Japan demonstrates the real limits on government spending

Last week, Reuters put out a story (October 30, 2014) – Special Report: Tsunami evacuees caught in $30 billion Japan money trap (thanks Scott Mc for the link) – which provides an excellent demonstration of the true limits of government spending in a currency-issuing nation. The underlying principles should be understood by all as part of their personal mission to expel all neo-liberal myths from their thinking and to help them see the nature of issues more clearly. Unfortunately, the application we will talk about is sad and has tragic human and environmental consequences, but that doesn’t reduce the relevance of the example for conceptual thinking. In a nutshell, the central Japanese government has transferred some $US50 billion worth of yen to the local government to combat the destruction caused by the tsunami in March 2011. Thirty billion is unspent despite people still living in temporary housing and suffering dramatic psychological trauma as a result. Why is this happening? Doesn’t Modern Monetary Theory (MMT) tell us that a currency-issuing government can spend what it likes? Well, not exactly. What MMT tells us is that a currency-issuing government can purchase whatever is for sale in its own currency and that propensity is limited by the availability of real resources. Here is a classic demonstration of the limits of government nominal spending.

Before we start, I expect to receive E-mails from people claiming that talking about this tragedy in terms of a monetary economy frame is heartless and showing a lack of empathy for the human suffering. It is nothing of the sort. So don’t waste your time! I have a very advanced set of skills associated with deletions.

On October 10, 2014, the Japanese news agency NHK World – reported – that:

The Olympic cauldron at the National Stadium in Tokyo has been removed in preparation for rebuilding the facility for the 2020 Summer Olympics and Paralympics.

Seems harmless enough. Apparently, the “Olympic memento will be on loan to Ishinomaki City in northeastern Japan until March 2019.”

Ishinomaki City is – located – in the Miyagi Prefecture, about 400 kilometers north of Tokyo and 150 kms up the coast from the ill-fated Fukushima Daiichi Nuclear Power Station.

Ishinomaki City is a fishing port and became famous for being Manga Land – given it adopted a civic aim of “creating a town where people were exposed to manga on a daily basis”. Manga being the particular Japanese style of comic.

A major developer of mango artistry – Shotaro Ishinomori – was born in this region.

The city created a one-km long “Manga Road”, which “is lined with 20 full-scale manga characters. Manhole covers, benches and even letterboxes feature manga motifs.” The road “ends at a large river. Its sandbar has been nicknamed “Mangattan” by local residents. The Ishinomaki Mangattan Museum is located here. It houses Ishinomori manga, anime and original artwork. There are game and library areas. The museum promotes the understanding of manga culture and history.”

The Ishinomori Manga Museum – was reopened in late 2012 after closing in 2011 for repairs.

Which leads us to the other thing that Ishinomaki City is famous for – the sheer devastation it suffered in the – 2011 Tōhoku earthquake and tsunami. It was one of the worst affected areas after the tsunami on March 11, 2011.

1. The city endured wave heights of around 10 metres, which travelled up to 5 kms inland.

2. The 2010 population was 164,294. 29,000 odd lost homes amd 56,000 buildings were damaged. More than 3,700 died.

3. 80 per cent of the houses in the coastal port area were destroyed.

4. 46 per cent of the city was flooded.

5. Many schools were destroyed (not to mention the massive human loss).

6. The earthquake lowered parts of the city by up to 1.2 metres and created new flood zones at high tide.

In other words, almost unimaginable destruction. The UK Guardian reported some 3 years later (January 27, 2014) – Ishinomaki: new communities rise from tsunami’s devastating divisons – that:

It is only when viewed from a nearby hilltop that the full extent of the destruction wrought on Ishinomaki, in Miyagi prefecture, becomes apparent. The city centre is no more. All that is left is a huge swath of flat land, reduced to rubble …

Now here is a question: Would you prioritise the construction of new Olympic facilities in Tokyo or getting Ishinomaki City back to the semblance of normality?

While the response of the Japanese government to the natural disaster was quick – promising huge amounts of cash – they are also funding the Olympic games construction.

MMT tells us that they can do both – yes? Yes and No! They can certainly fund both the reconstruction and the Olympic games construction. There is no issue with that.

But they cannot put real resources – labour and capital – into both ventures if there is not sufficient resources available. The real resource limits constrain what a currency-issuing government can and cannot do – there are no intrinsic financial limits.

The problem is that public policy choices are ruled by the mythical financial limits (usually voluntarily self-imposed) and this precludes sensible choices being made.

In Australia, I pointed out yesterday how the Australian government is cutting the real pay of its defence force personnel at a time it is calling on them to go into dangerous life-threatening situations – all because it thinks a fiscal surplus is desirable. This is at a time the Australian economy is slowing and unemployment is rising. Nonsensical.

