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richard koo

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Richard Koo believes Europe and the West has another disease…

Japan has had a long and protracted economic crawl over the last 15 years. It has not really followed any norms of current taught economic theory. In economics there are certain rules we look to embrace, otherwise we have little founding on which to base arguments and theories. One such rule is that all business managers aim to maximise profit, but Richard Koo has a theory (based on acute observations made over the last 15 years in Japan) that these rules of engagement are being broken in this current economic climate.

Normal recessions will be brought about due to an overproduction of something, the tightening of monetary policy or inflationary pressure. But in this instance this is not the case. He suggests that this is a not a normal recession, but instead a new disease. He calls it a Balance Sheet recession. This is when business managers are looking to minimise debt instead of maximising profits.

Normally when interest rates are low, business managers will look to borrow money so that they can invest and grow sales. However Richard Koo suggests that although the current interest rates are low business managers are not looking to borrow more money, but are instead paying down debt.

He argues there are two forms of bankruptcy. You can be bankrupt without cashflow or with cashflow. If you have no cashflow and your balance sheet is ‘underwater’ you go out of business. Simple… However, if you are bankrupt with cashflow, the best for all stakeholders in the company, from shareholders to workers, is to use this cashflow to pay down debt. The idea being that if you can reduce this debt over a few years, then the company can work its way out of this liquidity issue and re-emerge to trade normally once more. This is the right thing to do at a micro level, but Richard Koo asks us to look at the macro level.

In the ‘assumed economy’, bank deposits are used by the financial sector to loan to other business to generate further sales and profits. However, if your balance sheets are in jepordy then business will not look to take on further loans but instead pay down debt. If all business are looking to pay down debt, and thus are not borrowing nor spending then affects are protracted. He equates this current economic dilema to the Great Depression, and says that this is what has been happening in Japan for 15 years.

He believes that only the opposite of public saving and debt reduction from the government can actually solve this issue. Government borrowing and spending, as in China in 2007, is the only remedy to this ‘pneumonia’.

Are we seeing a returning argument for the role of mixed market economies, and Keynesian Economic Theory?

Some interesting ideas to take into my first economics lectures next year. I swear this is one of the best/worst times to be learning about economics!!!

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