Alt+0 to show this section, Tab to navigate forward, Shift+Tab key to navigate backward, Enter to access link, and Esc to reset

Press tab key to access skip links section. Press Alt+0 to access it anytime.
Menu

12 Dec 2013

UK and Japan economic recoveries

Stephen King

by Stephen King

HSBC Group Chief Economist

UK and Japan economic recoveries

The financial crisis provided the opportunity to wean the UK off the housing-led, debt-financed consumer booms of old

Both the UK and Japan would like to see sustained economic recoveries but, until recently, the recoveries they craved were fundamentally different in nature. The UK ideally wanted an export-led recovery supported by plenty of productive investment. The financial crisis provided the perfect opportunity to wean the UK off the housing-led, debt-financed consumer booms of old. Japan, meanwhile, hoped to see a shift towards a consumer-led recovery, helped along by an end to the deflationary curse which had persuaded the Japanese to hoard cash and repay debt.

In truth, QE is a blunt instrument. To suggest that economies can be "fine-tuned" in favour of either export-led or consumer-led growth is a triumph of wishful thinking

Despite these different hopes and aspirations, policy makers in the two countries have pursued remarkably similar monetary policies. True, the Bank of Japan's recent monetary actions came a few years later than the Bank of England's but, in both cases, the zero rate bound on interest rates forced both central banks to adopt quantitative easing. The results were similar: balance sheets expanded rapidly, domestic financial asset prices surged, headline inflation picked up and the exchange rate fell. It is odd, then, that while the hopes of one country have rested on a rebalancing towards export-led growth, hopes in the other country have rested on a rebalancing towards domestic consumption.

In truth, QE is a blunt instrument. To suggest that economies can be "fine-tuned" in favour of either export-led or consumer-led growth is a triumph of wishful thinking. Even if it helps improve economic conditions, there is no guarantee that, on its own, QE will deliver the "right" outcome. Supplementary drugs may also be needed.

Shinzo Abe, Japan's prime minister and the only Group of Seven leader to have given his name to an economic stimulus package, is fully aware of this. On its own, exiting from deflation provides no guarantee of lasting recovery. If prices rise but wages do not, the resulting squeeze in real incomes will leave Japanese consumers considerably worse off, hardly consistent with a rebalancing towards consumer-led growth. It is for this reason that Mr Abe is keen to persuade Japanese companies to pay their workers more over coming months, an upside-down version of the incomes policies that proved the kiss of death for western policy makers in the 1970s. At the macroeconomic level, the approach makes sense. At the microeconomic level, it may make no sense whatsoever.

Meanwhile, if domestic demand fails to recover, what options does Japan have? There's been much talk of productivity and efficiency-enhancing measures, all part of the so-called "third arrow". Structural reform, however, takes time and, as southern Europe has discovered, can be associated with painful losses in the short term. The other alternative is to engineer a further softening of the exchange rate through even more aggressive action from the BoJ. That, however, would move Japan closer to the UK's original aim of rebalancing towards export-led growth and would doubtless provoke accusations that Japan was engaging in "beggar-thy-neighbour" currency wars.

The UK has the recovery Japan craves but which, in the past, has done the British economy no end of harm. Perhaps the most remarkable feature of the UK story since the onset of the financial crisis is that - for all the supposed deleveraging, the loss of economic activity and the initial drop in sterling - the balance of payments current account deficit has simply got bigger and bigger. In 2008, the deficit was less than 1 per cent of gross domestic product. In the first half of 2013, it was more than 4 per cent of GDP. If the recovery seen so far this year persists - fuelled by lower household savings, a strong housing market and renewed credit growth - it is just possible that the balance of payments will end up a lot worse in years to come.

One option is to launch even more monetary stimulus to force the exchange rate lower - particularly in the light of sterling's recent strength - but given the absence of any serious trade benefit from the British pound's big drop in 2008, it is tough to imagine policy makers embracing such an approach with any degree of enthusiasm. The other option - one strongly hinted at by Mark Carney, governor of the BoE, in his festive speech to the Economic Club of New York this week - is to choke off some of the excesses of unbalanced domestic growth through macroprudential policies. "The bank demonstrated this flexibility recently with a package of measures targeted at the housing market, and it has outlined a broad range of additional tools if further action were required," he said.

This, you could argue, is Mr Abe's third arrow in reverse. Whereas Japanese policy makers are keen to unleash animal spirits in a bid to release Japan from a suffocating burden of excessive regulation, protectionism and cultural conservatism, UK policy makers are thinking of doing exactly the opposite, hoping that the hedonistic ways of old can somehow be curbed. But none of this can be achieved through monetary policy alone.

The big question, therefore, is not so much what monetary policy can achieve but, instead, what is required in addition to monetary stimulus to deliver an appropriately balanced recovery. The answer - both in Japan and the UK - appears to be for policy makers to intervene in the workings of markets to nudge behaviour in one direction or another. Mr Abe is more than happy to offer a gentle nudge to encourage the payment of higher wages. Mr Carney is equally content to temper animal spirits in the UK housing market. Perhaps these approaches will eventually pay off. They do, however, mark a fundamental shift in philosophy towards a world in which the policy maker, rather than the market, is king.

This article originally appeared on the Financial Times website on 11 December 2013.
Disclaimer

Related content

Eurozone needs new austerity

04 Dec 2013

Is the eurozone pursuing the wrong type of austerity? Other developed…