Economic Development of Japan

No.11 Economic Maturity & Slowdown

YEN

OIL

TRADE

TOPICS – 1970s & 80s

• End of catching up, economic maturity• Global stagflation in the 1970s• Growth vs. inequality (and other social evils)• Interpretation of the Japan system• Current account surplus & international

politics – trade friction, exchange rate pressure, systemic demands

• The 1955 Regime (LDP dominance)

Growth Slowdown in the 1970s-80s• Japan’s economic maturity—income reached

the world’s highest level• Oil shock and global stagflation• General floating of major currencies

Catching Up: Real Per Capita GNP(1995 dollars, conversion at actual exchange rate)

0

10000

20000

30000

40000

50000

US 10582 12060 13046 15454 17310 18754 21392 23858 26744 28157

J apan 776 1336 2127 3984 6962 11676 16486 15658 28912 40421

1950 1955 1960 1965 1970 1975 1980 1985 1990 1994

US

J apan

Per Capita Income at PPP(US=100, price- level

adjusted)

0

20

40

60

80

100

1955 1965 1975 1980

ItalyUKJapan

FranceW.Ger.US

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

Japan

Singapore

Hong Kong

Taiwan

S. Korea

Malaysia

Thailand

Indonesia

Philippines

Vietnam

China

Speed of Catching Up: East Asia

Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating).

Per capita real income relative to US(Measured by the 1990 international Geary-Khamis dollars)

Real GDP Growth (Fiscal Year – April to March)

Source: The System of National Accounts site, Cabinet Office.

Average 1974-90 4.2%

Average 1991-2010 0.9%

Average 1956-73 9.1%

The Cause of 1970s Stagflation

Supply shock view• OPEC’s oil price hike was the main cause.

Aggressive wage hikes also contributed.

• Expansionary fiscal & monetary policy accommodated and softened the blow.

Global monetarist view• As US lost monetary discipline, the fixed rate

regime collapsed in 1971-73 and USD fell.

• Major central banks expanded money to counter appreciation pressure, causing global liquidity glut in the early 1970s.

• Oil shock was the result, not the cause, of global inflation.

PP.188-90

AS

AD

P

Y

0

2

4

6

8

10

12

14

1960

1962

1964

1966

1968

1970

1972

1974

%World Money Growth

Source: McKinnon (1979), p.264

Bretton Woods World Dollar Standard• USA as the center country providing price stability to the world (“benign

neglect”: US to mind domestic affairs only); all other countries set “parities” against US$ (“adjustable peg”). Gold=US$=other currencies

• 1950s-early 60s: American prices were stable; BW system achieved high growth & price stability globally.

• Mid 60s-early 70s: US began to inflate & US$ was under downward pressure (war in Vietnam, social welfare, space race with USSR).

• Gold=US$ link broken (1968); US$=other currencies link broken (1971-73: Nixon Shock). Floating exchange rates began.

Monetary Growth and Inflation (12- month change)

-20%

-10%

0%

10%

20%

30%

40%19

65Q

119

66Q

119

67Q

119

68Q

119

69Q

119

70Q

119

71Q

119

72Q

119

73Q

119

74Q

119

75Q

119

76Q

119

77Q

119

78Q

119

79Q

119

80Q

119

81Q

119

82Q

119

83Q

119

84Q

119

85Q

119

86Q

119

87Q

119

88Q

119

89Q

119

90Q

119

91Q

119

92Q

119

93Q

119

94Q

119

95Q

119

96Q

119

97Q

119

98Q

119

99Q

1

M2+CDWPICPI

Monetary Growth and Inflation (12-month change)

Bretton Woods fixed dollar system ends General float

begins

1st oil shock 2nd oil shock

Plaza Agreement

Bubble

Bubble collapses

P.187

High Growth & Inequality Japan, Korea and Taiwan narrowed internal income

gaps (personal, sectoral, regional); but in China, Thailand, Philippines, Indonesia, Vietnam, etc. income became polarized during high growth.

