Why Demographics Matter: Japan’s Lost Decade Was An Illusion

Via Lars Christensen, Daniel Gros points out Japan’s performance over the past two decades hasn’t been as bad as it looks (excerpt):

The Japan Myth

…How should one compare growth records among a group of similar, developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population represents an economy’s productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ.

When one looks at GDP/WAP (defined as population aged 20-60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population.

The difference between Japan and the US is instructive here: in terms of overall GDP growth, it was about one percentage point, but larger in terms of the annual WAP growth rates – more than 1.5 percentage points, given that the US working-age population grew by 0.8%, whereas Japan’s has been shrinking at about the same rate.

Another indication that Japan has fully used its potential is that the unemployment rate has been constant over the last decade. By contrast, the US unemployment rate has almost doubled, now approaching 10%. One might thus conclude that the US should take Japan as an example not of stagnation, but of how to squeeze maximum growth from limited potential…

...Two lessons emerge from this consideration of the influence of demographic factors on economic growth. First, the idea of a Japanese-style “lost decade” is misleading – even when applied to Japan. Slow growth in Japan over the last decade was due not to insufficiently aggressive macroeconomic policies, but to an unfavorable demographic trend.

Second, a further slowdown in rich countries’ growth rates appears inevitable, given that even in the more dynamic countries the growth rates of the working-age population is declining. In the less dynamic ones, like Japan, Germany, and Italy, near-stagnation seems inevitable.

I’ve gone on the record as saying that I think that achieving high income status for Malaysia is practically inevitable – and Malaysia’s demographics is one of the main factors underlying my view. Based on the latest projections from the US Census Bureau, here’s what Malaysia’s working age to total population ratio will look like:

Based on the above, the maximum impact on growth (about 1%-2% per annum based on IMF research) will be reached in 2023. Even this might be underestimating demographic potential – last year’s projections showed the peak being reached in 2015, so there’s a good chance as the actual numbers come in that we’ll see Malaysia’s growth spurt continuing well into the 2020s.

The flip side of course is that this demographic evolution will make the overall GDP/GNI numbers look good (even on a per capita basis), without necessarily saying anything about actual output or income per worker. Singapore’s discovered that fallacy this past decade – growing headline numbers by importing labour (even highly-paid, skilled labour) hasn’t done much to increase individual household welfare.

High income status is no panacea.