Let's Dream a Dream for Greece


February 3, 2012

(This item originally appeared at Forbes.com on February 3, 2012.)

http://www.forbes.com/sites/nathanlewis/2012/02/03/lets-dream-a-grand-dream-for-greece/


In 1949, Japan was a wreck. Four years had passed since the end of World War II, but the economy was still moribund. The major cities, flattened and burned during the war, remained mostly unreconstructed. Only two trains a day ran on the most important rail line, between Tokyo and Osaka. Hyperinflation made normal commerce impossible. What industrial assets remained after the war, such as electricity generation plants and factories, were being stripped by the occupying army as “reparations,” and shipped overseas. The previous government was disbanded, and a new constitution, and a new government, were established. People were on the brink of starvation.

This was the beginning of one of the greatest economic advances of the twentieth century.

In comparison, Greece’s problems are trivial. Banks are insolvent? That is nothing but paper accounting. Try having your major cities bombed to rubble, and a generation of young men slaughtered on islands in the Pacific. Government default? So what. Hyperinflation? Nowhere to be seen. Starvation? Hardly. Occupation by a hostile foreign military? Not on anyone’s list of worst fears.

Nothing particularly bad has happened in Greece. Default and insolvency is nothing but a bookkeeping adjustment. So why can’t the country begin twenty years of outstanding expansion, as Japan did in the 1950s and 1960s?

Many people accept the notion that the outcome of these relatively minor developments must be a generation of stagnation and decline. In fact, this is quite common. We often see once-promising countries stumble and fall, and they never seem able to fully recover. Argentina used to be one of the wealthiest countries in the world – the name itself means “moneyland” – but today it struggles to be considered an “emerging market.”

Or perhaps the United States today?

I often say that the Magic Formula for economic success is Low Taxes and Stable Money. Today, Greece is headed the opposite way. People are clamoring for the introduction of a new drachma, whose sole purpose seems to be devaluation. I say the only reason to introduce a new currency is if it is even more stable and reliable than the euro. What about low taxes? Greece’s government just keeps raising its tax rates, and finding that the only result is more economic deterioration and greater tax evasion. Not only does this reduce tax revenues, it makes even more people dependent on state welfare and state employment, which makes cutting expenditures politically impossible.

Today, Greece is on the well-worn path to twenty years of deterioration, just as many fear.

However, it could be different. Japan’s recovery started with a dream, among politicians and business leaders. In their imagination, Japan would rise from the ashes – actual, real-life ashes – and become again a great and prosperous nation.

This clear vision quickly led to a plan of action. The situation in 1949, of hyperinflation and crushing taxes, was plainly not in accordance with the goal of a prosperous Japan, so the leaders set about fixing the problem.

They had virtually no resources to do so. The economy consisted mostly of black-market subsistence, tax revenues were negligible, and issuing debt was impossible. Since tax revenue was far less than the government’s needs, the government subsisted mostly by printing money, with the usual consequences.

One of the first things they did was to make government debt issuance illegal. It remained so until 1965. Then they refused any more economic aid.

In 1949, they pegged the yen to gold, immediately ending the hyperinflation.

Then, they eliminated the consumption tax (national sales tax).

In 1950, the income tax schedule was revised. The top rate fell to 55% from 85%. But more importantly, the income at which that rate (and others) applied was raised dramatically.  This rate originally applied to income of 500,000 yen. By 1957, the 55% tax bracket applied to income of 10 million yen, twenty times higher.

In 1951, interest and dividend income were taxed at a separate, lower rate. In 1953, capital gains were exempted from taxation completely. Interest income was taxed at only 10 percent. Businesses received a truckload of favorable treatments, in the form of accelerated depreciation, deductions, and exemptions. In 1955, interest income was made tax-free.

Throughout the 1950s and 1960s, the government had a specific goal: to keep tax revenues, and the size of the government, below 20% of GDP. They reasoned that this would be best for the brisk growth of the private sector. It worked.

The Japanese people, as we know, became wealthy in those years. Wealthy people are able to pay more in taxes than poor people. Between 1950 and 1970, tax revenues of the central government increased by sixteen times, all in non-inflationary gold-linked yen.

As the country became wealthier, and GDP grew, then the services that the government could provide on a budget of 20% of GDP grew as well. Welfare and national healthcare plans were added. Dirt roads were paved. Sewage systems were built. There was no conflict between government services and the private sector. Both became prosperous together.

This story is well known to those who follow such things. If someone asks the question – how do we produce fantastic economic advancement? – and they persist with it, soon enough they find the answer. It’s not particularly complicated, or obscure.

The real question is: why is it that some people find this path, and others seem to be completely disinterested? Why do some groups have the dream of advancement, and act upon it, as the Japanese leaders did in 1949, and others drift into generations of deterioration?

Greece could adopt such a plan today. You simply start with a goal: to become radically prosperous. Then you make a plan. You might adopt something like the flat tax reforms that have been successful in neighboring Albania and Bulgaria. You would have some solution to create “stable money” – either to keep the euro, or, possibly, to introduce an even more stable and reliable alternative. Germany is doing this right now, with preparations for a “Nordic euro” in case the European Central Bank’s mismanagement of the existing euro becomes intolerable.

You would have a plan for the size of government, perhaps 20% of GDP as in the Japanese example, or even less, such as the 14% of GDP of Singapore. You would adjust the compensation and headcount of government employees to provide the necessary services efficiently and effectively.

You might even dispose of the existing 23% VAT tax. In one go. Pow. Gone. Why not? Japan’s government did it, while simultaneously outlawing debt issuance!

Do you see the difference between greatness and mediocrity?

That’s how it works. First you dream. Then you plan. Then you make it happen. Alas, even Japan has forgotten how to do this today. By all appearances, they are primed for many more years of hardship.

If Greece adopted a plan like this, while the rest of Western Europe continues down its present self-destructive path, we might find twenty years from now that today’s predictions are entirely wrong.

We might find, in the year 2032, that Greece has become the wealthiest country in Europe.