United States of Japan?

Victor Joecks

Stop me if this sounds familiar.

A country with a previously roaring economy (due in part to an economic bubble) hits an economic downturn. A recession results. In order to “fix” the economic problems the government spends billions of dollars in economic stimulus and keeps interest rates artificially low.

And that country is … Japan in the late 1980s. What’s happened as a result of this Keynesian approach to the economy?

But the bubbles popped in the late 1980s and early 1990s, and Japan fell into a slow but relentless decline that neither enormous budget deficits nor a flood of easy money has reversed. For nearly a generation now, the nation has been trapped in low growth and a corrosive downward spiral of prices, known as deflation, in the process shriveling from an economic Godzilla to little more than an afterthought in the global economy.

Now, as the United States and other Western nations struggle to recover from a debt and property bubble of their own, a growing number of economists are pointing to Japan as a dark vision of the future. Even as the Federal Reserve chairman, Ben S. Bernanke, prepares a fresh round of unconventional measures to stimulate the economy, there are growing fears that the United States and many European economies could face a prolonged period of slow growth or even, in the worst case, deflation, something not seen on a sustained basis outside Japan since the Great Depression.

 The parallel with the United States and the governmental attempts to fix the economy should be obvious, from the failed stimulus to the record-low interest rates. So what to do?

If you’re Paul Krugman, you call for even more government spending and intervention, because if doing something the first time didn’t help, the solution is to throw more money at it. That’s what we’ve been doing for K-12 education for the last 50 years, and look at how well that’s turned out.

But Japan’s mistake is that it intervened too much, not too little.

Many economists remain confident that the United States will avoid the stagnation of Japan, largely because of the greater responsiveness of the American political system and Americans’ greater tolerance for capitalism’s creative destruction. Japanese leaders at first denied the severity of their nation’s problems and then spent heavily on job-creating public works projects that only postponed painful but necessary structural changes, economists say.

Creative destruction is an essential part of the free-market process. Until it is allowed to work – and it works best uninhibited by the government’s tinkering and intervention – the U.S. economy will continue to look like Japan’s.

Bonus: Enjoy this Keynes vs. Hayek rap contrasting two economic approaches to the boom-and-bust cycle.