Thursday, August 23, 2012

Why Noda Chose The Consumption Tax Or How Rick And The SSJ Meet Dracula's Daughter

There are two major list-serves on contemporary Japan, the NBR Japan Forum and the SSJ-Forum. Many of the same individuals contribute to both, with the NBR Japan Forum being heavier on economics and security and the SSJ-Forum, unsurprisingly, being more often on society, culture and politics. Of the two, the SSJ-Forum is generally the more useful, as a large number of the posts are events schedules, calls for papers or book release announcements. Also the SSJ-Forum does not tend to get clogged up with long-winded debates over issues relevant to the participants but irrelevant to contemporary Japan (Rod Armstrong and Mike Smitka, I am not talking about you. Keep up the good fight!).


On August 4, Richard Katz of the Oriental Economist newsletter posted a question to the SSJ-Forum:
I'm curious to know how rational choice theorists would explain PM Noda's single-minded devotion to pushing the unpopular consumption tax hike.

My understanding of rational choice theory is that it borrows its methodology from economics in which actors try maximize their utility in the narrow sphere of the
marketplace, and utility is defined by some fairly well-specified objective function, e.g. firms try to maximize profits, consumers try to maximize materal (sic) living standards and so will buy a $300 TV rather than a $400 one if the two are perceived to be identical. In the case of rational choice theory about politicians, as I understand it, the objective function is usually said to be to gain power by getting elected and re-elected, rising in the ranks of their party and office, and being part of a ruling party. Ideology, principles, beliefs are all laid by the wayside.

How can any of this explain Noda's actions? As a result of the tax hike and his mishandling of the nuclear restart issue, the Democratic Party of Japan is headed for a calamitous defeat. Most surveys (as well as my own personal conversations with DPJ and LDP Diet members) suggests the DPJ would win about 100 seats if the election were held now whereas the LDP would win 200. One first-term DPJ Diet member from western Japan, a genuine reformer, bitterly told me he may need to switch to Hashimoto's party if he wants to survive the next election. Needless to day, Noda will no longer be head of the DPJ in the aftermath of such an electoral disaster (assuming he remains PM in the run-up to it). Whether these numbers turn out to be right or not, depends on the Hashimoto party and other factors, but I don't know of anyone who believes the DPJ will win.


So, how does rational choice explain Noda's willingness to sacrifice his own career and his party's fortunes in order to "do the right thing" as he saw it?

If one says that "doing the right thing" is now part of the objective function, then rational choice theory is basically left with saying: "he did it because he wanted to do it." That, to me, hardly seems like a contribution to either explanation or prediction.

BTW, this is not a rhetorical question on my part. I have little doubt that rational choice theorists do have an explanation for Noda's actions; I just can't
figure out what it would be. I'm hoping that its advocates on the list can help me out.
The question has prompted a number of luminaries in the field -- Aurelia George Mulgan, Thomas Berger, Ellis Kraus, Okumura Jun -- to post partial answers to Katz's question. These having been popping into my mail box at the rate of about one every 18 hours.

All of which makes me feel like Dracula's daughter -- at least as she is portrayed by Lily Tomlin in her one-person sketch, "Lud and Marie Meet Dracula's Daughter" of, oh, way too long ago.

Have a listen.

OK, now that you are back -- here is problem with the question -- which is the problem with the discussion.

When asking about how a given theory explains how a certain choice is made, it is helpful if the choice actually existed. To whit, asking, "I'm curious to know how rational choice theorists would explain why men prefer apples with blue and white Kusama Yayoi-style polka dots on them?" would be worthwhile if there were apples with blue and white Kusama Yayoi-style polka dots on them.

[An aside, but it always fascinates me that 99% of the articles promoting one of Kusama's exhibitions or analyzing her work manage to avoid mentioning that she is clinically insane. She lives, voluntarily, in an assisted living community as she is well aware that she is bonkers.

Her insanity informs her art, I think. Keeping her mental condition under wraps is a real disservice.]

