Freeman

FROM THE PRESIDENT

Japan and the Macroeconomic Debate

Will Printing More Yen Cure Japan's Recession?

MARCH 01, 2002 by MARK SKOUSEN

Filed Under : Inflation

“Economics is a very dangerous science”

-JOHN MAYNARD KEYNES1

“Economics is haunted by more fallacies than any other study known to man.”

-HENRY HAZLITT2

There is no better example of today’s heated debate over macroeconomics than Japan. What policy should this nation–economically the second largest in the world–adopt to start growing again after a decade of sluggish performance?

It seems that Japan has tried all the traditional remedies since it collapsed into recession in the early 1990s and lost out as a world economic model. The Bank of Japan lowered short-term interest rates to zero. Tokyo raised taxes, ran huge deficits, and spent billions on public-works projects. But neither an easy-money policy nor an aggressive fiscal policy has done the trick. Japan is still mired in recession and rising unemployment, and now faces the largest debt burden among industrial nations.

In the late 1980s, Japan was considered the model of prosperity. Economists predicted that it would surpass the U.S. economy in 2000; the next century belonged to this Asian giant. Its lifetime-employment and bonus system was considered a superior business-labor management strategy. But the weaknesses of the Japanese economy became apparent in the 1990s–its model was too static and homogeneous for the dynamic global new economy. In 1990 the Fraser Institute’s economic freedom report ranked Japan ninth in the world. Now it is ranked only 20th primarily due to the growth of government and the mismanagement of the banking system.3

I witnessed firsthand this endless story of economic frustration when my wife and I spent a few days in Tokyo last June. The government has spent several trillion yen building a massive underwater highway called Aqualine. Now Tokyo residents have a fast alternate route outside the city. But the government charges $50 one way to go five miles under water and, as a result, even the Japanese are reluctant to use Aqualine.

Classical economists long taught that the government should produce only viable public works, where the benefits clearly outweigh the costs. But John Maynard Keynes turned the world upside down when he proclaimed that in a downturn, “To dig holes in the ground, paid out of savings, will increase, not only employment, but the real national dividend of useful goods and services.”4 Apparently several Japanese prime ministers have fallen under the Keynesian spell, but to no avail.

New Medicine: Print More Yen!

Several prominent economists have urged the charismatic new prime minister, Junichiro Koizumi, to adopt a more radical proposal–flood the country with yen. “Japan needs to spur demand,” argue Jeffrey Sachs of Harvard and Paul Krugman of Princeton. Even Milton Friedman, the celebrated free-market economist (famous for his refrain, “There’s no such thing as a free lunch”), has joined forces with top Keynesians to promote aggressive easy money as a way to jump-start a weak economy and counter deflation. Friedman has supported a rapid increase in the money supply in Japan since late 1997.5

At the Mont Pelerin Society meetings in September 1999, I confronted Friedman on this issue. He and his wife had organized the program under the topic “Can Creeping Socialism Be Stopped?” In one of the breakout sessions I asked him about his easy-money solution to Japan’s economic problems. I held up his article in the Wall Street Journal and noted how it made no reference to cutting taxes, deregulation, or opening up the Japanese economy; only inflation was proposed as a solution. “Isn’t printing more money another example of creeping socialism?” I asked. He was not amused. Friedman said that historically increasing the money supply stimulates economic growth, and fast monetary growth was necessary given Japan’s fragile condition. “Then there is a free lunch?” I asked. “A free disaster!” responded Friedman. Afterwards, Professor Jim Gwartney came up to me and said, “You attacked God today!” Indeed. Yet even free-market icons can make mistakes.

Fortunately, Prime Minister Koizumi has rejected this artificial stimulus and favors a supply-side agenda. He supports a regimen of capping government spending, requiring banks to write off and restructure their mammoth $1.2 trillion in bad loans, and privatizing the massive postal saving system, which funded much of the misconceived public works of the 1990s. Tax cuts would also be highly beneficial. Koizumi would be wise to follow the lead of the Obuchi administration (1998-99), which pushed through moderate tax cuts in personal and corporate income taxes. But he has postponed this vital supply-side ingredient until the crushing government-debt burden can be reduced.

Structural reform, as opposed to easy money and public spending, can work wonders in getting the Japanese economy back on track. For example, in 1994, when Japan deregulated the cell-phone industry, prices dropped and sales skyrocketed, and this year cellular-related revenues are expected to exceed $72 billion, nearly 2 percent of economic output.

The lesson is clear: Free the economy and prosperity will follow.


  1. John Maynard Keynes, Essays in Biography (New York: Norton, 1951), p. 107.
  2. Henry Hazlitt, Economics in One Lesson, 3rd ed. (New York: Arlington House, 1979), p. 15.
  3. James Gwartney et al., Economic Freedom of the World Annual Report 2001 (Vancouver, B.C.: Fraser Institute, 2001), p. 182.
  4. John Maynard Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1936), p. 220.
  5. Milton Friedman, “Rx for Japan,” Wall Street Journal, December 17, 1997.


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