To Recover, Japan Must Ignore the Fallacies

"The possibility of a rapid repair of their disasters, mainly depends on whether the country has been depopulated. If its effective population have not been extirpated at the time, and are not starved afterwards; then, with the same skill and knowledge which they had before, with their land and its permanent improvements undestroyed, and the more durable buildings probably unimpaired, or only partially injured, they have nearly all the requisites for their former amount of production."~ John Stuart Mill, Principles of Political Economy, Book I, chapter 5.

The ongoing tragedy in Japan has unsurprisingly generated a great deal of commentary covering how - and if - the country will recover economically from difficulties that at least from the television screen, seem insurmountable. The happy news is that if history is any kind of indicator, Japan will rebound with great speed.

And since Japan will recover, it's important to discuss some of the economic falsehoods that like Groundhog Day, always reveal themselves anytime a country suffers a natural disaster. This is useful because in discounting what's ahead for Japan, it's necessary to discredit the fallacies that will have nothing to do with the country's resuscitation.

First up is the sad, discredited, and surely horrifying notion that the collapse of country infrastructure, and its subsequent rebuild, will be economically stimulative. This false belief system was long ago discredited by economists Bastiat and Hazlitt who helpfully noted that while broken windows might stimulate glaziers, the unseen would be the investment that wouldn't occur in order fix what wasn't previously broken.

To buy into the silly reasoning popular among journalists and allegedly intelligent economists such as Larry Summers is to believe that each time the U.S. experiences an economic downturn, the path to recovery would consist of dynamiting various cities in order to put Americans to work. A more absurd bit of economic thinking would be hard to conceive, but sure enough, newspapers have been filled with just that kind of commentary since the tragedy in Japan struck.

As Adam Smith long ago observed, stationary economies are failed ones, so for a region or country to rely on disasters as a form of stimulus would be for both to see investment and the jobs it creates eventually depart. Destroying wealth in order to recreate it is the picture definition of a stationary economy, so only the truly dim would suggest that there's a silver lining tucked into Japan's monumental struggles.

Of course other supposed thinkers in the economic commentariat are making the point that due to the massive budget deficits run up by the profligate Japanese government over its two lost economic decades (stimulus spending advocates should take note: there is a correlation), the debt markets won't support the kind of government spending needed to rebuild what's been destroyed. But rather than worry about what may or may not be true, we should rejoice if Japan's politicians are in fact constrained.

To see why, it's necessary to look back to both Germany and Japan in the aftermath of World War II. As Howard Kershner wrote in his essential book, Dividing the Wealth, Germany "had suffered the loss of many millions of her strongest young men and had seen a great part of her homes, factories and business buildings destroyed." In short, Germany suffered something exponentially greater than did Japan last week.

Told by American advisors to engage in deficit spending to get Germany's economy moving again, the great German Finance Minister Ludwig Erhard responded that "We are not going to do it. We intend to balance our budget, not to incur any indebtedness, to avoid inflation and keep the mark stable and sound."

Thus began a major economic reawakening in Germany built on reduced taxes that rewarded those who sought profits in rebuilding the destroyed country, and underpinning this elevation of the productive was a mark that maintained its stability thanks to its link to a dollar defined in gold. As Kershner noted, "in a few short years Germany became the most prosperous country in Europe, if not in the world."

Japan was similarly reduced to rubble after WWII, and with its new government lacking any credibility to deficit spend, it too had to rely on the productive. So with a yen defined in terms of a gold dollar, Japanese politicians proceeded to reduce taxes every year after the war on the way to Japan becoming an extraordinarily rich country within a short period of time.

Fast forward to the present, capital is always scarce, and as such, the worst thing that could happen would be for Japan's government to go into debt even more in order to oversee what would almost certainly be a slower, more wasteful reconstruction. Better it would be for the country's politicians to reduce the cost of success on the way to a private sector revitalization that would only be hamstrung if the Japanese government were competing with it for scarce capital.

As Americans our instinct might be to petition Congress for foreign aid, but capital is capital, and any government charity coming from here would merely subtract from what private actors would access to rebuild. On the other hand, if we truly want to aid the Japanese, the single best thing we could do would be to demand a strong, stable dollar. The world's currencies remain vaguely or explicitly pegged to our greenback, so in stabilizing our currency, we'd be offering the Japanese something to peg to, and stable money is the single best way to drive the investment necessary for recovery.

Regarding those who wonder if Japan can recover at all, the mere question is absurd. Awful as the recent tragedy was and is, it's exponentially smaller than what befell Japan over fifty years ago. Japan will surely rise again, but it only will if its leaders avoid the embrace of economic fallacies, and simply allow the country's "vital few" to rebuild with profit in mind.