Japan’s Problem is Supply, not Demand

Paul Krugman wrote in the NYT that we are talking too much about Greece: “Despite a chorus of voices claiming otherwise, we aren’t Greece. We are, however, looking more and more like Japan.”

According to Krugman the U.S risks ending up like Japan, because of “policy makers… doing too little”.

First the cheap shot. A year ago, Krugman wrote “Well, I’m sure I’m not the only person to notice this: Japan doesn’t look so bad these days.”

Does the U.S risk becoming a new Japan if we don’t pursue even more Keynesian spending and borrowing policies?

Let’s first look at the lost decade, 1991-2000. When the rest of the world was having rapid, IT-fueled growth, Japan was stagnating. Here are the growth rates in real GDP between 1991-2000:

For all the nice years Japan had 9.6% growth compared to 38.7% for the U.S and 22.7% for the EU.15. The U.S grew by an average of 3.7% per year, Japan only 1.0% per year.

But as most of you know Japan is undergoing a rapid demographic transition. The country was and is aging. Because the old and children cannot work, when we want to compare countries with very different demographic characteristics instead of calculating GDP per capita, it makes sense to calculate GDP per working age adult (people aged 15-65).

Whereas the number of potential workers in the U.S increased by 13% during Japans “lost decade” (1991-2000), and by 3% in for example France, the Japanese potential workforce actually shrank during these years. Adjusting for this, the growth in Japan was 9.8%, compared to 16.9% in Germany, 17.3% in France, 16.3% in Italy and 23.2% in the United States. The U.S grew by twice, not four times of Japan (remember that these were the best years of the U.S and the worst years of Japan).

The importance of the demographic transformation in Japan is even more clear if we include the entire 1990-2007 period.

In non-population adjusted figures, Japan’s real GDP grew by 26% in total these years, the lowest in the OECD. In comparison the figures are 63% for the U.S and 44% for the EU.15.

But during this period the U.S saw it’s potential labor force (the number of people between 15-65) increase by 23% and the EU.15 by 11%, while Japan had a decrease of 4%.

Between 1990-2007, GDP per working age adult increased by 31.8% in the United States, by 29.6% in EU.15 and by 31.0% in Japan. The figures are nearly identical!

Japan has simply not been growing slower than other advanced countries once we adjust for demographic change.

Also notice Italy (who does better than we think) and Ireland (who does worse, much of the growth was due to their young population).

Nor did productivity grow any slower in Japan than Europe.

Someone could ask why Japan did not outgrow the U.S, since they started at a lower level, or why the old Japanese don’t work more to keep up income. But there has really been no dramatic change in institutions during this period, and thus little reason to expect Japan to catch up with the U.S. Japan is already as rich as Europe, so there is no catching up there. And at any case, there is nothing Keynesian deficit policies can do about a shrinking workforce.

Next, to Krugman’s point that the problem is “policy makers… doing too little” (by which he means spending too little). Japan has been running Krugman-Obama sized deficits averaging about 5% of GDP for a decade and a half.

Here is their national debt as a share of GDP. Europe 4 are Germany, U.K, France and Italy.

Clearly, it did not work. Krugman is simply dogmatic when he claims that Japan’s policy of massive deficits failed because the deficits were not large enough(!). What if someone wrote that the deregulation of the American financial markets did not work just because they did not go far enough? Would Krugman accept this line of reasoning?

Krugman is obsessed with demand, and ignores the (usually) far more important factor, which is supply.

Does the U.S. risk being the next Japan? Probably not, since the American workforce is growing. And at any case adjusting for population Japan has simply not been doing that badly in growth terms. Their problem now is their debt, which they have thanks to Keynesian policies.

Capacity utilization is high in Japan, including a low unemployment rate. Stimulating Demand just won’t do it when the problem is supply. If Japan wants growth they have to go for supply factors, including hours worked.

About Tino Sanandaji 39 Articles

Tino Sanandaji is a 29 year old PhD student in Public Policy at the University of Chicago, and the Chief Economist of the free-market think tank Captus.

Visit: Super Economy

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