:

Kan told reporters yesterday he will tackle “various issues aggressively,” and pledged to make sure the proposed 92.3 trillion yen 2010 budget is passed by the Diet.

Meanwhile, Kyodo quoted Mr. Hatoyama:

“Kan is someone involved in compiling the budget, so there is no impediment—I believe we can adequately get through the Diet session,” the prime minister said.

On 10 January, NHK reported:

Deputy Prime Minister and Finance Minister Naoto Kan has said the key part of the pledges made by the governing coalition has been achieved in the fiscal 2010 budget plan.

The budget was passed on 24 March. Only four budgets in Japanese history were enacted more rapidly. It was the largest budget in Japanese history, with the highest amount of debt and the greatest reliance on deficit-financing bonds.

Two days ago, fewer than three months after the budget passed, the Associated Press reported on a speech by now-Prime Minister Kan:

Japanese Prime Minister Naoto Kan says his country could become the next Greece if it doesn’t reduce its current debt load….Kan says Japan needs to rein in spending before things spiral further out of control. “It is difficult to sustain a policy that relies too heavily on issuing debt,” he said. “As we have seen with the financial confusion in the European community stemming from Greece, our finances could collapse if trust in national bonds is lost and growing national debt is left alone.”

Here’s the Will Rogers punchline. AP characterized Mr. Kan as a “fiscal hawk”.

Did the AP mention his role in compiling the budget, getting it passed, and making Japan bend over for the insertion of all that Grecian style debt?

Don’t make me laugh.

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With their typical verbal ingenuity, the Japanese have started to refer to the prime minister’s theories as Kannomics. They seem to instinctively understand they can’t call it “economics”.

Takahashi Yoichi took a look at Kannomics in an article for the 7 June edition of Gendai Business. It was titled, How will the new Kan Naoto administration handle the economy? Here it is in English.

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One securities dealer wasted no time in using the new Cabinet as a business opportunity by quickly sending out a solicitation that said, “There will be growth under the Kan administration, and the yen will decline, so we recommend investment in either Japanese stocks or foreign bonds.”

To be sure, Mr. Kan was at first quite spirited after being appointed Finance Minister in early January. He ignored the wishes of ministry apparatchiks by calling for a cheaper yen. The Finance Ministry put a lid on that talk right away, however, and his course turned in a more dangerous direction.

He later stumbled, being unable to answer a question in the Diet in the latter part of January about the multiplier effect of the child allowance, i.e., what the macroeconomic effect of the allowance would be. In the beginning of February, a large contingent of ministry bureaucrats accompanied him to the G7 (finance ministers’) meeting.

His relationship with the bureaucrats changed markedly around that time, and the opinion began circulating around Kasumigaseki that “Finance Minister Kan is studying very hard.”

Then, as expected, Mr. Kan argued on television in mid-February for a sweeping overhaul of the tax system, including an increase in the consumption tax. Until then, he had insisted a debate on increasing the tax should start next year. His ideas underwent a significant change and he accelerated the start of the debate well in advance of his original intentions.

That signifies Mr. Kan has completely fallen under the control of the Finance Ministry bureaucracy.

What then will become of the Japanese economy in the Kan administration? Will the yen decline?

The keys to deciphering that are the split with Ozawa Ichiro and the rapprochement with the bureaucracy. That he has split with Mr. Ozawa is clear from the makeup of his Cabinet and his choices for party offices.

Further, the rapprochement with the bureaucracy is clear from his personnel choices for deputy chief cabinet secretary. He retained Matsui Koji and appointed Furukawa Motohisa, veterans of the Ministry of Economy, Trade, and Industry (MEIT), and the Finance Ministry respectively. Prime Minister Kan has fallen into the clutches of the Finance Ministry.

This will be a sharp difference from the Hatoyama Administration, which had initially proclaimed a disassociation from the bureaucracy. It is obvious that the new growth strategy and mid-term financial framework announced this month were created by METI and the Finance Ministry.

Viewed from the perspective of economic policy, the break with Mr. Ozawa and the rapprochement with the bureaucracy are consistent with a course of tax increases.

Mr. Ozawa had a negative view of tax increases because elections are always the priority for him. Politically, the break with Mr. Ozawa makes it easier to talk about tax increases. They will likely create a plausible reason for public consumption, such as the danger avoiding tax increases will present for “fiscal reconstruction”.

