A comparative case study of Japan and China - Research Paper Example

? Topic: Lecturer: Presentation: The Great Depression The great depression was experienced in most parts of the world in the 1930s due to interconnectedness among nations. Many countries at this time were recovering from the effects of the just concluded First World War which began in 1914 and just a decade preceding the Second World War. It was experienced from the 1929 to late 1930s for some countries and early 1940s for others. It is believed that most of the countries came out of the depression as a result of the Second World War. This depression was the longest, widespread and deepest depression of the 20th century and is believed to have started in the United States and spread to other parts of the world. A depression results after a prolonged recession and results in loss of income, reduced profits, decline in trade, and increased unemployment among others. There have been various recessionary periods over the last several decades especially the Japanese lost decade of the 1990s, the Asian crisis and the recent financial crisis of 2008 but not to the magnitude of the great depression. The paper will discuss the various policies undertaken by the governments of Japan and China in response to the crisis and why the policies were adopted as well as their effectiveness in overcoming the crisis. Japan and China had almost similar conditions in that they relied on export of cash crops to the US and European countries especially silk and cotton. They also had most of the population as small agricultural farmers hence were affected much as a result of declining crop prices. However, Japan was under the gold standard system of monetary policy while China was under the silver standard hence not affected much by the great depression. China was also under attack from Japan as it was expanding its imperialist policies and the two governments were under political pressure at the time. Before discussing the policies adopted by each country it is better first to understand how the crisis began and what caused it. Causes of the Great Depression Various categories of economists have different explanations as to how the depression began and what caused it. These include the Keynesians, monetarists and the contemporary theorists. The Keynesians who rely on demand side macroeconomics attribute the great depression to fall in demand and international trade. A fall in demand or underconsumption and overinvestment results in an economic bubble and coupled with incompetence of government policies resulted in lack of confidence (Frank & Bernanke, 8). The lack of confidence resulted in decline in consumption spending as well as investment spending causing panic among bankers and deflation. The investors found it more profitable to hold money rather than invest as profits were declining hence reacted by keeping clear of markets leading to low economic activity. Low activity leads to unemployment and loss of income thus aggravating the situation due to reduced demand. The decline in prices also meant that consumers could buy a lot of goods with less money hence they did not demand more of the goods leading to drop in demand. This causes a recession which refers to a period of economic downturn as a result in reduced aggregate demand. A prolonged recession leads to a depression. The monetarists on the other hand, explain that the depression was as a result of ordinary recession. In the business cycle, recessions do occur and are necessary to stimulate the economy but it is government policies undertaken at such a time that worsen the situation. The monetarists thus believe that policy mistakes by the monetary policy authorities were the cause of the depression. The policies caused the shrinking of money supply thus worsening the situation (Bernanke, 5). The decline in money supply due to contractionary monetary policy and bank failures beginning 1930 was believed to have caused the depression. The federal government did not use expansionary monetary policy to counter the decline in money supply and restore confidence for banks hence more banks failures resulting in decline in economic activity (Dams & Ratsugi, 111). Other contemporary theorists do not take into account the explanations given by either the Keynesians or the monetarists. According to them especially the neoclassical macroeconomists blame the labor market policies for the situation. The labor market institutions lowered the normal and steady state market hours per person hence reduced output and unemployment. Others believe that the breakdown of the financial system cold have accelerated the crisis as there was breakdown in information about customers hence denial of funds by banks to all regardless of their creditworthiness (Dams & Ratsugi, 111). This hindered investments leading to reduced income and consequently low demand. The gold standard is also blamed for the great depression especially the spread to other countries from the US due to interconnectedness of monetary system. The gold system involved fixing of exchange rate in terms of gold to the gold standard bloc. The rate of exchange was thus predetermined and was based on trust and cooperation between different nations. It also involved free movement of gold between people and countries and currency was convertible into gold upon request. Another feature of the gold standard was that there was no institution operating at international level to facilitate co-ordination of the exchange. The system was also based on the principle of deflation rather than devaluation. Those countries with a balance of payment deficit restored their equilibrium