In a front page Milwaukee Journal Sentinel Crossroads' column, Amity Shlaes cites the failure of Japan's "huge" fiscal stimulus program in the 1990s as a cautionary tale for President-elect Obama.
Shlaes who has become the darling of free market conservatives for her repudiation of the New Deal and all things Keynesian misrepresents the Japanese experience as a case of large public expenditures in infrastructure that failed to ignite the economy, arguing that infrastructure investments are better left to the private sector.
Leaving aside the obvious problem that a fiscal stimulus is needed precisely because private investment has collapsed, it's apparent that Shlaes is misinformed about Japan's experience. Perhaps she has not read Adam Posner's definitive work, Restoring Japan's Economic Growth, which is a detailed refutation of her arguments.
Japan's 1990s fiscal stimulus, changes in government spending and taxes, was disappointingly modest, not huge, as Shlaes contends. It amounted to only about a third of the announced stimulus and according to Posner: "This limited quantity of total fiscal stimulus was disbursed in insufficiently sized and inefficiently administered doses, with the exception of the 1995 stimulus package."
In 1995 Japan implemented an aggressive fiscal stimulus that led to strong economic growth in 1996. But its impact was undermined in 1996 and 1997 by fiscal contraction. Posner concludes: "On net, the Japanese fiscal stance in the 1990s was barely expansionary...."
The problem in Japan was not a huge stimulus package, as Shlaes contends, but an overly timid one.
This is similar to the U.S. experience in the 1930s. The economy began to grow in 1934 in response to increased deficit spending. But President Franklin Roosevelt, under pressure from his era's balanced budget hawks, was forced to cut federal spending in 1937 and the economy began to contract, only to be rescued by World War II and dramatic increases in federal spending.
So what are the real lessons President-elect Obama and his advisers should learn from Japan and the New Deal? First the stimulus package must be large enough ($700 billion to $1 trillion) to ignite the economy. And second, once the stimulus begins to work and the economy begins to grow, the Obama administration should reject any pressure from the Shlaes' crowd to prematurely cutback on the stimulus.