Why Japan’s economy is still stumbling

The US has much more to lose: the loss of its long-standing global preeminence. Whatever the details, 17 years of net American economic stagnation would effectively end the post-Second World War era, with potentially frightening consequences around the globe. There is a heavy obligation to avoid such a development, perhaps equal in weight to the obligation to lift the American economy in the near term.

Avoiding American lost decades

In many respects, the US economy has mirrored Japan's. While Japan built its economy around an unsustainable export-based model, America has run large, unsustainable, and (until very recently) ever-growing trade deficits. Since the beginning of the decade, the US has accumulated a trade deficit of more than $4.5 trillion.

An important difference between Japan and the US is that the Japanese export-led model is explicitly a matter of government policy. Japan set out to construct such an economy decades ago and, as a matter of government policy, has been unable to move toward a more balanced model. In contrast, there is no American policy favouring large trade deficits. On the contrary, a more balanced trade position is preferred.

Although persistent and unsustainable American trade deficits are not a desired policy outcome, they do follow naturally as a consequence of a wide range of federal policies. In the area of tax policy, for example, the US maintains the second highest corporate tax rate among industrialised countries, limiting the international competitiveness of American businesses.

In addition, the federal income tax often punishes many forms of saving by taxing the returns to saving at high marginal rates. Discouraging domestic saving means importing significant amounts of net saving from abroad, the flip side of importing significant amounts of net good and services from abroad.

Among the many other federal policies contributing to the trade deficit:

• the federal tax treatment of health insurance distorts the insurance market, encouraging excessive coverage and driving up health care costs;
• US energy policy is replete with contradictions, the net effect of which is to diminish domestic energy production and increase energy imports;
• Federal spending is absorbing a large and increasing share of resources, some spent in innovative fashion, some spent on the social safety net, but much spent foolishly and wastefully. An excellent example is how the federal government subsidizes the health insurance of high-income seniors through the unquestionably unsustainable Medicare program; and
• a wide range of regulatory policies distort allocation of resources across a spectrum of activities. The federal government maintains thousands of regulations relating to worker safety, consumer protection, environmental protection, market competition, and more, some of which may have been justified at one point but today are antiquated, ineffective, overreaching, and burdensome on America's companies.

Whether Japanese trade surpluses or American trade deficits, large, persistent international trade imbalances are truly unsustainable.

The US at risk

Japan's lost decades stem partly from an inability to reconfigure their economy away from export reliance. The US risks its own prolonged period of weakness if it fails to correct the policies that have contributed to excessive trade deficits and reliance on foreign saving. And in the case of American stagnation, the consequences would be far worse.