Interviews (Edward J. Lincoln)

Edward J. Lincoln

Edward Lincoln is an economist who has never been afraid to speak his mind. A specialist in the Japanese economy and U.S.-Japan economic relations, Dr. Lincoln is Senior Fellow at the Council on Foreign Relations. Prior to his appointment, Dr. Lincoln spent a total of 16 years at the Brookings Institution, a career interrupted by a stint of three years at the American Embassy in Tokyo as Special Economic Advisor to Ambassador Walter Mondale in the mid-1990s. He also lectures on the Japanese economy at the Johns Hopkins University, School for International Studies (SAIS).

Dr. Lincoln is the author six books, including East Asian Economic Regionalism (2004), Arthritic Japan: The Slow Pace of Economic Reform (2001), Troubled Times: U.S.-Japan Trade Relations in the 1990s (1999), Japan’s New Global Role (1993), Japan’s Unequal Trade (1990), and Japan: Facing Economic Maturity (1988). A frequent public speaker and television commentator, Dr. Lincoln writes a regular column for Newsweek Japan, and his articles have appeared in Foreign Affairs, Nihon Keizai Shinbun, and the Brookings Review.

A graduate from Amherst College in 1971 with a degree in Economics, Dr. Lincoln holds both a master’s degree in East Asian Studies (1974) and a doctorate in Economics from Yale University (1978). He is fluent in Japanese.

Interview: June 23, 2004

Our favorite softball question: Why Japan? How did you get involved in Japan? Was there a grand design at work?

Actually, it was a complete accident. My wife is Japanese. She was an AFS (American Field Service) student at my high school—we went to the prom together. It was through her that I got interested in Japan. She went back to Japan of course, after high school—as all AFS students are required to do. After college (Amherst), my first job was teaching English in Doshisha—which coincidentally was started by an Amherst graduate, Joseph Hardy Neesima [Class of 1870]. After a while, I thought since my major was economics, I could combine the two. In those days, it was unheard of—no one studied Japanese economics as an area of study.

Eventually I studied under Hugh Patrick at Yale. I thought I would teach somewhere and combine microeconomics and Japan—an unheard of combination at the time as everything was divided up by branches of theory, not geographic region. So I went to JEI (the Japan Economics Institute) and then to the Brookings Institution.

When was the first time you moved to Japan?

It was 1971—I came to Japan three days after the exchange rate broke. It went from 360 yen to 345 yen in one day just before I got there. . .I thought it was a real tragedy then. . .little did I know. . .

It’s interesting that you say your introduction to Japan was an accident. Japan: the System that Soured author, Richard Katz, said something similar – not necessarily that he had a Japanese spouse, but that he stumbled into Japan through other interests.

Well, Rick is younger. It was funny. I was at a dinner party once here in Tokyo—mostly business and embassy Japan specialists: Glen Fukushima was there. He got up and asked, “How many of you have Japanese wives?” Every single person, except the single guy, raised his hand.

It was not until the mid 80s that I got students interested in Japan simply because they thought Japan was important, or interesting as a subject in itself. Actually these days, there are fewer students like that and more who I would characterize as interested in Japan for atypical reasons—you know, they came to Japan to teach English for a few years. . .the “hey, maybe I can make a living doing this” crowd. . . that kind of thing.

The Council on Foreign Relations (CFR) is truly “inside the Beltway” – in your view as a Washington observer, who are Bush’s as advisors/insiders on Japan and Asia?

The four main people are Richard Armitage, David Asher, Michael Green, and Jim Kelley (and for a period of time, Matthew Goodman). Very few people know about Japan in the Bush Administration, though I have to say it is an improvement from under the Clinton Administration. Four people are not a lot of people.

What about U.S. Trade Representative Robert Zoellick?

He doesn’t know anything about Japan; he’s a generalist. The South Americans think he’s a South American specialist and the Japanese think he’s a Japan specialist. The fact is he’s neither.

Why would you say that?

Well, first of all, when Bush came into office, there was a lot of continuity from Clinton’s second term. When Clinton first came to office, Japan was big news—people made speeches about it in Congress. Clinton made all these announcements it was a key ally, etc. But in Clinton’s second term, Japan became irrelevant: not to the people who worked on Japan, of course, but to the people in power: the White House.

How infectious is this “irrelevance” and how far can it go? In a 2003 strategy report to institutional investors, Nikko Salomon Smith Barney (Nikko Citigroup) chief equity strategist, Alexander Kinmont, concluded that “well-informed opinion of Japan [in terms of finance] has become a mere ‘luxury’” (see JRN interview). On a wider policy-oriented basis, do you think Kinmont may be right or is he wrong?

