Japan Stagnation

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Accounting for slow growth in Europe and Japan

Christopher Phillip Reichera

Kiel Institute for the World Economy

This version: August 29, 2011

Abstract:

In this short paper I discuss some of the likely sources of Europes and Japans slow growth

relative to the United States in the decade and a half leading up to the Great Recession. I

argue that slow and decelerating growth in much of Europe and Japan could be explained by

two major factors: Differing population dynamics and an apparent end to postwar

convergence. I also explore the issue of movements in the output gap as a factor underlying

slow growth. I find using two measures of the output gap that Japans lost decade of the

1990s did not see a persistent negative output gap. While the worst of the lost years

between 1998 and 2004 saw a series of adverse cyclical shocks, the slow growth performance

of Japan and also Germany since 1990 is the result of their finishing its process of postwar

convergence combined with a shrinking population.

a Contact information: Hindenburgufer 66, 24105 Kiel, Germany.

Email: [email protected]; Phone: +49 (0)431 8814 300.

JEL: E00, N10, O47

Keywords: Slow growth, Japan, Germany, output gap, convergence.

None of the opinions expressed here are the opinions of the Institute or my colleagues.


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Accounting for slow growth in Europe and Japan

Introduction and motivation

In a recent blog post entitled, Where does the Japanese slowdown come from?, Tyler

Cowen has quoted a paper (2011) where I argue that it makes little sense to look at the

unemployment rate as a guide to the Japanese business cycle. The Japanese unemployment

rate does not vary by much over the business cycle; almost all of the cycle in Japan comes

from fluctuations in measured productivity with some contribution from hours per worker.

An implicit conclusion of that paper is that it makes sense to look at output growth directly

since unemployment is not a reliable cyclical indicator in Japan. Just because Japan has had

low unemployment does not mean that it had not suffered through a severe slump. Between

1991 and 2007 (excluding the Great Recession), Japans economy had grown at a

continuously compounded annual rate close to two percent slower than that of the United

States. Based on a simple comparison of growth rates between the countries, Japan appears to

have become and remain mired in a deeper and more persistent depression than the Great

Depression in the United States.

There is a problem to simply looking at output growth, however. It is necessary to look at

such things as population growth when comparing the growth of output across countries. For

instance, much has also been made of the lower growth rates experienced before the crisis in

Europe than in the United States.1

Similarly, much of the discussion of the lost decade or

lost years in Japan is predicated on the assumption that the low GDP growth of the 1990s

and 2000s reflects some sort of failure for the Japanese economy to produce near its potential.

The rest of this note explores the sources of different growth rates between France, the United

Kingdom, Germany, Japan, and the United States in the past two decades. These are major

economies for which reasonably good annual time series data exist since 1970.

First I discuss the behavior of the components of GDP growth relative to the United States,

and then I discuss what the effect of these different components has been in each country

relative to the United States. I argue that the patterns seen in Japan, Germany, and to some

extent France, are the result of the end of convergence in output per worker and a sharp

decline in the hours worked per worker. In the case of Japan, labor market outcomes have

1 For instance, Dovern, Jannsen, and Scheide (2009) blame the entry into the Euro for an overvalued real

exchange rate and hence slow cyclical growth in Germany from 1999 through 2005.


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converged toward U.S. patterns, while much of Germanys and Frances great stagnation

come from a secular decline in hours worked per worker to levels well below U.S. levels. In

addition, population dynamics in these countries have been such that these countries will

naturally grow more slowly than the United States.

Then I reexplore the issue of the cyclicality of unemployment, particularly in Japan. By

looking at the Okuns Law relationship between unemployment and output, I find that there is

a moderately strong relationship between unemployment and the cycle which can be used to

try and approximate the output gap in Japan. When doing this, I do not find evidence of a

persistently negative output gap during the 1990s, though I do find evidence that the 1998

recession was a strong one. Other estimates of the output gap during that period support this

assessment. Japans Great Stagnation is primarily the result of a decreasing population and

an end to convergence in productivity and not primarily the result of a string of adverse

cyclical shocks during the early 1990s.

This paper seeks to discuss growth in Europe and Japan in a nontechnical way. The role of

this note is to plot some data and try to put together a rough narrative as to what has happened

to economic growth rates across countries since 1990. I find that the data broadly support the

idea put forward by Cowen (2011) that a large amount of early postwar growth consisted of

picking low-hanging fruit, with Europe and Japan continuing to pick low-hanging fruit until

about 1990 or so. I hope to offer a few pieces of data which suggest that the growth situation

in Europe and Japan has not been quite as bad over the past two decades as critics have made

it out to be.