Now in the case of Noda's choice, Katz has, in his written work for the Oriental Economist and his two public presentations in Japan, one at the Foreign Correspondent's Club of Japan and the other at Temple University Japan, taken at face value Prime Minister Noda's claim or insinuation that he had three major projects to undertake in the near future to bolster Japan's economic health:

1) begin formal, unequivocal discussion on joining the Trans Pacific Partnership

2) restarting Japan's nuclear power plants as soon as possible

3) raising the consumption tax in order to stabilize the funding of the nation's welfare and pension systems

For a Japan optimist like Katz, who sees Japan's output gap and suppressed domestic spending as criminal and reversible, the prime minister's decision to pursue option #3 at the expense of options #1 and #2 is perverse. The Japanese government's current borrowing costs are among the lowest on earth. The currency is one of the world's strongest. There is no crisis in confidence in Japan's ability to finance its debts. Furthermore the previous raising of the consumption tax in 1997 contributed to a crushing of domestic GDP growth, helping trigger the financial meltdown of 1998 and in the end reducing overall tax receipts (I think the little matter of the Asian Currency Crisis of 1997 had a little more to do with the 1998 crisis than the consumption tax rise -- but my memory is perhaps faulty).

Why pursue an end that will likely damage rather than strengthen the economy?

As Katz's question indicates, he also cannot see the political value of pursuing a rise in the consumption tax. Every single past instance of the tax either being imposed, raised or even talked about (2010) has led to the ruling party getting hammered in the next election.

However, if you look carefully at the three major policy programs listed above, it is clear that only the third, the consumption tax, was real. The first and second options, however economically sound, were political red herrings or lead balloons (choose your metaphor).

Any analysis of the "choice" a DPJ prime minister makes or may make must consider paramount the control the Liberal Democratic Party has over the passage of legislation through the House of Councillors. If the LDP does not like a policy, it has no chance of being implemented.

Looking at the TPP, one can immediately see that no matter what the government or the Nihon Keizai Shimbun may be saying, it is dead on arrival. The liberalization of the agricultural sector makes the TPP anathema in the rural districts, which are as ever overrepresented in the current Diet. Voting for the TPP would kill the reelection prospects of a DPJ representative in a rural seat. As for the LDP, which wants to regain the rural seats it lost to the DPJ in 2009, the TPP is also poison, though the LDP leadership, in pandering to the business lobby that also abandoned the LDP in 2009, keeps the TPP among its verbal bag of tricks.

So pursuing the TPP was a hopeless endeavor, especially after it turned out that the gatekeeper to Japan's joining the discussion was the U.S. Congress, particularly the U.S. Representatives and Senators from the state of Michigan and other U.S. auto producing states. There is only one thing negotiators of this blessed land want to show the legislators from the states dependent on America's bailed-out auto industry, and that is their naked backsides.

Restarting the nuclear power plants was also political poison. The country is in the grips of a deep and irrational fear of nuclear power and the nuclear power industry. Any politician speaking up for the restarting of nuclear power would be suspected of being in the pocket of the nuclear village.

Noda rational expectation was that Japan's industrial and commercial interests understood that this was their fight, not his. It was up to Japan's economic actors to make the case to the public that dangerous and unpredictable as it may be, the nuclear power plants had to be restarted, lest the country suffer economic damage or even catastrophic blackouts.

This industry pointedly failed to do. Perhaps it was unaccustomed to doing heavy political lifting by itself, having always relied on the bureaucrats of the Ministry of Economics, Trade and Industry to do their dirty work for them. Perhaps the elites in both the bureaucracy and industry, unaware that the political ground had shifted underneath their feet, thought that they could cow the populace into silence with just the hint that an interruption in the reactors restarts could hurt output and thus employment and remuneration.

Whatever the reason, industry failed to convince anyone that the country was on the brink of disaster. It took a personal intervention by the prime minister, at the last minute, and a chancy game of chicken with political maverick Hashimoto Toru, to persevere in a struggle to just get the Oi #3 and #4 reactors back on line before this summer, which has turned out to be a scorcher.

