Japan’s Lost Decades? Not Quite

From the East Asia Forum (excerpt):

The missing piece in the puzzle of Japan’s lost decades
Ippei Fujiwara

Japan’s average GDP growth rate was around 9.5 per cent between 1955 and 1970, and 3.8 per cent between 1971 and 1990.

But in the past two decades it has dropped to just 0.8 per cent a year. This big drop in the growth rate is synonymous with ‘Japan’s two lost decades’…

…Persistent deflation might arguably have been avoided if the Bank of Japan had adopted a more aggressive and expansionary monetary policy in the 1990s. But the Bank of Japan was operating under uncertainty about responses in the economy — an inevitable problem with policy making in real time. Optimal policy can look very different with the benefit of hindsight…

Japan’s per capita GDP level reached almost the level of the United States toward the end of the 1980s. When that happened Japan’s era of high growth, which was based on the technological catching-up, inevitably came to an end. Thus, the puzzle of the lost decades is not what caused the fall in growth chronologically, but the difference in growth rates across countries, and particularly between Japan and other advanced economies. Between 2000 and 2010 (in the second of the two lost decades), other advanced economies grew at an average rate of 1.4 per cent while Japan grew at around 0.9 per cent.

What are the reasons for this difference and can the growth rate be lifted now?

The rapid ageing of Japanese society is a widely known phenomenon. Total population has recently started to fall, and the working age population had already started to fall around 1995. A most important factor in producing economic output is the input of labour. With the working age population shrinking, unless technology allows a smaller workforce to produce more output per head, GDP is bound to grow more slowly. Yet, if the output growth rate per person of working age is compared with that of other industrial nations, Japan records the highest growth rate among advanced economies in the 2000s…

…These supply side factors have had a significant impact on Japan’s GDP growth rate, at least since 2000. Society’s ageing results in not only a decrease in production inputs, but also in a future increase in the scope for fiscal and social security expenditure. This is likely to further constrain aggregate demand by reducing permanent income.

Ageing will continue to have wide-ranging effects on the Japanese economy and Japanese society; the priority is to manage the policy changes needed to continue to lift the productivity of a declining workforce and maintain and improve living standards.

Those first few paragraphs made me think, gosh, there’s a high income trap?

But seriously, there’s a couple of very important points here about productivity as it relates to growth, and about demographics.

First is that there exists a technological boundary to growth – potential growth is limited by the existing state of technology i.e. how we use machines, organisational structures and communications to increase output. In a word – productivity. At this moment in history, the United States as the most technologically advanced country represents the global “speed limit” as it were.

But if you’re below the technological production frontier, having not fully adopted all the advances in machinery, technology and best practices, its more than possible to achieve substantially faster growth. In this catch-up phase, its possible to boost economic development by simply adding inputs of labour and capital, and improvements in factor productivity provide a further boost on top of that.

Much of the Asian Economic Miracle (if you’re old enough to remember the stories and accompanying hubris), was really down to adding lots of capital (infrastructure) and a fast growing work force that was shifting from rural to higher-productivity-urban occupations.

Once you hit the technology frontier, its still possible to grow a little faster if you can continue to add more capital and labour. But even then, headline growth rates won’t give a full picture. Capital is subject to diminishing returns, and higher incomes generally lead to slowing population growth.

In Japan’s case, a rapidly ageing population means that the labour input into growth has actually reversed. The bottom line will thus hinge on productivity growth, which is one reason why there’s such an emphasis on it, even if in Malaysia we’re still well below the point where it could possibly become the only source of growth.

I think the key point I’m trying to make here is that we shouldn’t be looking to critically at headline growth rates to judge how well we are doing, especially when looking across at other nations. It’s more important to focus on how much we’re getting out of the resources we have. It’s also probably important to focus on how widespread the benefits are.