An interesting Reuters – Special Report: Tsunami evacuees caught in $30 billion Japan money trap – (October 30, 2014) tells us that of $US50 billion allocated by the Japanese government for reconstruction:

Thirty billion dollars in funding for roads, bridges and thousands of new homes in areas devastated by the tsunami in Japan three and a half years ago is still languishing unspent in the bank … Japanese government funds budgeted for reconstruction and transferred to local governments are stuck in banks across the tsunami-ravaged northeast … The central government has paid out more than $50 billion directly to local governments in Miyagi, Iwate and Fukushima prefectures, the areas hardest hit by the disaster. But about 60 percent of that money remains on deposit in the region’s banks.

Ishinomaki, where more than 3,700 people died in the tsunami – the most casualties of any city in the disaster – has been deeply affected by the funding paralysis. The port city, where 56,000 buildings were damaged, has been showered with money for reconstruction – about $4.1 billion in the three years after it was hit.

But almost 60 percent of the money, or $2.3 billion, remains in bank deposits. And fewer than five percent of the planned new homes for the city’s nearly 25,000 evacuees have been completed.

Only “2,700 housing units of a planned 29,000 have been completed”. The government keeps modifying its targets for completion downwards as the reality hits.

There are several factors present:

1. Red tape – approval processes are apparently very slow and delaying public works.

2. There is a “labor shortage exacerbated by the siphoning of workers away from the disaster zone to build commercial facilities for the 2020 Tokyo Olympic Games … [which] … has slowed reconstruction.”

3. The labour shortage and construction boom has created a “spike in the cost of building materials and problems in procuring land in the disaster zone.”

The so-called Reconstruction Agency formulated a budget of “$158,000 for a new home” in 2011 but by April this year the estimate is now “$217,000 – almost 40 percent higher than the original figure”.

The boss of the effort was quoted as saying they cannot keep up with the rising costs and contractors are not interested in tendering because of the contractual uncertainty with respect to costs.

There are two points to note here:

(a) The fiscal implications of the rising costs are irrelevant – the government could just up the allocations any time it wanted to.

(b) But the inflationary trend suggests that any further nominal spending would only exacerbate the rising costs. The government is thus stymied by real resource constraints – presumably, in the form of a regional bottleneck.

Real resource shortages can be global (nationwide) or localised and without perfect mobility the local shortages can persist even if there are underutilised resources elsewhere in the economy.

The problem for Japan is that they are attempting to major projects – the mammoth north-east reconstruction and the less significant Olympic preparation with few free labour resources.

Where has the unused money gone?

The Reuters report tells us that:

Much of the reconstruction cash has ended up on the ledger of 77 Bank in Sendai, some 50 kilometers (30 miles) west of Ishinomaki. Government deposits at 77 Bank, the region’s largest lender, have jumped four-fold to almost $17 billion in the past three years as reconstruction money flooded in … the rapid inflow of deposits has been a challenge for the bank to manage since the money could be withdrawn on short notice. The solution … has been to invest in short-term government bonds. As a result, 77 Bank’s government bond holdings have risen two and a half times to $20 billion since 2011.

The Report claims this has created a “a closed loop of financing. By buying government bonds, the banks’ investments are essentially helping to fund the borrowing that the government undertook to make the disaster-related allocations in the first place”.

Yes, but the funds to purchase any bonds have had to come from government spending in the first place. The shortage of real resources which has led to the unspent funds has not made it easier for the Japanese government to ‘fund’ its spending. The Japanese government has unlimited yen spending capacity in nominal terms.

The Government can always instruct the Bank of Japan to issue credits on its behalf in return for some assets which we can call government bonds.

Reuters correctly claims that the “The government is under mounting pressure to cut a public debt load that is more than twice as large as annual economic output” but should have said this is just political nonsense rather than economic reality.

There is no problem – ever – in the government servicing this debt or rolling it over. Should the non-government sector get sick of buying the government bonds, the government could tell the BoJ to buy them or stop issuing debt altogether – the preferred option.

If push comes to shove that is what would happen. Governments play the game of voluntary constraints and elaborate accounting procedures (aka known as shuffling cash here and there) which make it look like they are spending ‘taxes’ or ‘borrowings’ but deep down they all know otherwise and if the political situation became dire they would soon spend up.

We saw that pragmatic streak emerge during the early days of the crisis. No-one questioned the US government when it transferred billions with a stroke of a pen to save the financial system. Where did the cash come from? Ben Bernanke told us that the US Federal Reserve created the cash out of thin air.

So all these financial issues are missing the point, which is the government cannot buy what is not available for sale and if it tries to compete for real resources against other users or bidders, then the price will go up – and the increased nominal spending will result in inflation.

The red tape arguments are different. The Reuters report puts these delays in a different light to the usual claims that governments are just inefficient.

We learn that the problems of reconstruction are very complex. Private property rights have to be respected legally and negotiating contracts to purchase new land for housing is time consuming.

For example, we learn that:

Before the city could buy land, it had to track down the legal owners. That proved tedious … Officials discovered that in many instances, properties had been passed down without proper inheritance procedures.

That seems like private sector inefficiency (fraud or rule breaking) rather than government inefficiency.

Further, while there is a massive reconstruction challenge “many local government officials, who would otherwise have played a role in reconstruction, either died in the tsunami or had their homes destroyed and are themselves living in temporary dwellings”.

