Tales from the dark side: Divining the causes of Japan's economic nightmare. . - Culture & Reviews - Dogs and Demons: Tales front the Dark Side of Japan - book review

Reason, March, 2002 by Charles Oliver

Dogs and Demons: Tales front the Dark Side of Japan, by Alex Kerr, New York: Hill & Wang, 432 pages, $27

IN THE ANCIENT Chinese philosophical text Han Feizi, the emperor asks a painter which subjects are the hardest and easiest to depict. "Dogs and horses are difficult," the artist says. "Demons and goblins are easy." In other words, the simple, everyday things are hard to get right; it's much easier to come up with big, eye-catching monstrosities. Alex Kerr, a long-time resident of Japan and author of the acclaimed Lost Japan (1996) believes that nation suffers from a severe case of "dogs and demons." Thanks to ossified and inefficient financial and political institutions, Japan has created all manner of monstrous projects and fiscal outcomes while failing to create the conditions necessary for economic growth. The result: The country that inspired all manner of economic envy and inspiration in Americans 15 years ago now inspires something else.

"In field after field," he writes in his new book on Japan, Dogs and Demons, "the bureaucracy dreams up lavish monuments rather than attend to long-term underlying problems." Kerr traces these problems to both political and cultural sources. The first, familiar to economists from the public choice school of analysis, is the tendency of bureaucracies to expand and defend their turf. Government agencies keep on spending money, building new projects, and finding new excuses to continue long after their original purpose has faded.

But culture plays a major role, too, Kerr argues. Japanese are taught from birth not to question authority, to fit in with the group. That leaves bureaucrats without much serious opposition, and explains why Japan has failed to address problems that are behind an economic malaise that has lasted more than a decade. Kerr is pessimistic that Japan can change before things get much, much worse, With the United States now facing its own serious economic problems, it is worth looking at Japan once again, this time as an example of what to avoid.

At the heart of Japan's economic problems--stagnant growth and a growing irrelevance in the world economy--is a banking system that no longer works. The government says that Japanese banks have some $400 billion in bad loans on their books. Adjusting for the size of the economies, that would make Japan's debt problem four times worse than the U.S. savings-and-loan crisis of a decade ago. However, many economists believe that Japan's bad debts are actually far higher, and may total more than $1 trillion. (It's difficult to get a grasp on just how large the debt problem is because banks use all sorts of accounting tricks to mask bad loans.) Most--if not all--of Japan's banks are technically insolvent. They can't lend enough money to keep the economy growing. Even if they could, there just aren't enough good borrowers out there to make a difference.

How did Japan reach such a state? "Japan's financial system rests on bureaucratic fiat," Kerr writes. The system was set up to pump cheap capital into the business sector. Banks rarely called in bad loans; companies were encouraged to borrow and expand continuously. "A company would borrow against assets such as land, and then reinvest the money in the stock market. The market would rise, and thus the company would have 'latent profits' against which to borrow more money, with which to buy more land. And on to the next round," according to Kerr.

Those cycles created huge real estate and stock market bubbles. But those tends couldn't be sustained forever. The bubbles burst in 1989, after the Bank of Japan raised interest rates, slashing liquidity growth and making it impossible for banks to keep pushing money out the door. The crash left banks with a mountain of bad loans. But they didn't call those loans in-that would have meant liquidating companies (and admitting that the "asset" of those loans was in fact worthless, bringing the bank's solvency officially in question). In fact, they often continued to make loans to those very same companies, piling up more bad debts.

Why? The government was reluctant to push through the sort of housecleaning that the United States went through in its S&L crisis. The muchreviled Resolution Trust Corporation stripped bad assets from the books of S&Ls and liquidated them. At the same time, it pumped money into the system to bail out depositors at the failed S&Ls. But Kerr says there are deeper forces at work in Japan. "Traditionalists hold the hallowed word Wa (peace, or harmony) as Japan's ultimate ideal, even going so far as to use Wa as an alternate name for Japan itself," he writes.

In a nation where harmony is the supreme value, no one is willing to strike a discordant note. Banks are reluctant to call in bad loans. The government is reluctant to force them to. It's better to paper over the system and ignore problems than it is to call attention to them and fix them. In effect, the search for Wa ends up rationalizing a lot of inefficiency and outright corruption. Kerr reveals that some police departments actually have manuals detailing how to cover up embarrassing events.)