Wednesday, October 17, 2012

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.


  1. I've really got much to say about this topic (coz you know, it's a refreshing change from all this fiscal-talk), but swamped at work at the moment.

    Will post something when I can.

  2. Alright got a few minutes to catch my breath,

    Pre-2008/9 crisis, I thought Japan was a serious basket case for developed economies.

    1) Huge debt pile
    2) Persistent growth-slowing deflation
    3) Probably the worst demographic stats in the world

    I have been giving it some thought for awhile...
    While it's true that they have QE'd since the start of the century to deal with the second problem, it only exploded the first problem when resolving the third problem is probably a more sustainable solution for the other two.

    Fixing the demographic decline isn't that hard (theoretically) but I have to acknowledge that politically it's kind of impossible. Nominal GDP growth can be restored if Japan had a more favourable attitude to immigrants ~ Singapore and post-war US are pretty good examples of this. Aside from inducing more private consumption, the Japanese tax base can be wider, easily solving for the 1st and 2nd problems.

    I personally don't think a high-income trap (slow GDP growth for rich countries) is inevitable - it's kinda artificial, when you think about it. Trade and labour movement barriers are just as prevalent in rich countries as they are in the developing ones. I think these barriers tend to repress growth a lot more in rich ones (can't find a study to prove this, but that's what I suspect).

    The benefits of free capital flows are temporary - although I'm not discounting the fact that it does help form a future job-creating industrial base - and not as efficient as trade or labour in the whole scheme of things when it comes to growth.

    Although you can just start increasing your potential access to natural resources (you know like purchasing some islands of the coast of China) to retain your growth, but I think that's already scraping the bottom of the barrel, huh?

    1. Jason,

      I think my point of view is this - if the welfare per person (aka GDP per capita) is continuing to increase, why obsess over the headline growth rate even if its zero or negative? It's not really relevant.

      In that context, I don't see the demographic situation as a "problem" to "solve".

      And if that viewpoint is correct, then both fiscal and monetary stimulus in Japan, especially over the past decade, have been seriously overdone.

    2. Well, I still think the headline GDP still matters.

      Although each individual in your economy has access to more resources (GDP per cap), but the economy as a whole will continue to produce less in real terms.

      I'm just saying that you can do the whole world a service (if we can equate utility to production) by opening up immigration and let cross-border wage adjustments fall where they may. If countries can advocate free trade and capital flows, why not immigration?

      As well, if you can fix both the debt and deflation problems (which when I gave it more thought, may be symptoms of the demographic problem), I say go for it.

      I guess if the priority for policymakers and citizens is the income per capita, they had better be content with persistent deflation and seeing their tax dollars spent on interest payments.

    3. Jason, does it matter if the whole economy is producing less in real terms if there are less people to consume that output? Remember that the national accounts are an identity - output=income=consumption+investment.

      I'm not arguing against your point on freeing up immigration, mind's a good one.

  3. I think the example of US and Singapore by allowing imports of talent is the way forward. Relying on one own talent pool will eventually hit the wall. So there must be cross fertilization as shown in many everyday examples - cross breeding of horses to run faster, rice to yield more, etc etc

  4. Sorry forgot to add my name - Zuo De

  5. Zuo De,

    See my reply to Jason, as that's relevant to your suggestion too.

    If you look at the actual pace of R&D spending and innovation in Japan, it's actually pretty good. The main drawback to growth is that when you look at the three inputs to growth (TFP aka technology, capital, and labour), much of the growth shortfall is coming from a decline in labour numbers.

    But if per capita GDP is still increasing, I don't see the need to artificially boost headline growth through immigration. Focusing on headline growth doesn't make a whole lot of economic sense to me. It's the same sort of logic that condemns Malaysia for being in a (non-existent) middle income trap.