The Japanese Economy: Past, Present, and Future

Edward C. Prescott

April 4, 2006

Japanese Center, Stern School, NYU

Current and Recent Past

Japan Recently Lost A Decade of Growth

Period 1992-2002

WHY?

Productivity growth almost stopped

What growth there was was due to deepening of capital – just as theory predicts given productivity growth slow down

Productivity growth recovered and Japan has regained a little of its lost ground.

Basic Growth Accounting

Production function

All numbers are per capita.

K is capita and H is hours

1 1( ) ( ) ( )tit it it itY A K H

With a little algebra

The first term is trend; the second is productivity; the third is capital intensity; the last is labor supply intensity

log( )1

tt t t

t

ky t A h

y

GDP per working age person about 73% of U.S. value

This is higher than the EU-15, which is about 67%

First correct for trend,

Why?

log .02

U.S. Per Capita GDP

1880 1900 1920 1940 1960 1980 2000Source: Maddison

1990

U.S

. $

2,000

32,000

16,000

8,000

4,000

Trend Growthabout 2% per year

Detrended Advanced Countries’ GDP per Capita

60

70

80

90

100

110

1991 1995 1999 2003Source: Maddison and IMF

U.S.

Japan

EU15

But, EU doing better than Japan

EU has more non market time

In terms of welfare, lifetime consumption equivalents, EU about 83% of U.S. level

While Japan is only 73%

On margin, value of market time twice that of non-market time.

Japan’s problems is not hours

EU’s problem is hours

Annual Hours Worked per Pop 15-64Relative to US

40

50

60

70

80

90

100

110

120

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Japan

EU-15

Japan’s Problem is Productivity

GDP per Hour Relative to US

40

50

60

70

80

90

100

110

120

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Japan

EU-15

Future

First why did productivity growth almost stop in the 1992-2002 period?

Future

First why did productivity growth almost stop in the 1992-2002 period?

Answer: The Japanese through the bureaucratic financial sector subsidized inefficiency businesses

Future

First why did productivity growth almost stop in the 1992-2002 period?

Answer: The Japanese through the bureaucratic financial sector subsidized inefficiency

Why did productivity resume under Koizumi?

Future

First why did productivity growth almost stop in the 1992-2002 period?

Answer: The Japanese through the bureaucratic financial sector subsidized inefficiency

Why did productivity resume under Koizumi?

He reformed the banking system

Banks stopped giving new loans to their customers so that they could pay the interest on their old loans

Financial Sector Key for the Future

New Prime Minister, Shinzo, is backing down on Koizumi reforms, in particular privatizing the postal savings and life insurance system

This leads me to be pessimistic about future Japanese prospects

Financial Sector Key for the Future

New Prime Minister, Shinzo, is backing down on Koizumi reforms, in particular privatizing the postal savings and life insurance system

This leads me to be pessimistic about future Japanese prospects

Why does Japan have this problem and neither the EU or the US has this problem?

Answer

Japan is not a member of an economic union of states

Which have a considerable degree of economic sovereignty with respect to taxes and spending

But are prohibited from blocking other member states multinationals from locating in their borders

Let’s look at the past

Membership in EU leads to Productivity Catch-Up

EU-6 Labor Productivity percent of US1900 - 2006

40

50

60

70

80

90

100

110

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

EU 6: France, Italy, West Germany, Belgium, Luxemburg, Netherlands

Started catching up afterTreaty of Rome

Pre War Japan

About 20% less than Western Europe because of its policies that keep people on the farms

50% of population rural in 1950

Less than 5% rural in 1970

1973 Joiners' Labor Productivity percent of Eu-61950 - 2006

70

80

90

100

110

1960 1970 1980 1990 2000

1973 Joiners = Denmark, Ireland, UK

Stopped losing ground after the Accesion Act of 1972

1995 Joiners' Labor Productivity percent of EU-61950 - 2006

70

80

90

100

110

1960 1970 1980 1990 2000

1995 Joiners = Austria, Finland, Sweden

Started catching up after the Accession Acts of 1994

Switzerland's Labor Productivity percent of EU-61950 - 2006

60

80

100

120

140

160

1960 1970 1980 1990 2000

Not in the EU, still losing ground

CE-8 Labor Productivity percent of EU-6: 1989-2006

25

30

35

40

1989 1991 1993 1995 1997 1999 2001 2003 2005

CE-8: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia

Treaty of Accession 2003

Conclusion

Japan will not be catching up to the EU-15 and the U.S.

Neither will Australia, which is a lot like Japan

Why? Neither is a member state of a U.S. or EU like economic union

Recovery in productivity growth in Japan had nothing to do with China

It was a change in Japanese policies