The Austrian Analysis of the Syndrome of Economic Japanization

In short, the main message revealed by the analytical tools of the Austrian School is that the only way to recover sustainable economic prosperity following a speculative bubble and credit expansion (which, as we already know, invariably lead to a financial crisis and an economic recession) is to promote economic liberalization and free enterprise at all levels. There is no other way.

This means that in very rigid economies, a number of fundamental structural reforms must be carried out. Basically, these are all microeconomic in nature, and none has to do with the macroeconomic manipulation of the money supply or of fiscal spending. Politicians and monetary authorities inevitably succumb to the temptation to engage in such manipulation in contexts of great institutional rigidity, financial crisis, and economic recession. Precisely what do the necessary microeconomic reforms consist of? Basically, they consist of systematically deregulating the economy; liberalizing markets, particularly the labor market (key in the case of Japan and of the European Union); reducing and rehabilitating the public sector and public spending; minimizing subsidies and reforming the “welfare state” to return responsibility to the citizens; and lowering the taxes that overburden economic agents, especially taxes on entrepreneurial profits and capital accumulation.

We must remember that profits are the signals which guide entrepreneurs in the market in their constant search for sustainable investments. And a tax system that falls on profits essentially smudges the traffic signals that guide us in the market, and this inevitably makes economic calculation chaotic and gives rise to a misallocation of scarce resources. Also, taxes on capital have a particularly adverse effect on wage earners, and especially on the most vulnerable, since their pay depends on their productivity, which in turn depends on the accumulated amount of well-invested capital per worker. Therefore, to stimulate economic development and push up wages, what is needed is the accumulation per capita of an ever-increasing volume of well-invested equipment goods. If capitalists are harassed and capital is taxed, the accumulation of capital is blocked at the expense of labor productivity and, ultimately, wages.

All of the reforms mentioned are geared toward encouraging the dynamic efficiency of our economies and promoting an environment in which entrepreneurial confidence is quickly recovered and entrepreneurs can detect the investment errors committed in the bubble stage and massively transfer the productive factors from projects in which they were mistakenly invested to sustainable investment projects. Certainly, these new, sustainable investment projects are not going to be discovered by the state, nor government ministries, nor public officials or experts, but only by an army of motivated entrepreneurs in a context in which they have recovered their confidence.


Therefore, we need an environment friendly to the world of entrepreneurship and the free economy, an environment in which taxes are low and never expropriatory, and in which it is worthwhile for entrepreneurs to accept the uncertainty in the continual search for and undertaking of profitable investment projects.

What happens when, instead of encouraging these structural reforms, none of them is implemented, the economy remains rigid, and the only reactions, as we have seen in the case of Japan, are a massive injection of money supply, the lowering of interest rates to zero, and an increase in public spending? In this case, two very important effects are brought about. First, an ultra-lax monetary policy is self-defeating; in other words, it prevents itself from fulfilling its
intended aim, and thus, it cannot possibly produce any of the expected results (for reasons we will soon consider). Second, an ultra-lax monetary policy acts as a true drug which blocks any potential political and institutional incentive to launch, support, and complete the necessary structural reforms. These are the two most important effects. An ultra-lax monetary policy is self-defeating and fails to achieve its objectives, and at the same time, it almost automatically blocks any incentive to carry out structural reforms in the right direction. And, as we will see, this hits home to us in Europe, especially if we recall the monetary policy the European Central Bank has employed.

There are various reasons an ultra-lax monetary policy is self-defeating. To begin with, if the interest rate is forced down to virtually zero, the opportunity cost of holding cash balances is practically eliminated. That is, in a normal economy in which interest rates are between 2 and 4 percent, holding money in cash involves that opportunity cost. If you do not invest the money, you are not receiving that rate of interest. If central banks artificially lower the interest rate to zero, the cost of holding that money in cash in your pocket is zero in terms of interest. This explains why ultra-lax monetary policies are always accompanied pari passu by a rise in the demand for money. In other words, people keep in their pockets much of the injected money. Above all, if, as occurs in our environment, structural reforms are not carried out, the economy remains highly rigid, thus fueling considerable uncertainty about the future. In fact, one of the main reasons for holding cash balances is precisely to be able to cope with and respond to any unexpected event that may take place. A desire to be able to cope with future uncertainties is one of the main reasons we demand money. And under such circumstances of great uncertainty and a rigid, highly controlled economy flooded with injected money, where the opportunity cost of holding cash balances is zero, without a
doubt the most sensible thing to do is to hold onto your liquidity.

