Italy and Japan appear tied together in a three-legged race. Before long at least one is bound to fall over.
Given all the recent publicity about Japan and the colossal amounts of money it is about to throw at reviving an ailing economy, it seems strange to lump the two countries together.
Different cultures and business practices should make for a very unlikely link, but they are in a similar hole and Japan is leading where Italy could mistakenly follow.
Italy and Japan were once the two largest Axis powers with Germany. After World War II, all three benefited from huge subsidies, mostly from the US and much of it in the form of debt write-offs.
Unencumbered by debts, all three amassed huge savings, almost all through 40 years of manufacturing prowess dating back to the 1950s. Exports of everything from toasters to car parts fueled an astonishing rise in living standards.
From the early 1990s, all three entered a long decline, each weighed down by their own financial problems (the integration of East Germany, the Tokyo property bubble, and Italy’s stagnant productivity).
Falling birth rates added to their woes (caused, arguably in part, by the state’s reliance on women to continue their domestic role without childcare when they entered the workplace).
Germany’s aging postwar baby boomers broke free of the triumvirate. Among other things, they endorsed then-German chancellor Gerhard Schroder’s mix of Anglo-Saxon (reduced wages and reduced job protection) and French-style child support alongside swingeing cuts to the terms and conditions for younger workers.
Rome and Tokyo opted to borrow to protect the living standards of their aging populations, while attacking the wages and conditions of the young. It did not work. Though they still appeared to churn out top-of-the-line manufactured goods, especially in Japan, increasingly it was for assembly by foreign companies.
In Italy, the car manufacturer Fiat is hemorrhaging sales, while Po Valley parts suppliers keep Germany’s BMW fully stocked with brake pads and door panels. Likewise, Japanese electronics firm Sharp has become more dependent on making iPad screens for Apple than TVs or mini hi-fi systems under its own brand name and has become a persistent lossmaker.
Japan’s newest tactic has grabbed the headlines in the last week. Put simply, it will combine a long-standing policy of running budget deficits amounting to 10 percent of GDP a year with a massive US Federal Reserve-style money creation spree. An increase in VAT is supposed to keep a lid on the budget deficit.
Charles Dumas, the eminent boss of economic analysts Lombard Street Research, describes in his latest monthly review how Japan’s refusal to adapt has cost its citizens dearly. Such is the loss of export competitiveness that per capita incomes are now about half that of the US. Deflation, in the form of persistently falling prices, has deterred consumer spending (why spend when prices will be lower in six months or a year) and encouraged savings because even though interest rates are at rock bottom, savings values rise each year relative to prices.
Dumas recommends Tokyo scrap its VAT rise for the time being and instead tax dead money doing nothing. His target is retained corporate profits, which are not invested or disbursed to shareholders. He recommends a punitive or even 100 percent tax, and a low or zero tax on their disbursement to get cash out into the economy. Not the stuff created by the central bank. Real cash.
While there is every reason to tax the wealth and savings of individuals, especially the super rich, attacking corporates, which in Japan combine wealth and caution in equal measure, is more politically acceptable.
Japanese Prime Minister Shinzo Abe said last week that the splurge in quantitative easing by the Bank of Japan will achieve the same end painlessly. Dubbed Abenomics, the policy aims to devalue the currency and push up inflation via more costly imported goods. Rising prices will persuade consumers to spend now, not later, making for a healthier, higher spending economy.
However, a cheaper currency raises the cost of the chief import, gas and oil, and everyone’s heating, lighting and transport costs. Pushing up inflation while cutting living standards could be self-defeating.
The knock-on effects of quantitative easing in the UK and US on consumer spending are also disputed. They have arguably kept inflation from falling precipitously, and asset prices are bolstered — witness the rising stock market — but economic activity has shifted only marginally.
All this means Japan could be left with higher debts and an equally sclerotic economy. There is no chance of immigrants coming to the economy’s rescue.
The same applies in Italy where the young and skilled are setting sail. Rome’s membership of the euro means it is unable to print money. It could tax unproductive money in personal and corporate bank accounts, but like many European countries its banks are not in the best of health. Without an expanding export sector, it must look inward and has recently put the emphasis, like the UK, on a bonfire of welfare benefits.
Unfortunately for an aging society, this policy brings us full circle. Without a welfare safety net that includes funds for childcare, the population will continue to decline.
If Germany’s example is anything to go by, Rome has already left it too late.
Almost 10 years of generous benefits appeared to arrive too late for Germans who have fewer children a head than Italians.
No wonder several economists have speculated that Italy and not Greece will be the first to leave the euro. With a budget deficit of almost zero, it can survive with funds from Brussels.
However, an exit and devaluation would be a way for Rome to repeat the “spend and devalue” that encouraged the formation of the euro in the first place. There is no easy way out.
Only when governments realize they need to tax the dead money in their economies to release the funds for investment that they desperately need, can the recovery begin.