To sustain growth and achieve high income, three policies are needed. In principle, they can be executed separately—cf. “pro-poor growth,” “inclusive growth”(1) Industrial policy—creation of growth sources (2) Social policy—coping with new problems caused by

high growth: income gaps, pollution, migration, traffic, congestion, crime & corruption, cultural change…

(3) Macroeconomic management under globalization—coping with global business cycles, price shocks, huge and unstable capital flows

Separability of Growth & Social Policies in E.Asia’s Successful Latecomers

Economic growth

New social problems Macro instability under

integration

Political stability

Developmental policies

Exit to a richer & more democratic society (examples: Korea, Taiwan)

START

END

Supplementing policiesA few decades later

Generation of growth sources

- Social policies- New macro management

0

20

40

60

80

100

Low

est

20%

Nex

t 20

%

Nex

t 20

%

Nex

t 20

%

Top

20%

J apan (1969)

US (1972)

W. Germany (1973)

France (1970)

UK (1973)

Italy (1969)

Productivity Change by Industry (%/ year)

-4-202468

1012

Food

Tex

tiles

Woo

d pr

oduc

ts

Pap

er a

nd p

ulp

Che

mic

als

Oil

and

gas

Cer

amic

s et

c.

Iron

and

ste

el

Non

ferr

ous

met

als

Met

al p

rodu

cts

Gen

eral m

achi

nery

Elec

tric

al m

achi

nery

Tra

nspo

rt m

achi

nery

Pre

cisi

on m

achi

nery

1954- 731974- 90

McKinnon-Ohno (1997) chap.2

Productivity Slowdown

(estimated by labor-material Cobb-Douglas prod. func.)

Income Distribution (Lorenz Curve)OECD Economic Outlook, July 1976

--Postwar land reform--Agricultural subsidies (1955 Regime)--Labor migration to cities

Sharing of Fruits of Growth between Rich & Poor, Urban & Rural, Industry & Agriculture

• Japan around 1960s—direct (income) tax for redistribution, rural-urban labor migration, SME support, fiscal policy in favor of rural areas (public investment, agro subsidy & protection, regional development plans, etc.); household Gini coef.: 0.31 (1963), 0.25 (1970)

• Korea around 1970s—Saemaul (New Village) Movement for invigorating and improving rural life and production; regional income gaps were small and even narrowed; regional Gini coef: 0.16 (1971), 0.08 (1981), 0.06 (1991)

• Taiwan 1960s-80s—Strong export-led growth driven by vigorous SMEs

• Indonesia—Gini coefficient 0.32 in 1990, 0.33 in 2002, 0.41 in 2012.

The Japan System: Delayed Reform?

• After catch-up industrialization, Japan should have changed its system in the 1970s

• However, large macro shocks (oil shocks, floating, stagflation, trade disputes) diverted policy makers’ attention from structural issues.

• As a result, the Japanese economy continues to be over-regulated even today.

Opposing view:• Don’t copy US financial capitalism—trust, stability,

equity, patience, teamwork should be maintained.

PP.190-91

Long-term relationsOfficial intervention

Open marketsPrivate initiative

The 1940 Regime: Farewell to the War Economy by Yukio Noguchi (1995)

• I would like to advance the hypothesis that the key components of the Japanese economy today were created during the war.

• The 1940 Regime--(i) production-first; (ii) suppression of competition, (iii) social policies to reduce friction

• These alien systems were implanted to execute total war (enterprise system, finance, bureaucracy, land reform) and they continued as systemic core even after the war.

• They worked well for high growth, but not for coping with change. Deregulation and consumer-oriented society cannot be realized unless this regime is removed.

Kaikaku Gyakuso (Reform in Reverse) by Hiroko Ota, GRIPS (2010)

• Prof. Ota was the Minister of Economy and Fiscal Policy during 2006-2008 (serving PM Abe and PM Fukuda), promoting economic deregulation and fiscal discipline.

• The Democratic Party government (2009-2012 ） has reversed the economic reform and reintroduced past policies that do not work any more:– Fiscal activism & random subsidies leading to fiscal

crisis– Economic deregulation was slowed down or reversed.

