Is The U.S. Economy Following The Japanese Death Spiral?

With ballooning federal deficits and slowing growth, the U.S. looks more and more like Japan…

“Last week a top official . . . bragged that _____ now is in a position to influence the value of the dollar, of our interest rates, and even our stock prices. And he warned that one day maybe they might just do that….

If China were in the above statement’s blank, it could fit right into this year’s political debates. In fact, this line comes from the 1988 vice presidential debates between Lloyd Bentsen and Dan Quayle, and the country in question was Japan. These debates came a few years after the best-selling book Japan as Number One from a Harvard professor predicted Japan’s economy would surpass the U.S.

Until the early 1990s, Japan’s economic growth far exceeded the United States but then fell significantly behind.

From the perspective of those times, the awe and even fear with which Japan’s economy was viewed are understandable. As shown in the chart below, from 1961 to 1992 Japan’s growth averaged 5.5 percent compared with 3.5 percent for the U.S. In only five of those 32 years did Japan trail the U.S.

From today’s perspective, the 1980s’ fear and awe of Japan is puzzling or even ironic. From 1993 to 2019, the U.S. averaged 2.6 percent growth, well behind the earlier era, but far ahead of Japan’s meager 0.9 percent. In only three of the past 26 years has Japan’s growth exceeded the U.S.’s.

What happened?

Big government happened — to Japan and, to a lesser extent, to the U.S. Japanese government spending was just 17.5 percent of the country’s GDP in 1960 but has grown, as illustrated below, to 38.8 percent of GDP today.

During its high growth era before the 1990s, Japan’s government was significantly smaller than the U.S. but grew larger as the country’s growth lagged.

Japan’s government surpassed the U.S. government’s share of 34.1 percent in 1994, and the island nation’s growth never recovered. The theory that government spending boosts long-term growth has failed in both countries for 50 years.

What government spending does is crowd out investment. In both Japan and the U.S., private investment is a relatively stable share of the private sector, but, as the private sector shrinks relative to government, investment declines. The next chart depicts the decline of Japan’s investment as its government grew.

As Japan’s government sector expanded its share of the economy, investment’s share declined.

The U.S. has seen a similar negative relationship between the size of government and investment share of GDP. Rather than a problem confined to the other side of the world, Japan’s death spiral is a pointed warning to the U.S. The U.S. and Japanese economies are on the same trajectory; Japan is simply further along the big-government, low-growth path.

This chart compares government spending and growth by year for Japan and the U.S. The two countries’ dots blend more or less seamlessly. Japan is just more concentrated at the two ends of the spectrum: It spent less than the U.S. during the 1960s and now spends more. Those looking to explain away this relationship point to business cycles: When the economy and investment are down, government spending goes up and vice versa. But long-term secular changes in government spending are far larger than cyclical changes. Both cyclical and secular changes similarly affect investment and thus long-term growth. The negative relationship of government spending with growth and investment holds with adjustments for cyclical influences such as using ten-year averages or the Congressional Budget Office’s estimates of cyclically adjusted U.S. government spending.

CBO data highlight how close the U.S. is to a Japanese-style death spiral. In March of this year, CBO projected a long-term rise in government spending to 35.3 percent of GDP in 2021-30, to 37.9 percent for the next decade, and to 41.5 percent for 2040-50. The above chart indicates that growth rates associated with these spending levels are 1.7-2.2 percent from 2021-30, 0.7-1.5 percent from 2030-39, and -0.1-0.7 percent for 2040-50. Of course, CBO’s recent forecast was prepared before the coronavirus shock and does not incorporate spending by a new Democratic government, so this dismal outlook is likely to worsen.

We cannot leave our children this bleak future. We must offer the disadvantaged the opportunity to contribute to a thriving society, not leave them scrapping in a zero-sum stasis. In the last decade of U.S. stagnation, black households lost half their gains from the previous 30 years compared with whites.

Boosting growth means restraining government. Restraining government means reengineering entitlements, which are the root of U.S. government growth. CBO calculates transfer payments, largely entitlements, have grown from 3.7 percent of GDP in 1962-70 to 12.1 percent in the 2010s. In that time, defense spending fell from 8.3 percent to 3.6 percent, government infrastructure investment fell from 6.5 percent to 3.6 percent, and domestic discretionary spending fell from 3.7 percent to 3.5 percent of GDP. Those valuing these government programs must recognize entitlements are gobbling them up.

Economically, it shouldn’t be too difficult to do better. We have an insolvent, low-return government-retirement program along with an insolvent retiree-health program — part of a Rube Goldberg health-care system where people with one kind of job get one thing, people with another kind of job get something else, old people get still another thing, and some poor people get yet another, all while tens of millions fall through the many cracks, and everything costs twice as much as anywhere else on the planet. Of course, politically, reform is a monumental challenge. Big-government ideologues must acknowledge the superior retirement returns and incentivized cost control of the private sector, while small-government advocates have to accept that government guarantees and subsidies may be possible at affordable cost.

The United States is at risk of entering a Japanese death spiral. Big-government clingers maintain Japan’s population decline means even stagnant growth increases incomes, but the United States cannot shrink its way to prosperity. Growth is a necessity for us, not an option. We can and must achieve it.✪