That prime minister Noda paid deeply for this intervention was made clear yesterday when he had to invite into the Prime Minister's Residence representatives of the crowds of anti-nuclear protesters who have been making his Friday evenings deafening affairs. In pointed contrast, representatives of the Japan Chamber of Commerce also paid a visit to the Residence yesterday to limply present the prime minister with a unwelcome written request that the government do more for the security of power supply.

As for the consumption tax, here was a policy program that had a chance in hell of succeeding, specifically because it was not a DPJ program but an LDP one. On the face of it, the LDP could not vote down one of its own campaign promises, when given the chance.

It is indicative of the intellectual and ethical rot in the LDP that the party nearly succeeded in convincing itself to negate the implementation of its own campaign program, even after the DPJ blew itself into to pieces in an act of self-sacrifice in order to accommodate the LDP.

So the answer to the question initially proposed is simple: Noda chose the consumption tax option because it was real. Governments have to do something, even seemingly stupid stuff, lest they be accused, and rightly so, of doing nothing.

"Rationality" had nothing to do with it.

Now, I will go listen to Ms. Tomlin one more time. I need the laughs.


Jan Moren said...

Ignoring Noda, the very premise of the question is faulty: "rational choice" has never been remotely applicable to individuals as any psychologist (or five minutes watching people in an electronics superstore) can tell you. It was ever only valid for the aggregate behaviour of large masses of actors, and only under a restricted, and rather unrealistic set of constraints.

If he did find a real-world person actually acting according to economic theory under an extended time I'd say he's found somebody with a fairly severe psychopathology.

Troy said...

Japan falls into the "I don't have any solution, but I certainly admire the problem" pile.

Few people actually understand the numbers underlying Japan's financial reality.

I'm not saying I do either, but I think the reality as I do understand it is very interesting.

The yen at 78.50 is indicative of Japan's strength as a global wealth-producer, and the strength of capital flows coming in vs. going out.

It's my general thesis that Japan Inc. essentially won the game in the 1975-1985 period within the 250-300 Yen/USD regime. Japan had a large hand in supplying late 20th century consumerism, and profited immensely thereby, and has continued this trade capture by working closely with its Chinese partners, 1990-now.

OK, back to Noda. Japan abandoned fiscal probity in the mid-90s aftermath of the crash of bubble economy:

Taxes were reduced and called savings. As we all know, 90%+ of Japan's national debt is just money their taxpayers owe their savers -- one pocket owes the other!

I think the controlling reality here though is that Japan's economy is unable to gracefully transition away from free-money policy due to the still sky-high land valuations that underpin all asset values.

Significantly higher tax burdens will do a number on rents and the valuation of land, but since 1990 Japan's financial system simply can't afford any more drops in asset value.

The 10% consumption tax, should it ever be actually implemented, is only a one-third solution to the budget shortfall, even in the optimistic predictions.

But since it is deflationary, the tax rise does give the BOJ more leeway for QE to mitigate the pinch of higher taxes.

One really has to knock one's ideological blinders off when thinking about Japan. This is complicated stuff with many, many moving parts.

Few media commentators can step up their game.

Anonymous said...

What has continually fascinated me about the 10% consumption tax brouhaha is that, maybe, even one of Japan's sister developed countries has a tax just like that---or higher. The tax is generally used to support public pensions for the elderly, or other social support services.

Even in America. Yes, we do not have a "VAT", but we have the Old Age and Survivor's (OAS) portion of FICA, the social security tax. It's 5.3% of the worker's wage, matched with 5.3% on the employer (in which the employer simply reduces the overall wage to the worker). Since most of America is under the $110,000 wage cap, and spends practically all of wage earner income on consumption (savings rate = 5% at best), it is no different than a consumption tax.

Japan has spent too long pretending that they have an adequate pension scheme for the elderly. That is the problem. They are pretending that the people's own savings or inheritances will be equal to a guaranteed annuity, for everyone. What secrets of portfolio management do the Japanese have, to make this happen?