by use of deflation. The deficit countries thus exchanged gold for currency thus gold outflow while those with surplus budget got gold in exchange for currency. As a result, the monetary policy of those countries operating under the gold standard was linked to the supply of gold hence deficit countries experienced deflation while surplus nations experienced inflation. Due to deflation in prices, the exports of deficit countries were desirable thus increased foreign exchange that restored the economy back to equilibrium (Dams & Ratsugi, 112-115). The gold standard worked well especially due to cooperation among nations until the federal government tightened its monetary policy in 1928 after the World War 1. Other central banks followed suit and tightened their monetary policies leading to deflation. The problem faced by many countries was that the gold standard restricted the use of devaluation of currency in support of deflation hence most monetary authorities could not use expansionary monetary policy to resolve the crisis (Eichengreen, 9). As a result, those countries which were under the gold standard experienced the worst effects as they had no policy choices unless they left the gold standard. The cause of the depression is attributed to the crash of the stock market in the US in 1929 commonly known as the “black Tuesday” but the gold standard is responsible for transmitting the crisis to other parts of the world through its system. Japan Japan was operating under the gold standard when the crisis began and therefore was affected by the crisis but not in a great scale. The Japanese economy was dominated by light industries especially textile industries. It was involved in export of cash crops such a cotton and silk which was considered as a luxury. The Japanese economy also depended on primary products by small scale farmers such as wheat, rice, and soybeans among others. Most of the exports of silk and cotton went to the United States and that is why the Japanese economy was affected by the great depression. According to Sasada (169), besides the gold standard, the great depression in Japan was caused by various other factors. She believes that the crisis was as a result of irresponsible activities by corporations through various mechanisms. The reckless financial management had caused a financial crisis in Japan in 1927 even before the depression began. The two big banks in Japan; bank of Taiwan and bank of Chosen went bankrupt and due to poor response other small local banks also went bankrupt (Dams & Ratsugi, 51). The Great depression thus coincided with a period when Japan was trying to recover from the financial crisis by returning to the gold standard in 1930s so as to maintain equilibrium. This had devastating effects on Japan as the gold standard prevented the use of expansionary monetary policy to bring the economy back to recovery. Sasada (172) also blames the crisis on opportunistic business management and lack of long-term prospects. Before the crisis, there was economic liberalism hence businessmen or investors operated in a free market aiming at maximizing their profits at whatever cost. These producers were thus producing goods in a disorderly manner hence disrupting the balance in production sector and causing disequilibrium between production and consumption. According to the Keynesians, producing more goods than consumption leads to an economic bubble which can burst resulting into a recession or depression (Frank & Bernanke, 8). Other irresponsible corporate activities that aggravated the crisis include; phony accounting and excessive dividend pay, unproductive business projects and greedy shareholders who often demanded for high dividends. When the crisis began, businesses reacted by forming cartels so as to avoid closure. The Japanese government thus had to formulate policies and institute mechanisms to regulate these corporations if it had to bring the economy back on its feet. These policies were to prevent overproduction, excessive investment, and irresponsible management as well as curb the cartels that had cropped up. The great depression had great impact on the Japanese economy. Since Japan depended on textile exports, and countries such as the US had began restricting imports the exports declined. The US imposed the Smoot-Harley Tariff in 1930 thus restricting imports and Japan depended heavily on silk exports to the us thus exports were heavily affected. This was worsened by competing currency devaluation among countries leading to a wave of serious deflation in international market. Japan exports declined by 53% between 1929 and 1931. The price of silk fell by 65.9%, cotton by 56.7% while revenue from silk declined by 54.0% and cotton by 42.0 %. The national income declined by 24.3 %( Sasada, 169). The recession due to decline in demand for exports lead to a decline in output and employment and consequently decline in gross national income. The firms’ profits declined by a great margin hence were forced to close down or reduce the number of laborers leading to unemployment and loss of income hence aggregate demand. Unemployment rose from 4.3% in 1929 to 6.8% in 1932. The rural population in Japan depended on sale of grains such as wheat and soybeans and also ilk and cotton. The prices of agricultural products declined leading to loss of income and rural poverty. For example, the price index of cocoon fell from 171 in 1929 to 75 in 1930 due to the collapse of export market in the US (Francks, 214). However, the prices of other products such as fruits and vegetables and livestock products were not much affected. Government policies The Japanese government undertook various