Two things to remember about Japan
Nov 14th 2011, 22:57 by G.I. | WASHINGTON
[Greg Ip] JAPANESE policymakers must watch Europe’s unfolding train wreck with mixed feelings. On the one hand, they take no joy in the economic and financial damage a vital trading partner is inflicting on itself. On the other hand, for a change they’re not the ones whose judgment is being dissected, debated and criticised.
That changes for one night, however. Tonight in my old stomping ground of Toronto, the following proposition will be debated: “Be it resolved that North America faces a Japan-style era of high unemployment and slow growth.” Paul Krugman and David Rosenberg take the “pro” side, while Larry Summers and Ian Bremmer represent the “con” side.
Japan has been studied so thoroughly that I may subtract rather than add value here. Nonetheless, there are two things I find get less attention than they deserve. They come in the form of a pop quiz:
1. How much of the gap between Japanese and American economic performance since the mid-1990s can be explained by demographics?
2. How much did fiscal tightening contribute to Japan’s steep recession of 1998?
The answer to (1) is “more than you think”, and the answer to (2) is “less than you think”. Okay, I don’t really know what you think. Still, when I learned the answers, I was surprised.
First, on demographics. Between 1994 and 2008 American GDP grew 3% a year while Japan’s grew 1.1%. That sounds dismal, but be sure you use the right benchmark. Japan’s potential growth slowed dramatically in the mid 1990s. As the chart at right illustrates, Japan’s working-age population at that time began a long decline, shrinking 0.4% per year over the period while America’s grew 1.2% according to the OECD. That 1.6 point differential can explain most of the difference in growth. Japanese productivity growth averaged a perfectly respectable 2.1% from 1994 to 2008, the same as America’s. At the time it was a disappointment because it was a sharp deceleration from prior decades. In retrospect, though, it may have been inevitable given that Japan had, technologically, almost caught up to America. (An overregulated and inefficient service sector made it difficult to close the remaining gap.)
Of course, poor policy and the dynamics of post-crisis deleveraging played a part. Japan has underperformed even its lowered benchmark; unemployment has trended higher. But when extrapolating to the United States, the demographic outlook should get more attention than it does.
Second, fiscal policy. In April, 1997, the government raised Japan’s consumption tax. That is now routinely cited as a cautionary tale against premature fiscal tightening since it was followed by a steep recession. But a closer examination suggests the tax increase alone cannot explain the length and depth of the 1997-98 slump. Private consumption actually grew in the quarter after the tax increase. Two other massive shocks played important parts. In July, Thailand devalued, touching off the Asian crisis, a major negative for Japanese exports. Then, in November, a series of banks and investment banks collapsed: Sanyo Securities, Hokkaido Takushoku Bank, Yamaichi Securities and Tokuyo City Bank. “Major financial institutions collapsed almost on a weekly basis in the month of November 1997,” a retrospective by the BIS notes. It was, for Japan, tantamount to Bear Stearns, Lehman Brothers, AIG, and Washington Mutual going bust all at once. The following year, Long Term Credit Bank failed. These events did enormous damage to financial-market confidence and contributed to a serious credit crunch.
This does not exonerate the fiscal tightening; it was, and remains, an error. But the more important lesson is that bad luck is as important as bad policy. Analysing the consequences of any policy must incorporate how bad luck may skew the outcome. The Japanese government wouldn’t have raised taxes if it had known what was in store. Fiscal tightening for America is a bad idea in its own right, but it’s particularly ill advised given that stuff happens. Like Europe.