What's Wrong with Japan

"The Wrong Problem" by Harald B. Malmgren, in The International Economy (Nov.–Dec. 2001), 1133 Connecticut Ave., N.W., Ste. 901, Washington, D.C. 20036.

Japan’s economy has been ailing for more than a decade, and the conventional wisdom is that the world’s second largest economy won’t improve until Tokyo gives top priority to dealing with the mountains of bad debt held by Japanese banks. That’s a fool’s errand, says Malmgren, a former deputy

U.S. trade representative (1973–75) who now heads the Malmgren Group.

Nobody knows how big the Japanese banks’ bad debt problems really are (including the banks themselves), but one thing is clear: Writing off such "nonperforming" loans will mean closing many businesses and prolonging the recession, thus adding to the mountain of bad debts. And banks that hold lots of bad debts won’t make loans to help businesses start up or expand.

Malmgren argues that the Japanese should learn from America’s painful economic restructuring. "In the 1980s we had the rapid emergence of private equity and venture capital, high-yield bonds, securitization of debt, derivatives, and myriad other new financial instruments. . . . This opened the way for dramatic changes in merger and acquisition activity, buyouts, mezzanine financing, incubation of startups, bundling of distressed assets, and many other essential steps on the path to restoring the competitive strengths of the U.S. economy."

The American financial revolution got money from savers into the hands of those who needed capital. Japan today has huge pools of "sleeping money" in pension funds and personal savings accounts. What’s needed is regulatory reform to spur the creation of "non-bank financial institutions" such as venture capital funds and mutual funds. (Such institutions now account for more than 80 percent of U.S. business financing.) In 1979, for example, a U.S. Department of Labor regulatory change allowed private pension systems to make limited investments in new and small businesses and other "risky" enterprises.

Yes, the banks’ bad debts need to be addressed, Malmgren says. But "working on bad debts first, without attention to the crying need for restructuring Japan’s stalled economy, can only bring even deeper recession and more deflation—and more bad debt."