The data and some narrative

The data come from the OECDs National Accounts and Annual Labor Force Statistics

databases. All variables are compared with their counterparts in the United States since the

PPP-adjusted GDP series come in nominal U.S. dollars. The comparisons can be broken

down based on an accounting identity which links the following items:

GDP = GDP per hour worked (productivity),

times actual hours worked per employed worker (the intensive margin),times the employment rate (employment as a share of the labor force),


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times the labor force as a share of the population aged 15-64 (the participation rate),

times the working age population.

Figures 1 through 4 show the first four of these objects for the five countries relative to their

U.S. counterparts. Figure 1 shows the evolution of productivity relative to U.S. productivity

since 1970.

Figure 1: Productivity (output per hour) relative to the United States

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France United Kingdom Germany (West) Germany (Unified) Japan

Source: OECD data and authors calculations. All numbers are relative to the United States.

During the first half of the sample, most of these countries played catch up with the United

States. Since 1990, most of these countries have seen their productivity relative to the UnitedStates stabilize at levels which vary between countries. Simply extrapolating past trends

would result in a very large measured output gap during the 2000s even though much

previous growth reflects convergence. Germany and France have stabilized at a level of

productivity roughly comparable to that of the United States. The United Kingdom has

stabilized at a productivity level of about 80% relative the United States, and Japan has

stabilized at about 70%. Much of the slowdown in Japan has come because it has stopped

converging with the United States. In Japan, convergence before 1990 was particularly rapid,

while it ground to a halt in about that year. Figure 2 shows hours per worker, the intensive

margin, relative to the United States.


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Figure 2: Hours per worker relative to the United States

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All four countries have seen a strong secular decline in hours worked relative to the United

States. Japan is not out of the ordinary, although it saw a particularly rapid decline in hours

per worker during the recession of the early 1990s. Falling hours worked relative to the

United States will cause GDP growth to be lower than it otherwise would have been.

Combining falling hours worked with falling productivity growth will cause output growth to

have decelerated particularly strongly in Japan and Germany relative to the United States.

Figure 3 shows the employment rate relative to the United States for these countries. In

Japan, the unemployment rate is consistently low, and the employment rate is almost always

higher than that in the United States. France and Germany endured a three-decade slump

relative to the United States; up until 2007 they had consistently lower employment rates (i.e.

higher unemployment rates) than the United States. The trend in Japan has been toward

falling employment rates and rising unemployment rates, though that trend has merely sent

Japanese employment and unemployment rates toward U.S. levels. In 2007, the

unemployment rate was 3.8 percent in Japan while it was 4.6 percent in the United States.


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Figure 3: Employment rate relative to the United States

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Figure 4 shows the behavior of the labor force participation rate. Europe has had lower labor

force participation rates over recent decades to go along with its lower employment rate.

Japanese labor force participation has in fact risen slightly since 1990 and is higher than that

in the United States. Arguments about Japans weak labor force participation rates do not

seem to show up in data on the labor force participation rate.

In short, just based on a look at Figures 1 through 4, it seems like Europe and Japan have seen

a Great Stagnation much stronger than that seen by the United States based on looking at

output growth. Much of their growth before 1990 was driven by simple productivity

convergence. Naturally, after convergence happens, an economy will grow more slowly

relative to its previous path. In Japan, the end of convergence is particularly sharp; it occurs

around 1990. In Germany, the statistics are clouded by the change in the definition of

Germany in 1990-91. It is striking that all-German productivity has hovered around U.S.

levels since the reunification in spite of clear improvements in eastern German productivity

and living standards since 1991.


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Figure 4: Labor force participation rate relative to the United States

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A counterfactual analysis

This section decomposes the differential growth experiences of these four countries relative to

the United States into components attributable to the components of GDP laid out in the

accounting identity. This answers the question, All else equal, if the United States had seen

growth in (for example, productivity) like that seen by (for example, Germany), what would

have happened to its overall GDP growth rate? Since the growth rates used here are

continuously compounded, these numbers are additive, and summing up the differential

growth rates in the components of GDP will give the differential growth rate in GDP.

Table 1: Counterfactual analysis from 1991 to 2007: Annual growth rates

Country Prod. Hrs / wkr E rate LFP rate Pop growth Total diff

France 0.07% -0.46% -0.13% 0.29% -0.76% -0.99%

United Kingdom 0.73% -0.27% 0.07% 0.08% -0.79% -0.19%

Germany (Unified) 0.12% -0.43% -0.35% 0.46% -1.32% -1.52%

Japan -0.07% -0.64% -0.26% 0.48% -1.50% -1.98%

Source: OECD data and authors calculations. All numbers are given as continuously

compounded growth rates relative to the United States.