Developing skilled labour takes time – several years in some cases by the time the requisite training has been delivered.

Conclusion

The reconstruction is the “largest such operation ever attempted in modern Japan” and the “construction industry as a whole has several times the amount of work it used to have before the disaster. That’s why naturally there is a shortage of workers and machines … It’s like building something in three years that took 50 post-war years to build.”

But think about this in a different way. Why is the construction industry booming? The answer is obvious. The fiscal expansion has stimulated spending and the private sector has benefitted with increased incomes and employment.

Who said fiscal policy does not create growth and jobs? Answer: most of the neo-liberal economists around.

Who said that there are real limits to what fiscal policy can do? Answer: MMT proponents.

That is enough for today!

(c) Copyright 2014 William Mitchell. All Rights Reserved.

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    10 Responses to Japan demonstrates the real limits on government spending

    1. Neil Wilson says:

      A very timely article.

      I’ve been arguing in the UK that increasing taxation won’t help the NHS that much at all – because the required doctors and nurses to implement a 7-day a week GP service don’t exist. And you can’t command them to arise fully formed from the plasma soup via the holy power of taxation. They have to be trained in training facilities for several years.

      Of the doctors registered in the UK nearly a third obtained their primary qualifications outside the UK. Although that is great for the UK, it is a ‘beggar thy neighbour’ approach, given that there is very unlikely to be a surplus of doctors anywhere on the planet! It is effectively stealing the investment of another country in a person.

      When you get that in the private sector – companies stealing people that have been trained by other companies – the result is nearly always an overall reduction in the level of training supplied to individuals.

    2. Ikonoclast says:

      The site countryeconomy (dot com) says Japan’s unemployment rate is 3.6% and youth unemplyment is 5.9%. Allowances have to be made for how each country does its figures and for under-employment etc. but these are numbers USA, AUS and EU prospective workers would love to see. The same site says Japan’s inflation rate is about 3.0%. This is still a very reasonable number. So, there are no rea; problems on that side of the ledger.

    3. Daniel D. says:

      Neil, wouldn’t the UK have to experience a paradigm shift in the extreme?

      Not that they would be alone, as how many nations publicly invest at appropriate levels for the education of doctors, nurses and health care workers in general?


      In Canada, doctors, nurses et al are primarily lured to the US and Canada recruits off-shore medical professionals to compensate ……

      There are private recruiting firms who do nothing else.

    4. dnm says:

      Officials discovered that in many instances, properties had been passed down without proper inheritance procedures.

      That’s interesting because it suggests yet another reason why Japan had so much trouble recovering from its previous bubble. There are currently millions of vacant homes in the country, and if the owners can’t establish title, they can’t sell, and property values go through the floor.

    5. James Schipper says:

      Dear Bill

      Nothing to find fault with here. What you said also applies to a redirection of financial resources. The real resources can’t be redirected that easily. Suppose that a government spends a lot on the military and very little on education and health care. It can easily change the budget and allocate less money to the military and more to education and health care. However, it can’t just transform military people into educators and health care providers.

      Regards. James

    6. Auburn Parks says:

      Great work Bill-

      This is a great example of a dilemma we have in the USA. Progressives here love the notion of infrastructure stimulus spending and they love the FICA tax (because they erroneously believe it funds SS and medicare). But the reality is that implementing 100s of billions of dollars in infrastructure spending and employment as is a very complex and lengthy process. And stimulus is by definition temporary so we could get huge spikes in employment when the stimulus is on and then reductions when its off. This type of gyration is horrible for businesses as they cant plan ahead accurately (same reason why the gold-standards wild inflation\deflation fluctuations are so destructive). Predictability is one of the most important inputs for businesses. All of this is why infrastructure stimulus is a bad idea. If its worth doing during a recession, its worth doing all the time.

    7. Auburn Parks says:

      Oops, forgot to add that all this explains why the most efficient (not most impactful, since infrastructure spending does have a higher multiplier) way to stimulate aggregate demand is through tax cuts for the working and middle class (FICA). Unfortunately, progressive wont cut FICA because of the belief its necessary for SS. Hence, the dilemma

    8. Kevin Harding says:

      perhaps we need an active government construction sector
      with ready to implement projects always available
      government run apprenticeships with a guaranteed job at the end of it
      at a below sector pay rate
      a targeted counter cyclical job guarantee
      when private sector construction work is down
      the government can increase the size or amount of public work projects
      to absorb unemployed workers
      As long as government local as well as national are always training
      and always running some projects .

    9. SteveK9 says:

      When people say ‘there isn’t enough money’ for this or that, I usually try to point out that focusing on ‘money’ in that sense is wrong, but that it is not wrong to focus on the ‘real’ resources. What matters is how we decide to allocate resources (manpower, materials), invest in creating new resources (power plants, or a trained chemist, etc.). ‘Money’ is mostly how we do that, keep track of whether the investments were good, …

    10. Bob says:

      Japan needs Land Value Taxation to reduce the number of vacant buildings.

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