To a large extent he is correct. Keep in mind that this development is not necessarily a bad thing. That is, part of the sag in interest in Japan is due to the fact that it is becoming a more “normal” nation, an affluent, large economy that has fewer serious problems of market access than in the past. In the 1980s people thought Japan was either the bogeyman or a tremendous opportunity for personal careers. Today perceptions have evened out. The Japanese do not dominate the world economy. Job opportunities for foreigners in Japan (particularly in investment banking) have improved, but overall the slow economic growth make Japan a less interesting site abroad to seek one’s fortune than appeared to be the case in the past.

All that said, it is discouraging to see the relative lack of interest in Japan that has taken hold in Washington and elsewhere (at least on the East Coast). Japan remains the world’s second largest economy (at nominal exchange rates); its firms in some industries remain at the forefront of global technology; and its private sector is a huge investor in the outside world. One would think that these attributes would lead to greater global recognition. But the Japanese play such a modest role in regional and global policy issues—both economic and political or security—that it is easy for those struggling to hammer out solutions to real problems to see the Japanese as largely irrelevant.

How would you characterize the current Bush Administration’s approach to Japan?

Lousy. But perhaps I should clarify. The people who work on Japan are not lousy and are fine analysts in themselves—although I wouldn’t include David Asher in that list—it’s just that Japan is just not a priority. Jim and Richard are military and security experts on Japan—salt of the earth guys. David Asher, though, has some pretty flakey ideas.

Would you care to elaborate?

Well, he has some strange ideas on government debt. He spent the late 1990s arguing that Japan was going to implode any day. Well, Japan may implode, but not for the reasons that David Asher gives—that markets will revolt at absorbing Japanese government debt issues.

So the level of government debt is not a problem? (Click here for "Japan's Current Fiscal Status, FY2003.")

No.

How so?

Countries do not go bankrupt. They can always print more money. 40% inflation p.a. could wipe out everyone’s debt.

Many economists would argue that monetary theory doesn’t necessarily match reality in this case, hence the concern. Can you elaborate on your position?

The GDP deflator is now falling at 2.7% p.a., while the CPI remains deflationary (Click here for "Can the Bank of Japan Create Inflation?") Bank of Japan (BoJ) Governor Fukui has already stated that the current policy stance will not change until prices have turned “stably positive.” Yet, there is no consensus on what “positive” means, let alone consistency behind the extreme volatility in the monetary base – from a decline of around 6% p.a. in early 2001 to a swing in growth of around 35% p.a. in early 2002. If credibility, clarity, and consistency are key factors in any central bank’s management of the aggregate price level (something the BoJ may lack), aren’t concerns about Japan’s exploding debt situation legitimate cause for long-term consideration? As it stands, the ratio of debt service costs to retained tax revenue (=total tax and stamp revenue – local tax transfers) is already approximately 70% and rising, with no monetization of the debt in sight.

There are two somewhat separate issues here: fiscal policy and monetary policy. Let’s start with fiscal.

The Japanese government clearly has no problem financing its debt. Interest rates are low, and except for occasional timing glitches, has no problem floating new issues. Interest rates are so low, in fact, that debt service as a share of total government expenditures (a more meaningful percentage than the contrived ratio to retained tax revenue) is lower than it was at the end of the 1970s. (Click here for "Trends of Japan's Debt Service Costs, FY2003.")

Government debt is mainly a problem when it is denominated in foreign currencies. Governments can run out of foreign exchange reserves from which to pay such obligations. But Japanese government debt is almost entirely held domestically. In this case the government can always monetize the debt (i.e. print money and use it to purchase government bonds) to whatever extent it wants. In the extreme, that might cause some distress through high inflation (as it did in the 1945-1949 period). But with deflation, that hardly seems to be a concern in the next few years. (Click here for "High Inflation in Japan's Early Postwar Period.")

Finally, also keep in mind that there are important distinctions between gross and net debt. Net debt is much lower than gross debt, and not out of line when compared to other countries, though it is certainly rising. Even if one doubts the value of assets that go into the calculations that people like David Asher have made in the past, net debt is not yet at disturbing levels.

To be sure, the monetary side of this story has been somewhat inconsistent in the past several years. Governor Hayami had been so determined to prove the independence of the BOJ that he slowed the rate of growth of the monetary base in 2000-2001 against the advice of virtually everyone outside the bank. I think Governor Fukui will avoid this pattern. If nothing else, the BOJ may have learned from this mistake.