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Table 1 shows the decomposition for the period 1991-2007, which covers the sixteen years

before the Great Recession. In the cases of France, Germany, and Japan, almost all of the

growth differential is explained by differences in population growth. Differences in

productivity growth have contributed almost nothing to the growth differential except in the

United Kingdom. The United Kingdom, as also seen in Figure 1, has seen continued slow

convergence with the United States, while France, Germany, and Japan have stopped

converging. The data support the assertion made by Daniel Gros (2011) that, ...the idea of a

Japanese-style lost decade is misleading even when applied to Japan. Slow growth in

Japan over the last decade was due not to insufficiently aggressive macroeconomic policies,

but to an unfavorable demographic trend.

In Japan, hours per worker have fallen more rapidly than in the United States. The same is

true, however, in the three other economies. Much more work would need to be done to

understand how much of this is due to convergence and how much of this is due to other

factors. In 2007, Japanese and U.S. workers worked comparable amounts (just under 1,800

hours per worker) while in 1990, Japanese workers worked 10% more than Americans. By

contrast, in 2007, the average German worker worked 1,430 hours while in 1970, the average

German worker worked slightly more than the average American worker. Either way, the

slow growth in Germany, France, and Japan, seems to be entirely driven by slower population

growth and by a fall in relative hours worked, in that order. None of it appears to be driven

by differential productivity growth or by large changes in the labor force participation rate,

and changes in the employment rate only contributed a small part to the differential growth

performance among countries over the longer term. The one country where the employment

rate did seem to matter was Germany, and Germany has performed much better with respect

to that metric since 2007.

A comparison with the period before 1990

This section repeats the same analysis for the period from 1970 to 1990 and discusses the

reasons for the growth slowdown between 1991-2007 and 1970-1990. Table 2 shows the

difference in relative growth rates for the different components of GDP, comparing the 1991-

2007 period with the 1970-1990 period.


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Of all of these countries, Japan has had the strongest growth slowdown relative to the United

States, though France and Germany have each also seen a strong relative growth slowdown.

Japan, France, and Germany have seen sharp slowdowns in productivity growth as

productivity has reached a plateau relative to that of the United States. Japan has also seen

more deceleration in its population growth rate, although Germany is not far behind. Table 2

basically demonstrates what a look at Figure 1 would showit is misleading to compare

growth rates across time in Japan since both population and productivity growth have slowed

dramatically. A naive extrapolation of either trend would show Japans slump to be far worse

than it really was.

Table 2: Difference between relative growth rates: 1991 to 2007 vs. 1970-1990:

Annual growth rates

Country Prod. Hrs / wkr E rate LFP rate Pop growth Total diff

France -1.89% 0.26% 0.14% 0.98% -0.31% -0.82%

United Kingdom -0.25% 0.01% 0.27% 0.49% 0.16% 0.68%

Germany (Composite) -1.71% 0.48% -0.18% 1.20% -0.72% -0.92%

Japan -2.62% -0.33% -0.24% 1.08% -1.14% -3.25%

Source: OECD data and authors calculations. All numbers are given as continuously

compounded growth rates relative to the United States.

In short, the great stagnation of Europe and Japan relative to the United States seems to be

driven by a strong combination of more normal productivity growth and, in the case of

Germany and Japan, an outright shrinking population. The long-run deceleration in growth in

Europe and Japan relative to the United States is mainly a product of a deceleration in

productivity convergence.

Okuns Law, the cyclicality of unemployment, and measuring the output gap

There are other ways to look at the issue of the cyclicality of employment. The study of

Reicher (2011) decomposes the variance of output growth based on the contributions of its

components and finds that measured productivity in Japan contributes most of the variance of

output flucutations. This analysis takes a different look, by using the (un)employment rate as

a cyclical indicator. The analysis takes the data from Reicher (2011) for France, Western

Germany, Japan, the United Kingdom, and the United States. All data are HP filtered with a

smoothing parameter of 100 and then taken in first differences; I get similar results if I take


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first differences and then filter. The data are constructed to provide consistent estimates for

Western Germany throughout the sample, and again the sample ends in 2007.

Table 3 shows the results of regressing growth in log GDP per capita on growth in the log

employment rate. The idea is that the employment rate is primarily driven by the cycle, while

the other components of output are driven mostly by their trends. Regressing GDP growth on

growth in the employment rate will give an approximate relationship between the output gap

and the employment rate gap.

Table 3: Results of regressing cyclical output growth on growth in the employment rate

Country Estimate Std. Err. R2

France 1.646 0.309 0.4475

Germany (West) 1.413 0.301 0.3871

Japan 4.590 1.057 0.3502

United Kingdom 1.060 0.250 0.3513

United States 1.699 0.172 0.7371

Source: Reicher (2011), from OECD and German national sources.