If they were really interested in fiscal reconstruction, a sequence should be followed before taxes are increased. They must try to increase revenue by boosting the nominal growth rate, reducing the vast amount of government assets, and cutting the salaries of public employees.

But boosting the nominal growth rate would lead to a discussion of inflation targets, which would result in conflict with the bureaucratic organization of the Bank of Japan. In addition, many of the government assets consist of loans and cash infusions in quasi-governmental corporations and quangos, which are nests for the amakudari (post-retirement jobs) of the Kasumigaseki bureaucrats.

A reduction of these assets would entail the elimination or privatization of these amakudari outposts, as well as a reduction of their duties, so this will meet with opposition from Kasumigaseki bureaucrats. Cuts in personnel expenditures for civil servants will be fought tooth and nail by all the bureaucrats. Thus, the rapprochement with the bureaucrats means they have eliminated the prior steps to be taken before a tax increase and gone straight to the tax increase.

Incidentally, Mr. Kan has not mentioned the phrase datsu-kanryo (disassociation from the bureaucracy) at all since his election as party head on the 4th. That phrase was part of the original DPJ party line before Mr. Ozawa joined.

On the other hand, Prime Minister Kan has frequently mentioned of late that the economy will improve with a tax increase. This seems to be the “Third Way” of increasing taxes, using the funds for employment, and creating new demand. It’s based on the claim that the first way was the public sector investments of the old LDP, the second way was the strengthening of the supply side during the Koizumi-Takenaka era, and that both were failures.

The Brains behind Kan are Keynesian

This Third Way is the slogan of the Kan administration. It was proclaimed by Osaka University Prof. Ono Yoshiyasu, who became part of the Cabinet Office on 26 February.

Prof. Ono’s economic theory is based on an elaborate mathematical model with rather debatable content, but it has some adherents among economists. Eliminating the technical details, however, there is little difference from orthodox Keynesian economics of relying on fiscal measures without using monetary policy.

At the backdrop to Mr. Kan’s assertion that the economy will improve if there are no mistakes in the use of the increased tax revenues is the Keynesian “balanced multiplier” (there will be economic effects even with increased taxes and public sector investment).

The premise of this theory, however, is that the government is smarter than the people. Prime Minister Kan makes that point by adding the condition, “if there are no mistakes in the way the money is used”. That is a classic case of easier said than done.

Additionally, the premise that the government is intelligent is consistent with Kasumigaseki governance. The bureaucracy will readily accept Prof. Ono’s idea as a theory.

Reality is not at all that simple, however.

Last December, Mr. Kan said at a Cabinet Office conference that it should be possible to create policies with a multiplier effect of 11 (JPY 11 trillion in benefits for JPY one trillion in government expenditures). Yet when Watanabe Yoshimi of Your Party asked him to provide a specific example during question time in the Diet in January, he couldn’t answer. If he could have given a real example, anyone would have recognized that the government was intelligent…

But the rationale behind the DPJ claim of disassociation from the bureaucracy was that they knew the government had wasted money. It’s not as if they can say that the government’s use of the money is intelligent.

Well then—what will happen if the unintelligent government raises taxes to collect money and use it?

If the private sector lacks money, they will be unable to make beneficial capital investments. Real interest rates will rise, which would threaten the growth of the Japanese economy, of which the private sector is the main element. The yen would be unlikely to depreciate.

Also part of Prof. Ono’s theory is that deflation is caused by the people’s “love of money”. It does not recognize the effect of an expansionary monetary policy.

Prime Minister Kan has shown the desire to overcome deflation, but judging from Prof. Ono’s “love of money” theory and the rapprochement with the bureaucracy, he would likely reject a monetary policy that would boost the nominal rate of growth. In that case, deflation will continue. From this perspective too, there will be no growth in the Japanese economy and the yen is unlikely to depreciate.

It is a fact, of course, that Mr. Kan has jawboned for a lower yen. Even if this resulted in a temporary depreciation of the yen, judging from the supporting economic theory (which the prime minister probably does not understand), Japanese economic growth will be harmed, and there is little hope for a cheaper yen.

Even if the yen were to depreciate, it would be because the tax increase and redistribution of income would not improve long-term productivity. Then the Japanese failure would really cause the yen to crash.

Afterwords: Two posts ago, there was a quote from a book by Hasegawa Yukihiro in which he charges (based on personal observation) that METI and the Ministry of Finance worked together to find ways to spend higher tax revenues as a way of ensuring later tax increases. See what he means?

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