The Keynesian Path to Economic Destruction, a Case Study: Japan
What follows is an excerpt from Thomas Woods' excellent book Meltdown. Among the many profound insights found within, including an Austrian School explanation of the boom-bust cycle and its application in the dot.com and housing booms and busts, is an overview of Japan's two decade recession.
But hey, whatever, I'm sure it will all turn out great. After all, behavioral economist Robert Shiller of Yale tells me that if I just smile real big, I'm doing my part to save the economy.
Meltdown by Thomas Woods
The Japanese Bust
Similarly [to the American housing boom], the 1980s saw a spectacular boom in Japan financed in large part by inflationary credit expansion - that is, the creation of money out of thin air through the banking system and the artifical lowering of interest rates that accompanies the increased money supply. When the inevitable bust came, it hit hard. The Nikkei, the Japaneses stock mart, dropped from 40,000 in late 1989 to 15,000 in 1992. Real estate prices dropped 80 percent between 1991 and 1998. All the while, the Bank of Japan and the Japanese government more generally did everything they could to prevent the liquidation and try to prop up prices and bad debt. They pushed interest rates all the way to zero. They obstructed market correction of the malinvestments of the boom. The structure of production therefore remained stuck in a pattern that did not correspond to consumer demand. As a result, Japan had an economic depression of its own for well over a decade.
A valuable piece of evidence in favor of the Austrian account of what happened to Japan's economy emerges when we examine the sectors that were hardest hit by the recession. If Austrian business cycle theory is correct, we should expect the most significant declines to be in the capital-intensive industries in the higher-order stages of production.  And that is exactly what the data shows. In order from most capital intensive [to the least] are mining, manufacturing, wholesale and retail, and the service industry. And that is also the order, from most to least, in which these industries suffered during the downturn.  Industries in the earliest stages of production suffered from the worst growth rates throughout the 1990s.
None of the traditional interventionist tools that supposedly bring about economic recovery - every one of which is being peddled before Americans today - did a single thing to revive her fortunes. What did Japan try? Increases in the money supply, interest-rate cuts, trillions of yen in public works (being proposed as part of a new "stimulus package" for the United States as this book is being written), other increases in government spending, government lending to business, and bailouts (and even outright nationalization) of some banks. That should sound pretty familiar, since these are the very proposals that supporters of the free market are being ridiculed for not accepting. The Japanese government set up a 20-trillion yen guarantee fund for zombie companies that were on their way to going bust. According to the Economic Intelligence Unit, funds "disbursed under the program are often going to companies that are not creditworthy and that would otherwise go bankrupt" - in other words, precisely the firms that need to be liquidated during the recession, and with which healthy firms are forced to compete for resources if they are artificially kept alive. 
Mechanisms were put in place by which the Japanese government itself would buy up shares in order to boost stock prices should the Nikkei drop below a certain level. During the 1990s the Japanese government launched no fewer than ten fiscal stimulus packages at a total cost of over 100 trillion yen. None of them worked. In addition to keeping the Japanese economy in the doldrums, these packages also put Japan in terrible fiscal shape, with its national debt (including various kinds of "off-budget" debt) in excess of 200 percent of GDP.  In order to get banks lending again, the Bank of Japan pumped money into the banking system at an extraordinary rate between 2001 and 2003 - in April 2002, the yearly rate of growth was 293 percent. It didn't work. During those years bank loans averaged a 4.5 percent annual decrease. 
All of these activities distort market processes and hinder the reallocation of resources that needs to occur as a boom comes to an end and a bust begins to set in.
The public works programs were especially extensive. According to Paul Krugman, who supports such programs:
"Think of it as the WPA [Works Progress Administration] on steroids. Over the past decade Japan has used enormous public works projects as a way to create jobs and pump money into the economy. The statistics are awesome. In 1996 Japan's public works spending, as a share of GDP, was more than four times that of the United States. Japan poured as much concrete as we did, though it has a little less than half our population and 4 percent of our land area. One Japanese worker in 10 was employed in the construction industry, far more than in other advanced countries." 
With an effort of this size and scope having failed, the best Krugman could do was to argue, lamely, that in the absence of these programs the situation would have been worse. The opposite is true: had government not distorted the market so severely and siezed all these resources for its own uneconomic use, the private sector would have been in a much healthier position to build toward recovery.
One thing these programs did succeed in doing was to plunge Japan very deeply into debt. Japan's deficit spending, says Krugman, has "pushed Japan's debt above 130 percent of GDP. That's the highest ration among advanced nations, considerably worse than either Belgium or Italy, the traditional champions. It's almost twice the advanced-country average and 2.5 times the figure of the United States." 
In short, the Japanese government did absolutely everything the Austrian theory suggests it should not do in order to fight the recession. It engaged in every single activity that Keynesians like Paul Krugman recommended. As a result, its slump went on for a decade and a half. Keynesians continue to recommend these very policies for the United States, as if the debacle in Japan never occurred. In late 2008 financial newspapers in the U.S. actually began to speak of a revival of Keynesianism (claiming, absurdly enough, that the present crisis gave the ideas of Keynes, one of the twentieth century's collection of inexplicably respected crackpots, a new lease on life), again with no mention of Japan.
1. Mainstream economics, it should be pointed out, can scarcely be said to possess any capital theory at all, much less one that conceives of capital as a series of time-consuming stages from higher order to lower order. Capital, to economists trained in that tradition, is a homogenous lump. As a result, it is impossible for the average economist even to perceive an Austrian-style boom and bust when it occurs. "If one were, for instance, to aggregate heterogeneous capital goods into 'capital,' the complex relationships among capital goods would be lost," write economists Gerald O'Driscoll and Mario Rizzo. Gerald P. O'Driscoll and Mario Rizzo, The Economics of Time and Ignorance, 2nd ed. (London: Routledge, 1996), p. 190. Keynes expressly disregarded the structure of production in chapter four of his General Theory, and in a 1937 actually boasted of having separated macroeconomics from capital theory - thereby assuming away everything that should be of interest to the economist studying business cycles.
2. For the statistics, see Benjamin Powell, "Expaining Japan's Recession," Quarterly Journal of Austrian Economics 5 (summer 2002): 48.
3. William Bonner with Addison Wiggin, Financial Reckoning Day ( new York: John Wiley & Sons, 2004), 237.
4. Powell, "Explaining Japan's Recession," 39
5. Frank Shostak, "Are Fannie and Freddie Too Big to Fail?" Mises.org, September 17, 2008. To force the Japanese to spend, figures like Milton Friedman and Ben Bernanke suggested, in the words of economist Mark Thornton, that "the central bank should simply print up unlimited amounts of money, that the bank threaten consumers (who are hoarding their own money) with ever-increasing levels of inflation, or that the central bank purchase worthless stocks, corporate bonds, real estate, and even directly fund government expenditures." Mark Thornton, "Apoplithorismosphobia," Quarterly Journal of Austrian Economics 6 (Winter 2003): 11n5.
6. Quoted in Thornton, "Apoplithorismosphobia," 14.
7. Quoted in ibid.