The results from Table 3 show that the United States, France, and Germany all obey an

Okuns Law with a coefficient of a similar magnitude. In those countries, the

(un)employment rate is a reliable guide to the cycle. In the United Kingdom, output moves

about one for one with unemployment. In Japan, output moves much more than employment,

at a rate of 4.5 to 1. This means that for a cyclical unemployment gap of one percentage

point, output falls short of trend by about 4.5 percent. Put another way, unemployment moves

in a very dampened manner relative to the rest of the cycle.

Figure 5 shows the output gaps in the five countries derived using Okuns Law. Surprisingly,

according to Okuns Law, Japans output gap was positive throughout most of the 1990s until

the Asian financial crisis caused output to collapse. Output during the early 2000s remained

low as unemployment peaked in 2002. Figure 6 shows the output gap as calculated by the

OECD using a production function approach. Figure 5 shows a much worse business cycle in

the early 2000s for Japan than Figure 6 does. Both figures give a broad impression that the

mid-1990s were not actually that bad for Japan and that the cycle only became a problem after

the 1998 financial crisis. If both measures of the output gap are any indication, Japans lost

years lasted roughly six years, from 1998 through 2004.


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Figure 5: Output gaps derived from Okuns Law

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France Germany (West) Japan United Kingdom United States

Source: Regression coefficients from Table 3 multiplied by the employment rate gap, derived

using an HP filter of 100.

Figure 6: Output gaps for five countries (OECD Economic Outlook)

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Source: OECD Economic Outlook 89 (2011).


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From what evidence can be pieced together using data on labor markets in Japan, the 1990s

did not appear to feature a persistently negative output gap. To the extent that labor markets

deteriorated in Japan and remained in a persistent slump, the worst of that deterioration

happened after the 1998 crisis and not after the collapse of the housing market and banking

system in the early 1990s. The derivation of the output gap is obviously sensitive to the

choice of filtering techniques, so the degree to which the output gap turned negative during

the 1990s in Japan is far from settled.

Conclusion

Relative to the United States, the economies of other industrialized countries have grown

rather slowly since about 1990 or so. This note has shown that most of the divergence in

growth from 1991 through 2007 has come because different countries have seen their working

age populations grow at different rates. In addition, falling hours worked per worker relative

to the United States have contributed somewhat to slower growth in Europe and Japan.

Looking at the deceleration of growth rates between 1970-1990 and 1991-2007, I argue that

most of the decelerating growth seen in Europe and Japan has come through the end of

convergence in productivity. Germany and France have converged toward U.S. productivity

levels; the United Kingdom has converged toward a level just over 80% of that of the United

States, and Japan has converged toward a level just over 70% of that of the United States.

Any analysis which depends on extrapolating past growth rates forward will detect a spurious

output gap in the latter period even where none exists. The apparent nonstationarity in growth

rates also makes it much more difficult to disentangle trend and cycle.

With those caveats in mind, I revisited the issue of the cyclicality of unemployment in Japan.

I find that Okuns Law in Japan displays a much larger coefficient than in the United States or

in Europe. This implies that one could view the output gap as a very large multiple of the

employment gap. Using unemployment data detrended using a smoothing parameter of 100, I

find that the worst of Japans lost years really occurred from the crisis of 1998 until the

onset of a cyclical revival which began in 2003-04.


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References

Cowen, Tyler, 2011. Where does the Japanese slowdown come from? Online at:

http://marginalrevolution.com/marginalrevolution/2011/08/where-does-the-japanese-

slowdown-come-from.html (Retrieved 26 August, 2011).

Cowen, Tyler, 2011. The Great Stagnation: How America Ate All the Low-Hanging Fruit

of Modern History, Got Sick, and Will(Eventually) Feel Better. Dutton Adult.

Dovern, Jonas, Nils Jannsen, and Joachim Scheide, 2009. Die Bedeutung monetrer Gren

fr die deutsche Wachstumsschwche 19952005. Kiel Working Paper 1492.

Gros, Daniel, 2011. The Japan Myth. Euronomics, Project Syndicate. Online at:

http://www.project-syndicate.org/commentary/gros18/English (Retrieved 29 August 2011).

Organization for Economic Cooperation and Development (OECD), 2011. Economic

Outlook 89. Electronic version, June 2011.

Reicher, Christopher P., 2011 A simple decomposition of the variance of output growth

across countries. Kiel Working Paper 1703. Forthcoming, Applied Economics Letters.

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Japan Stagnation