To be sure, Fukui has not announced an “inflation target” to help us understand how long the BOJ will keep its policy of rapid growth in the monetary base. But do we really need this? So long as markets realize that the BOJ is sticking to a consistent policy until there is clear evidence of positive inflation at some undefined but positive level, I think markets will be satisfied.

But as you rightly point out, nothing is without its consequences. You yourself have argued that Japan is very good at "muddling through"; nothing ever seems to actually happen. On the eve of an implosion -- something you acknowledge could happen someday (just not as David Asher predicted) -- can you give us 5 telltale signs that it is time to cut our money and run?

Here are some possibilities that I would take seriously:

1. Emergence of persistent rumors about the health of multiple banks (or other financial institutions) at one time. That is, the current approach seems to be one of dealing with banks one at a time, so such rumors would be a sign that the policy was insufficient to cope with the problems.

2. Any sign of significant inflation. It's hardly a problem now, but inflation rising above roughly 6-7 percent could be a sign of emerging problems concerning government debt. That is, it could be sign that the government was resorting to excessive monetization of debt in the face of bond market resistance to holding more bonds.

3. Conversely, any sign of significant deflation. The deflation since 1998 has been pretty mild by historical comparison (especially if one believes the GDP deflator has overstated the decline.) But a worsening of deflation, bringing the CPI to, for example, a minus 4-5 percent rate on an annual basis for a couple of years could trigger a large jump in NPLs.

4. Declines in employment at a pace faster than that of the 1998-2003 period (the annual data show employment dropping at a shallow 0.6 percent average annual rate from a peak in 1997 through 2003, for a total decline of 4 percent.) In the long run, growth comes from consumer demand; so a sharper drop in employment would be a bad sign for household income, spending, and financial solvency. I would worry if, for example, employment dropped at a higher 2 percent annual rate for a couple of years.

5. Significant increase in the number of Diet seats held by the Liberal Democratic Party (LDP). If the LDP could return to ruling on its own, and not worry much about losing power as it did in 1993, it could bring a return to dysfunctional policies that would harm the economy (e.g., decelerating the pace of dealing with NPLs and other financial problems, or a return to higher levels of public works spending).

Going back to the Bush question: what are they saying about Japan’s economic ills.

The sad truth about Washington is that that they have no leverage with Japan. Japan is a creditor country—you can tell a debtor country what to do, but you can’t tell a creditor anything.

What are the major differences in Japan policy that you see from when you served the US Embassy in Tokyo during the Clinton Administration and the current Bush Administration?

The big difference is the shift from economic issues to security. The heavy emphasis on contentious economic issues characterized only the first term of the Clinton administration, but economics and security had a balanced relationship in the second term. In contrast, the Bush administration’s policies toward Japan are dominated to an unusual degree by security considerations. To put it in a nutshell, the administration was so happy that Koizumi supported the war against Iraq that economic issues have faded far into the background. There are issues (such as the Japanese government’s heavy interventions in the exchange market), but they are not being discussed openly.

What would a potential Kerry Administration mean for U.S.-Japan relations? Can we expect more of the same?

Certainly there would be no big changes. The Japanese worry every four years about this, along the lines of thinking the Republicans are free traders and the Democrats protectionists. The campaign rhetoric may reflect this to a minor degree (though Kerry carefully distanced himself from the more overtly protectionist stances of some of his Democratic rivals in the primaries). But the reality is that Democrats may behave in a less protectionist manner than Republicans. Clinton resisted protecting steel, for example, and George W. Bush did not.

You are no longer at Brookings and are now at the Council on Foreign Relations. Will the Brookings Institution shut down their Japan operation? Your departure from Brookings made news in major US and Japanese newspapers—usually staff changes at think tanks go unnoticed with little fanfare. We’d like to know: What actually happened? And why do you think this attracted so much media attention? Were you surprised at the Japanese media’s reaction?

Research institutes occasionally shift priorities. This happened at Brookings. With new management (both a new president and new director for Foreign Policy Studies), an implicit decision was made to shift the resources of the organization to focus on the crisis issues of the day—the war on terror, homeland security, and the war (and occupation) in Iraq. Japan, which is not an important factor in any of these issues, dropped off the map for them. This was never said to me directly, but the lack of interest in interest in Asia was made explicit to a colleague who worked on Southeast Asia and who lost her position as well.