Mercantilist Pressure on Surplus CountriesKomiya (1994), McKinnon-Ohno (1997), McKinnon (2005)

When a country emerges as a new industrial power, it is often criticized for unfair trade practice and an undervalued currency. Trade and exchange pressures mount. But the trade gap cannot be eliminated by currency appreciation or trade liberalization.

Ronald McKinnon

Elasticities Approach vs. Absorption Approachin Financially Open EconomiesConventional view (elasticities approach)

• Exchange rate adjustment can reduce Japan’s trade surplus and US trade deficit.Fred Bergsten, W. Cline (IIE, Washington)

Krugman—the Mass. Ave. Model: Imports = f (yt, rert-2)

Friedman, Krugman— “daylight saving time” argument for currency float

PP.191-94

Our unconventional view (syndrome of the ever-higher yen)

• Thanks to wrong economics and Washington lobbying, the yen-dollar rate was manipulated for mercantile purposes.

• But yen appreciation could not reduce Japan’s surplus and US deficit, because it was structural (US savings < US investment). The real solution was increasing US savings. Current account = Y – A = S – I

• Intermittent yen appreciation only destabilized the Japanese economy through recession, deflation and depressed interest rates.

Japan’s surplus with US

1971-73, 1977-78, 1985-87, 1993-95 Pressure to

appreciate yen

Bilateral tradenegotiations

Persistenttrade gap

American responses

Reinforcement through failure

Exchange Rate Impacts Are Complex...

E Tradebalance

Competi-tiveness

Inflation

Absorption

Monetaryexpansion

(-)offset

(-)

(+/?)

Pass-through

Reverseabsorption effect

Yen appreciation

Relative price effect

LM curve shifts

Subject to M-L condition & J-curve

Price channel

Quantity channel

Engi-neered

“Endaka fukyo” orhigh-yen induced recession

--Countries with large foreign exchange inflows often buy up USD to resist currency appreciation

--However, having too much foreign reserves may cause: --Excess liquidity and bubbles --Unbalanced asset position --Exchange risk

International ReservesTrade surplus against US ($billion)

“Original sin” (inability to borrow in home currency)• Developing countries that borrow in USD face

exchange risks in trade and debt payments. This may lead to higher risk premium, higher interest rates, balance-sheet mismatches, and the possibility of currency crisis.

“Conflicted virtue” (inability to lend in home currency)• Any high-saving country that lends in USD faces (i)

exchange risk on accumulated foreign assets, both private and public; and (ii) accusation of unfair trade and pressure to appreciate the currency by deficit countries (esp. US)

• If the leading economy (US) is the largest lender, this problem does not arise. In fact, it is now the largest borrower.

Estimates of Japan’s Net Liquid International Asset Holdings

(% of GDP)

- 10%

0%

10%

20%

30%

40%

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

PrivateOfficial

USD 1.17 trillion

Source: R. McKinnon, “Japan’s Deflationary Hangover: The Syndrome of the Ever-Weaker Yen,” April 2007.

The 1955 Regime (LDP political dominance)• The Liberal Democratic Party (LDP) formed in 1955,

held power until now (except 1993-96, 2009-12)• Securing rural votes by subsidizing agriculture and

building rural infrastructure (firmly established by PM Kakuei Tanaka 1972-74).

• LDP had many factions and zoku-giin groups (politicians promoting subsidies in particular sectors)

• Opposition parties were too weak to challenge LDP’s rule.

• Reform movement inside LDP Koizumi reform—how successful? Was it desirable? Abe, Fukuda, Aso: weak PMs Now second Abe

P.178

LDP

Factions & zoku-giin

Other parties

Pure dictatorship

Full democracy

Democratic institution

(Form)

Political competition

ConstitutionLawsParliamentElectionCourt

Reform vs conservatism, big vs small government, other policy debates

EdoMeiji

Taisho

Fascism

ConstitutionParliament

Democracy movement,

Party cabinet

DemocratizationNew constitution

Showa2

War1937

1945-51 LDP dominanceLack of policy debate

Male suffrage

1960US rule

Defeat

Showa1

1889

1925

1931Military rises

1937-45

(Content)Political fights

Now?