policies to bring the economy back to health hence the depression did not last for a long time. The economy had shrank by 8% from 1921-1931 and the finance minister had to do everything possible to save the economy. Takahashi the then finance minister thus began utilizing the Keynesian and monetarist policies which involve stimulating aggregate demand. This involved use of fiscal stimulus and devaluation of currency to create employment and increase income hence increased economic activity. The government thus increased its spending by buying munitions for the armed forces and investments in heavy industries as opposed to light industries such as textile manufacture (Myung, 127-144). It also used support price by stockholding but due to the elasticity of demand of luxury products like silk, a heavier demand shock led to price decline thus the policy worked for just a few months. This decline was referred to many as the ‘silk crisis’ in 1930s. On the monetary policy, the Japanese government had returned to the gold standard in 1930 so as to deal with the financial crisis at the time. However, it returned at a time when other nations such as Britain were withdrawing from the gold Bloc hence it lead to negative rather than positive effects. The foreign exchange was controlled by Yokohama Specie Bank and it sold dollars to foreign as well as the big Japanese banks unconditionally leading to outflow of gold. These banks bought dollar or sterling with the species thus according to Syu, the government lost over ? 700 thousand species hence the policy did not work. The gold standard did not allow currency devaluation hence when a new government came into power in 1931; it withdrew from the gold standard to allow use of expansionary monetary policy. This led to devaluation of the yen and consequently a fall in exchange rate making exports more attractive hence restoration of silk price in 1932-33 (Ryu). The great depression led to decline in exports especially of silk since it was considered a luxury hence Japan had to adopt other measures such as engaging in heavy industries but it did not have the resources. It thus engaged in imperialist activities to acquire the resources needed for its industries by invading North Eastern China thus occupying Manchuria in 1931. This led to a high demand for weapons and armaments by the government thus increased government expenditure. The government also increased its industrial production of metal, machinery and chemicals which have more demand in the world market than light industry products. It also expanded its trade to underdevelpped countries where it sold its textiles instead of relying on the US. As a result, the balance of payment problems were resolved leading to economic recovery (Dams & Ratsugi, 51). The industrial production also led to increased private investments in plant and equipment thus increasing domestic demand. Increase in demand leads to increased employment and output thus increased economic activity ending the depression. The government also engaged in policies to revive the rural economy and reduce rural poverty. The problems faced by farmers in rural areas was shortage of credit hence the encouragement on the use of informal types of short-term credit for example, by borrowing loans from the landlords. This kind of loan was offered to mutual savings club who would then use it to improve on agriculture. The government also developed the rural financial and social institutions such that they could be able to deal with short-term falls in prices and incomes. The farmers also shifted from production of consumption products to products which could be sold for income such as rice and wheat. However, the government efforts to promote products such as wheat were not much appreciated as they viewed wage employment in urban areas as worthwhile (Francks, 214). Some of the policies were effective while others did not achieve the desired results. Increased expenditure by the government through purchase of weapons was effective in reviving the economy. Investment in heavy industries rather than light industries also stimulated both domestic and international trade hence growth. Withdrawal from the gold standard also enabled the monetary authorities to use expansionary monetary policy to stimulate the economy especially through export growth. However, the price support system through stockholding did not work due to the elastic nature of luxury goods such as silk. According to Ryu (2) the price support needed more stockholding for it to work. The imperialist policies to acquire materials for heavy industries though effective brought about the war between Japan and China in `1937 thus affecting economic growth. It also led to tension between Japan and other powers such as Britain and US further worsening trade. Overall, the Japanese economy revived rapidly from the crisis and kept the GNP in real terms at a level reached before the crisis. China China as opposed to Japan was weakly linked to the global economy especially by its use of the silver instead of gold standard. According to Wright (697), the great depression in China was a direct result of the crash in the west. The economy also consists of sub-economies which are under the control of Chinese government. These include the South East China, North East, coastal area, the central plains among others. Each economy has its own industry and trade for example; the coastal area is involved in international trade while the central plains engage in agriculture and other industries. The depression thus began in the Western China and spread to other areas since the economies are linked through similar government (697-738). Just like Japan, China was experiencing internal problems before the crisis which were worsened by the depression. For example, it was experiencing civil war just like Japan was engaged in conflicts between nationalists and liberalists. The fall of Qing dynasty in 1911 had also resulted in instabilities and disruption of economic activity hence China was on the road to recovery before the depression. The economy depended on exports especially of cotton to European countries and a small quantity to the United States hence the restriction of imports by the US after the stock market crash had an effect on Chinese exports but not as much as Japan whose exports went to US. For example, red tea exports dropped by 57% between 1931 and 1933 (Huang, 121). Its agricultural exports entered the international market in the 19th and 20th century. China was thus involved in the export of cotton, silk, soybeans and tea among other agricultural products. The products came from rural areas hence the decline in agricultural prices had a great impact on rural income leading to rural poverty. The depression led to reduced imports by US and European countries as they tightened their monetary policies hence reduction in silk demand and consequently fall in silk prices. The silk prices fro China fell earlier than Japanese prices since it depended on European markets and due to withdrawal from US market while Japan depended on US and US did not reduce its imports drastically but gradually. The Chinese silk was 54% cheaper in 1930 while Japanese silk was only 18% cheaper. Due to lack of market, Japan turned to Asian countries to expand trade and furthermore it had captured parts of China in 1931. As a result, the Chinese market was affected by dumping from Japanese silk manufacturers leading to fall in prices of its products. In 1931-32, the value of silk exports declined from 147,000,000 Yuan to 56,000,000 while silk prices declined by 30%. Another impact was decline in agricultural activity due to reduction in prices. The acreage under mulberry dropped from 1930-32 and some farmers refused to pick the leaves because it was not profitable; market price was below the labor costs (Huan, 122-123). The Chinese economy was also liberalized or under laissez-faire hence the producers were free to carry out their operations without government intervention. As a result, there was overproduction of agricultural goods leading to a massive fall in prices and an increase in imports. For example, in 1928 China imported 12 million bushels of rice whereas in 1931 it imported 21 million bushels. This was also as a result of increased competition in the world market (Ryu). The silver standard involved exchange of currency between the Chinese dollar and US dollar and was determined by the relative price of silver and gold unlike the gold standard which involved a fixed exchange rate determined by relative contents of gold. The fluctuations in silver prices therefore undermined the monetary system especially after withdrawal of Britain and other countries from the gold standard thus destabilizing the economy (Shiroyama, 153-161). However, the same silver standard brought her out of the depression. As the silver price slumped, it depreciated the Chinese dollar hence making her exports attractive. This led to capital inflow and consequently an improved balance of payment and sustained price level in the economy. The great depression had great impact on the Chinese economy. The GDP rose at the first stages due to insulation from the effects by the silver standard but it stagnated in 1933 and collapsed by 8.7% in 1934. The GDP growth was due to depreciation of the dollar which made exports cheaper hence attractive in the world market. When other countries abandoned the gold standard in 1932, the currency appreciated leading to decline in exports and consequently the country suffered trade deficits which were difficult to balance. For example, in 1929 deficits were 0.51% of GDP and by 1933 they were 0.75%. The country experienced deflation in 1935 due to appreciation of silver (Shiroyama, 15-29). The decline in global trade led to decline in primary product prices. The products such as cotton were earning less than what the rural farmers needed to buy consumption products such as rice hence their standards of living declined. The rural agriculturalists borrowed loans from local financial institutions hence they were in huge debts. Another area affected was the real estate as the real estate bubble burst. The domestic market for industrial goods also declined as the purchasing power of farmers declined. While exports declined, the imports were increasing due to dumping by the western nations. For example, the grain imports in 1928 amounted to 900000 bushels whereas in 1932, it amounted to 15 million bushels. This led to decline in national income from 28.8 billion in 1932 to 23.7 billion in 1935 (Shiroyama, 153-161). Government Policies The Chinese government adopted various policies to deal with the crises. First it utilized aggressive monetary and fiscal policies. However, the policies did not work to alleviate the crisis for various reasons. First, the monetary policy could not have any results since the money supply which was linked to the silver was not under the control of the government but was controlled by the world market. The silver or currency thus was volatile leading to depreciation in the first years and appreciation afterwards leading to deflation in 1935. The silver in circulation could not be controlled and its price was determined by supply and quality of silver. Supply of silver could only be increased through foreign borrowing