I hear that Brookings is seeking to replace me now, but with someone who works on security issues. To the best of my knowledge, they have not yet filled that position. Part of the problem may be the manner of my ejection. I was give just over six months notice that “barring a miracle” my contract would not be renewed at the end of the fiscal year. That may be common in the business world. However, the job market for an institute like Brookings is largely located in the academic sector. The previous tacit understanding at Brookings had been that people had quasi tenure status, and, at worst, would get a full year of advance notice of their departure. Even a year can be a short time if one intends to move to a senior academic job; universities do not make decisions on senior positions quickly or easily. Therefore, I believe that the short notice give to me has made it somewhat more difficult for them to find someone on Japanese security issues.

The temporary blip in media attention was due to shock among those in Washington who work on Japan or Asia issues that a large, well-rounded institution like Brookings would willingly drop their Japan scholar. Changing direction in the research program is certainly the prerogative of any think tank management, and beefing up the work done on terrorism and Iraq makes sense. But to do this at the expense of maintaining expertise on an important country like Japan puzzled or angered many people around town. As an aside, do keep in mind that the media attention came because at that time the Washington Post was running a weekly “gossip column” about developments at think tanks, parallel to the column it has on the federal government. This particular column has since been dropped, so had this change in my employment occurred now instead of in late 2002, it would not have received any media attention.

In a series of articles, Japan Information Access Project's Mindy Kotler asserted that the Brookings Institution pulled out of Japan research because the Director of Foreign Policy, James B. Steinberg, asserted there was too little money in Japan studies. Is the Brookings Institution best characterized as “study for money?” Is that the prevailing trend in Washington?

Well, let’s be serious. All public policy research institutes are non-profit organizations that live by raising donations—from foundations, rich people, and corporations. Most major donors like to have some voice in how their money gets used, or else they won’t give it. In many respects, the job of management is to minimize the direct impact of the donors’ views on how money should be used. If, however, no donor is interested in Japan, then it would be difficult to support much research. Brookings has a large endowment that covers close to 30 percent of the annual budget, so it has some cushion, but it is not total.

That said, the problem at Brookings was not about the lack of money from foundations for Japan studies. That was just the official excuse. The reality was that James Steinberg was not interested in Japan, or even very much in Asia as a whole, other than the nuclear issue in North Korea.

By extension, what pressing research on Japan needs to be carried out on Japan? Is that need being met by other institutions and think tanks?

As the second largest economy in the world, with some $3 trillion in assets held around the world, it behooves us to understand what is happening to both the Japanese economy and the government’s policies toward the outside world. The Council on Foreign Relations, the Center for Strategic and International Studies (CSIS), and some other places understand this.

That said, I have felt the need to branch out. My most recent book, East Asian Economic Regionalism, branches out from my past focus just on Japan. And my next project will probably also have a broader perspective than Japan.

In a JRN interview, equity strategist and author Peter Tasker lamented that “Japan studies have been useless from the point of view of the practical man looking for applied knowledge to this country for the past ten years or so.” What is the quality of Japan research by academics? What is the nature of these studies? Are the majority of these studies economically/practically oriented or are more “original” theoretical ideas being put into play in academic fora?

If this remark is about Japanese Studies in general, it has always been true. The bulk of academic research and teaching about Japan involves language, literature, and history. Political science and economics have been relatively under-represented at universities. Nevertheless, speaking for economics alone, there has been quite a bit of interesting research in the past decade that should be of some use to practical people looking for applied knowledge. Various people—both Japan specialists and general economists—have wrestled with the question of what went wrong in Japan in the 1990s and what might need to be done to restore the economy to a healthier level of economic growth. And in recent years, the handful of political scientists working on Japan have wrestled with what is or is not changing in Japanese politics as a result of the stresses of the past decade.

In your penultimate book, Arthritic Japan: The Slow Pace of Reform, you examine the causes and reasons behind Japanese government’s lack of action in dealing with its economic woes. [For the benefit of the readers who may not have read the book] What are your main ideas and arguments?

That book was inspired by a popular view among some in New York and Washington around 1998 that the Japanese had finally figured out that their economic system had “failed” and would now quickly adopt new rules more in line with those governing the U.S. economy. I thought this argument was very naïve. I agreed that Japan did have an economic system that had some features distinctively different from those of the U.S. economic system, but that the speed of change in these institutions and behavior patterns would be slow and would not lead to an economy as reliant on relatively freely operating markets as is the case in the United States. The reasons for this conclusion included the fact that the “failure” of the 1990s did not lead to much distress among voters (since per capita GDP continued to rise slowly). In addition, the kinds of change being discussed were complex and interrelated so that they would be difficult in any society. Meanwhile, groups and individuals with a vested interest stake in the existing system were represented at least a very large minority of society, making the politics of change more difficult. Finally, I argued that the existing system had been advertised to the public as being compatible with desirable attributes of Japanese social behavior, and that the reformers faced a difficult task of figuring out how changes in the system could remain consistent with current perceptions of what represents desirable behavior in society.

