Sunday, November 23, 2014

Is America Turning Japanese?

BERKELEY – Back in the late 1980’s, Japan seemingly could do no wrong in economists’ eyes. They saw a clear edge in Japan’s competitiveness relative to the North Atlantic across a broad range of high-tech precision and mass-production industries manufacturing tradable goods. They also saw an economy that, since reconstruction began after World War II, had significantly outperformed the expected growth of European economies. And they saw an economy growing considerably faster than North Atlantic economies had when they possessed the same absolute and relative economy-wide productivity levels.

The safe bet in the late 1980’s seemed to be that mechanization, computerization, and robotization would proceed. Political and economic pressure would lead more Japanese sectors to undergo the transformation to machine-intensive, high-productivity modes of organization that export-oriented manufacturing had already undergone (and that sectors like agriculture and distribution had undergone or were undergoing in the North Atlantic region).

The Japanese work ethic would persist, the reasoning went, and Japan’s high savings rate and slow population growth would give it a substantial edge in capital intensity – and thus in labor productivity – on top of whatever economy-wide advantage it might develop in total factor productivity. Moreover, proximity to a vast pool of low-wage workers would allow Japan to construct a regional division of labor that took full advantage of its high-paid, well-educated workforce and outsourced low-skill, low-wage, and hence low-productivity jobs to continental Asia.

As Japan equaled and perhaps surpassed the North Atlantic in terms of capital intensity, industrial knowhow, and standard of living, the global economy’s most highly rewarded activities – research and development in high-tech industries, high-end consumer fashion, high finance, and corporate control – would increasingly migrate to Tokyo Bay.

With one-third the population of the United States, Japan was unlikely ever to become the world’s preeminent economic superpower. But Japan would close the 30% gap (adjusted for purchasing power parity) between its per capita GDP and that of the US. The prevailing belief was that, by 2015 or so, Japan’s per capita GDP would more likely than not be 10% higher than in the US (in PPP terms).

None of that happened. Japan’s economy today is some 40% smaller than observers back in the late 1980’s confidently predicted. The 70% of per capita US GDP that Japan achieved back then proved to be the high-water mark. Its economy-wide relative productivity level has since declined, with two decades of malaise eliminating the pressures to upgrade in agriculture, distribution, and other services.

Japan’s export-oriented manufacturing industries have maintained their edge but have not attracted other high-end activities – in fashion, finance, or corporate control – to any significant degree. On the contrary, since the late 1980’s, Japan’s high personal savings rate, rather than being a source of supply-side strength, has been a source of demand-side weakness, financing investment abroad and government debt rather than spurring a domestic investment boom that would boost capital intensity and labor productivity.

Japan is not a poor country today. But its economic structure and level of prosperity make it look more like Italy than its counterparts in the eastern Pacific Rim – the US coastal states of Washington, Oregon, and California.

Seven years ago, prior to the global financial crisis, the overwhelming consensus among economists was that, in retrospect, Japan’s expected convergence in productivity levels to America’s Pacific coast was not in the cards. Japanese culture produced enormous blockages to employing half the population – women. And Japanese politics entrenched rural and small-business interests in a way that impeded the diffusion of export-oriented manufacturing.

Japan, the argument went, was too different in too many ways for the North Atlantic to serve as an economic-development model. And the export-oriented manufacturing firms that had been stimulated and shepherded by the Ministry of International Trade and Industry were not the core around which the rest of the Japanese economy would crystallize, but rather a separate and walled-off estate.

Thus, the Japanese economy’s potential annual growth rate slowed by roughly an additional two percentage points at the beginning of the 1990’s, as the post-WWII development model lost its steam. It was largely a fluke that this growth slowdown coincided with an asset-bubble collapse and a cyclical depression – one that caused Japanese output to shrink by about 10% in a few short years, followed by only a slow recovery to the new, lower potential growth rate.

But from the perspective of the past seven years, this clearly needs to be rethought. According to all evidence, the US economy’s fall from its long-run growth path has left America 7% poorer today (and into the indefinite future) than expected back in 2007. And this assumes that there is only a one-time permanent downward shock, with no additional slowdown in the rate of potential output growth.

Yet there are reasons to fear that there will be such a decline: slower growth means fewer competitive pressures for heightened efficiency; diminished risk tolerance means a lower appetite for innovation and experimentation; and nominal interest rates pinned at the zero lower bound means that society’s savings cannot be used effectively.

If a mostly well-handled bubble collapse in a low-inflation US economy could permanently push down potential economic growth by roughly 10% over a decade, is it out of the question that a poorly handled bubble collapse could, over a generation, leave Japan’s economy 40% poorer than it might have been?

One thing is clear: economists no longer dare to assume that trend is trend and cycle is cycle, and that their reciprocal interactions are small enough to neglect on the first pass. That approach has left many economists themselves living in countries that are considerably poorer than they expected.

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    1. CommentedHerbert Walter

      The simple fact is that the growth path de Long dreams about was for most of the last 30 years based on an astronomical current account deficit. This has come down to "a mere" USD 400 billion a year or so. If de Long, Summers and Krugman had had their say it would be about USD 1 trillion a year. This is what this famous "gap in spending" really amounts to: America spending tons of other peoples' money. That's the ideal growth path Neo-Keynesians are talking about.

    2. CommentedYoshimichi Moriyama

      Mr. Mukherjee may be right that Japan did better than the US if compared on the basis of per capita GDP, but the problem, at least with Japan, is that the income divide has become bigger. The number of househoulds recieving welfare has increased and we have more young Japanese than before who do not earn enough income to get married or to live independently of their parents. These 'young' Japanese are entering the middle age or even the old age group.

    3. CommentedVal Samonis

      The critical distinguishing feature of EM is demography: so CEE is in a very bad position as the dependency ratio there grows at horrifying rates.

      Val Samonis
      Vilnius U

    4. CommentedWalter Gingery

      "Japan's high personal savings rate. . .has been a source of demand-side weakness. . . ." This is certainly one of the dangers facing the US economy at present: too much income going to the rich, who save it or invest it unproductively

    5. CommentedG. A. Pakela

      Good, out of the box thinking. Isn't this an implicit criticism of the QE policies and Keynesian deficit spending on infrastructure? Japan has done the latter for two decades and the U.S. the former since 2008. Neither policy has had much impact at least in comparison to the comparatively heady growth rates that proceeded the respective collapse of the bubbles.

    6. CommentedProcyon Mukherjee

      An excellent article, but only one pointer that if we shift the comparison from GDP growth rates to GDP per capita growth, Japan did better than U.S. in the years from 2007 to 2013, a remarkable feat that should not be missed sight of. If I extend it further to compare the three states, California, Oregon and Washington, for the same period, the picture would be even better in favor of Japan.