as well as remittances by foreigners. The situation was worsened by the American Silver Purchase Act of 1934 which required the use of three quarter of gold and one quarter of silver and this was rejected by the Japanese government. However, the US implemented the policy leading to appreciation of silver. The Chinese government tried to use silver export taxes and balanced tax to combat the situation but the policies failed leading to flow of silver to the US. Just like in Japan, the monetary policy was thus a failure; Japan was restricted by gold standard while China was restricted by the Silver purchase Act. The solution for China was to abandon the silver standard and therefore in 1935 when a new government came into power, it replaced the silver standard with a paper currency called Fabi and established a central bank to take control of the monetary policy (Shiroyama, 15-34). The fiscal policy involved increased government spending on military and heavy industries. Government spending thus increased from 3% of total government expenditure to 17.6% in 1934. However, due to dumping and competition by European countries and Japan, the prices were affected and hence the fiscal spending did not have any effect rather the country suffered deflation. The spending was also not used for development purposes but for military purposes hence it did not help the situation. The government was also involved in improving rural financial institutions where farmers took loans to improve agriculture. Farmers also engaged in activities such as cotton-spinning. Another setback resulted from a financial crisis brought about by bursting of the real estate bubble which affected large cities such as Shanghai in 1934 after a boom from 1929-1931 (Shiroyama, 153-161). The Chinese government also moved away from laissez-faire economic policies which led to overproduction and business mismanagement to state controlled economy. There was also change in government to a nationalist government namely the Republic of China which helped China to deal with the war against Japan. However, the war Japan continued from 1937 as the League of Nations was too weak to help Japan and other superior nations such as Britain, France and US were not willing to help. The reform in government from laissez-faire to protectionism was effective as it enabled China to deal with the war with Japan. It also carried out monetary reforms which saw the abandonment of the silver standard in favor of the fiat currency controlled by central bank hence the recovery of the economy in 1936. The use of loan facilities in rural areas also enabled them to maintain a balance of trade although most of them were left in debts. Conclusion The great depression was the most severe, widespread and deepest recession in the world history. It affected most of the countries but it did not have a serious impact on Japan and china especially because was insulated by the use of silver standard. However, both countries suffered deflation leading to decline in exports, fall in agricultural product prices, decline in income, unemployment, and political upheavals. The effect of the great depression on China and Japan is that the two nations abandoned democracy and resulted to militarism and nationalism hence overthrowing their governments and instituting protectionist regimes. This was to regulate the businessmen who acted on their own interests hence resulting to use of poor management practices. The new governments carried out monetary reforms by abandoning the gold and the silver standard and this enabled the economies to recover from the effects of the depression. They also engaged in expansion of trade especially the heavy industry trade and also on the recovery of rural financial systems as the rural population was the most affected in terms of lost income due to decline in agricultural prices and unemployment. Their efforts to use monetary policy was futile due to the nature of the monetary system; Japan was under the gold standard which restricted currency devaluation and China was under the silver standard which was very volatile and the government had no control over it rather the world market determined silver prices. They were both at war during the depression but they eventually managed to bring their economies back to health but only after institution of new governments. References Bernanke, B. Essays on the Great Depression, Princeton: Princeton University Press, 2004. Dams, T., Ratsugi, T, eds, Protectionism or Liberalism in International Economic Relations? : Current Issues in Japan and Germany, Berlin: Duncker & Humblot, 1991. Eichengreen, B. Golden Fetters: The Gold Standard and the Great Depression, Oxford: Oxford University Press, 1992. Francks, P. Rural Economic Development in Japan: From 19th Century to the Pacific War, London: Routledge, 2006. Frank, R., Bernanke, B. Principles of Macroeconomics, 3 ed. Boston: McGraw-Hill, 2007. Huang, P. The Peasant Economy and Social Change in North China, California: Stanford University Press, 2008. Myung, S. “Did Takahashi Korekiyo Rescue Japan from the Great Depression?” The Journal of Economic History, 63 (1) pp 127-144, 2003. Ryu, S. The Impact of Great Depression on Korean Silk Industry, Seoul National University, 2009. Sasada, H. Institutions, Interests and Ideas: The Evolution of Developmental State, ProQuest, 2008. Shiroyama, T. China during the Great Depression: Market, State, and the World Economy, 1929-1937, Cambridge: Harvard University Asia Center, 2008. Wright, T. “Distant Thunder: The Regional Economies of SW China and the Impact of the Great Depression,” Modern Asian Studies, 34(3), pp. 697-738, 2000. Read More