To this, we must add that most entrepreneurs are still wary and fearful, due to what happened in the last financial and economic crisis, in which they lost a great deal, and they see that the economy is still highly controlled, that it is practically impossible to take a single step without asking permission from the authorities, that there are many bureaucratic and labor-related difficulties, and so on. Moreover, entrepreneurs are fully aware that if, in spite of everything, they hit the mark and are successful, the state, through various taxes (corporate tax, income tax, and wealth tax), is going to take more than half of the profits they earn. Under such conditions, we can understand that the great temptation entrepreneurs face is to throw in the towel and avoid trouble. (“¡Que invierta su puta madre!” [Let some other damn fool invest!] as the sentiment is so graphically expressed on tshirts my students designed and are so successfully distributing around the university campus.)

We must bear in mind that all economic actions are incremental and that at the margin, many thousands of introductory steps that would have been taken to seek out sustainable entrepreneurial projects in the right direction and launch them are not taken. And this accounts for the difference between an economy that starts to sustainably recover, though perhaps with great difficulty, as in the case of the United States, and an economy that remains indefinitely lethargic or in recession, as in the case of Japan.

However, central banks sell us the idea that the solution lies in injecting massive amounts of money and lowering interest rates to zero so that the banking system will grant loans (whether viable or not) and people will be inspired to request them. And so that bankers will avoid mistakes and lend wisely (not to the wrong people), all sorts of precautions, inspections, and new banking regulations (Basel I, II, and III) are established, along with higher and higher capital requirements, etc. And in the end, what happens? Well, the banking system is unable to lend the money it is practically given, because ordinary entrepreneurs as a group remain wary in an environment of great uncertainty and distrust, and thus, they return their old loans faster than they request new ones. This causes an additional monetary contraction which largely blocks, compensates for, and sterilizes the expected effects of the injection of money.

Hence, monetary injections are self-defeating; they do not achieve any of their objectives; they block and paralyze the recovery; and they never increase prosperity.

At this point, we come to the maximum outrage: negative interest rates. In a natural, uncontrolled market economy, interest rates can never be negative. If the interest rate is negative – for instance, if I lend you one thousand euros, and at the end of one year, you have to return only 990 – obviously, this is an encouragement for people to do nothing and avoid investing. It motivates people to leave the money in their pockets and a year later, to pay back exactly 990 euros, and make ten euros without doing anything and without having to take on any entrepreneurial risk or endure the harassment and incomprehension of bureaucrats. If, as an entrepreneur, I ask for trouble, invest,
and things go badly, I may not be able to return even the 990 euros, and if I earn something, half of it will be taken away, public officials will come after me, and unions will make my life miserable. In contrast, with negative interest rates, the best thing to do is to endlessly request loans, sit on them and do nothing, and then pay back less than the borrowed amount, keep the difference, and make a sure profit without taking on any risk. Therefore, in conceptual terms, a negative interest rate leads directly to doing nothing, to lethargy, and to economic Japanization.

Furthermore, the aberrant monetary policy of negative interest rates has another very harmful side effect: The policy is used to automatically finance the public deficit at no cost and without limit, thus blocking the few incentives that might remain for governments to implement any structural reform. In contrast, such a monetary policy encourages the authorities to increase subsidy policies and vote buying, which inevitably sink our societies into demagoguery and populism. Indeed, we have a crystal clear illustration of what I am talking about: In our own country, Spain, and in the rest of Europe, practically the same day the European Central Bank introduced quantitative easing in 2015, all reforms were paralyzed. And the countries that needed them the most and were about to adopt them, but had not yet done so, shelved them indefinitely. Therefore, policies of monetary manipulation do not achieve any of their objectives; they are self-defeating; and they block the only thing that could pull the country out of its lethargy: the necessary structural reforms and economic liberalization.

And now, the final blow. Stunned and disconcerted, central bankers see that they are achieving none of their objectives and are simply turning their economies into drug addicts, since at the slightest mention of withdrawing the stimuli, the economies sink into recession. And because these authorities see no way out of this vicious circle they themselves have created, all that occurs to them is to recommend the adoption of a fiscal policy involving vigorous increases in public spending. This is even worse, because it distorts the real economy even further by placing a growing number of productive factors in projects which depend on the government and have no more sustainability
than a mere political decision. For instance, in Spain, employment has increased due mainly to the public sector and to projects related to it (and in the case of Japan, to projects connected with the 2020 Olympic Games). However, the growing volume of public-sector employment is not sustainable, and its continued existence is not backed by consumers and will depend solely on the future decision of politicians to maintain that expenditure or not. Again, such fiscal policies prepare the ground even more (if that is possible) for the development of the Japanese economic illness.