Given current world events, would your amend your conclusions?

No. Everything that has occurred since the book came out (spring of 2001) fits with my analysis. Change in institutions and behavior patterns continues, but at a very slow, cautious pace. The unknown in 2001 was whether these changes would be sufficient to keep the economy from confronting some sort of crisis, perhaps in the form of a collapse in the financial sector. Today, the risk of crisis is far less, reinforcing the conclusion that change will continue to be incremental.

We’re simple people. What needs to happen in Japan right now?

Japan is in the midst of cyclical upswing, which makes everything easier. However, I would continue to advocate that three things happen. First, aggressively deal with non-performing loans to reduce this problem to insignificant levels while the economic recovery makes it easier to do so. Second, keep monetary policy accommodative (interest rates low and the monetary base growing rapidly) until inflation is clearly above zero. Third, continue to pursue structural reforms and deregulation to reduce the chances of a repeat of the mistakes of the 1980s and 1990s.

Do you still feel that Japan has little option but to muddle through? If so, what possible catalyst would destroy the “muddle through” scenario?

Probably. I do not see the political energy to pursue a more aggressive policy on either non-performing loans or the structural changes that I think would help underwrite a stronger, longer-term recovery of the economy. There’s nothing like some good GDP growth numbers to cause politicians and bureaucrats to slack off the reform agenda. But keep in mind, that this outcome is certainly better than the possibility of crisis with a major drop in GDP and substantial deflation that was certainly conceivable. The danger of such a crisis has receded, and the Japanese deserve some credit for managing to muddle through.

What are you working on now? What are you focusing your energies on right now?

I am intending to write a book on why and how economics matters to foreign policy. I am tired of listening to the so-called “realists” talk about “power” in international relations, and for political scientists in general to dominate the discussion of how economics fits into models of international relations. It’s time for an economist to weigh into this discussion. This will not be a book about Japan, but Japan will figure in the analysis, since it is one of the preeminent examples of a government that has discovered how to cope with the outside world without having a major military stick to wave around.

OK, then what if you could assign every freshman and tourist a reading list on Japan. What would be on it?

I’d have to say Alex Kerr’s Dogs and Demons would be on it. I saw him lecture with his slides—it was really interesting, comparing the world class hotels of Kyoto and Bangkok—Japanese hotels just could not compare, though perhaps that’s a bit unfair. He does raise a number of interesting points and he’s really good when he talks about what he really knows and is passionate about, like his village in Shikoku. He disabuses romantic notions of Japan.

I’d also include Richard Katz’s book [eds. -- Japan: the System That Soured], although I should probably say his new book on Japan [eds. -- The Japanese Phoenix: the Long Road to Economic Revival], although I haven’t read it yet, and Gerald Curtis' The Logic of Japanese Politics -- a book on how it all broke down in the 1980s and 90s.

Also, when we were at the U.S. Embassy in Japan, we used to give away copies of Dave Barry Does Japan—that’s a great one though perhaps a bit dated now.

How about your least favorite book on Japan?

Well, Eamonn Fingleton’s Blindside would be on that list. He was on BBC the other day and even the interviewer couldn’t believe that he was saying that there was nothing wrong with Japanese banks. The man doesn’t even read or speak Japanese. How would he know?

How about books on Japan for pleasure?

I read a lot about Japan for work of course, but not necessarily for pleasure. I don’t read much Japanese fiction. I can’t really get into it.

What are you reading right now?

Actually, I recently picked up a wonderful book about Japan that I am most pleasurably reading for pleasure. This is Isabella Bird’s Unbeaten Tracks in Japan (reprint by Traveler’ Tales Inc.), who was a British woman traveling through the hinterland on her own in the late 1870s. She provides an absolutely fascinating outsider’s look at Japanese society shortly after the Meiji Restoration. If I have a regret it is that my profession, with its focus on contemporary issues means that I have little excuse to explore Japanese history.

I also read a lot of Civil War histories as well as diaries. I’m actually a sergeant in Company F, Second Rhode Island Volunteer Regiment, a reenactment group. We attend about half a dozen reenactments and living history events each year.