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When will political destruction become creative?

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Austrian economist Joseph Schumpeter invented the concept of “creative destruction”.  But as Japan has demonstrated, a path of self destruction may not always become creative.

First, let’s look at economic self destruction.  Over the past two decades, Japan has had a chronically weak economic performance, rising public debt and deflation.  Perhaps no other country did so well, and then did so badly.

And when it came to the recent global financial crisis, Japan, which should have been well placed to ride through the crisis, was hit harder than most any other country.  Its 2009 fall in GDP was more than twice as big as the US decline in GDP, as exports crashed.  And deflation has now come back.

According to Yale's Professor Koichi Hamada, the Bank of Japan is to blame.  Hamada is none other than the former professor of Bank of Japan (BoJ) Governor Masaaki Shirakawa!

Hamada argues that, in contrast to the US Federal Reserve, the Bank of England and the European Central Bank, the Bank of Japan BoJ did not expand the money supply following the Lehman shock.  The BoJ could easily have done so by using unconventional monetary policy through buying bonds and securities, or by foreign exchange market intervention.  The result of inaction is deflation and an overvalued exchange rate, both of which are crippling the Japanese economy.  The BoJ is too narrowly focused on fighting inflation, without regard to the broader consequences for the economy.

Why is the BoJ sticking so stubbornly to this policy?  Hamada claims that it is the influence of former BoJ staff members who work in the gold market and who benefit from high interest rates.  He also claims that academics will not speak up against the BoJ, because they are hoping for an appointment on the BoJ Board, and do not want to spoil their chances by making waves.  He is also surprised at the silence of the media on this issue.  There are not enough checks and balances in Japan. 

These are damaging allegations.  Could they be true?  Does Hamada have a score to settle?  What ever the case, it does seem mighty curious that the great minds of Japan are not capable of solving deflation and getting the economy growing again.

Second, we now turn to political self destruction.  At the end of August last year, the Japanese public threw the Liberal Democratic Party (LDP) out of power.  A good thing too, as the LDP system had become rotten.  Yukio Hatoyama of the Democratic Party of Japan (DPJ) was elected Prime Minister.  The hapless Hatoyama messed things up, good and proper, by trying to throw the American forces out of Okinawa, but without a sensible plan of action.

So Hatoyama committed hari kari, and Naoto Kan was appointed Prime Minister.  Ichiro Ozawa, the powerful Secretary General of the DPJ, and eternal spoiler, also stepped down from his position.

It was hoped that Kan would steady the ship ahead of this week’s Upper House election.  The DPJ needs to win 60 seats to have a majority in the Upper House.

Kan started well.  He brought a sense of urgency into the debate on Japan’s public debt.  He raised the specter of a Greek style crisis.  Japan needed an increased consumption tax, he said.  And then, the familiar pattern began to repeat itself.  Kan started to wobble on the consumption tax – he would consider it, in the future, on the basis of what the public thought.  It’s a pity, because the Japanese public is prepared to be led and support responsible policies.

Ozawa has now started agitating, and undermining Kan.  Will he never give up?

What will happen in this weekend’s elections?  Will the Japanese public give the DPJ another chance, and seek to avoid instability? 

Let’s hope so says Professor Gerald Curtis of Columbia University, because the DPJ has done many good things – tackling amakudari (parachuting of former bureaucrats into high paying jobs), wresting some power from bureaucrats, and cutting some wasteful budgets.  Transforming the old LDP system into something modern, which works, will take time.  We really do need a process of creative destruction

The risk is that the public will desert both the DPJ and LDP, with smaller parties picking up lots of votes.  This could lead to a fractured Upper House, with no party being willing and able to join in a coalition with the DPJ.  An agitating Ozawa could challenge Kan for the DPJ leadership.  Alternatively, pressures could build for another general election.

In short, there is a big risk of continuing instability.  We will see the emerging landscape in the coming days.  




Tuntex Professor of Economics

Yale Department of Economics


Gerald L. Curtis

Burgess Professor of Political Science

Columbia University