Lecture 17. REVIVING JAPANESE ECONOMIC GROWTH Economics 1490 THE WORLD ECONOMY: GROWTH OR STAGNATION? with Professor Dale W. Jorgenson Lecture 17. REVIVING JAPANESE ECONOMIC GROWTH October 26, 2017 Harvard University Department of Economics Fall 2017

THE WORLD ECONOMY: GROWTH OR STAGNATION? A. Comparing Economies B. U.S. Crisis and Recovery C. European Slowdown D. Asian Economic Miracles E. Sustainability of Economic Growth F. World Economic Outlook

D. ASIAN ECONOMIC MIRACLES 16. Is Asia’s Miracle a Myth?  17. Reviving Japanese Economic Growth 18. The Rise of Developing Asia 19. China: The World’s Largest Economy 20. India: The Most Rapidly Growing Economy

TIME LINE FOR THE JAPANESE ECONOMY Premier Ikeda's Income-Doubling Plan Led to the Economic Miracle of 1960-1973, Increasing Japanese GDP by 3.7 Times. The Japanese Economy Continued to Grow Rapidly Until the Collapse of Real Estate and Stock Market Bubbles in 1990. Monetary Policy Remained Very Restrictive, Leading Ultimately to a Prolonged Recession and Deflation Lasting Two Decades. The Bank of Japan failed to expand its balance sheet after the U.S. Financial and Economic Crisis, Leading to Yen Appreciation and a Severe Economic Downturn.

THE PLAZA ACCORD The Plaza Accord of 1985 was a crucial turning point for the Japanese economy. In 1985 the yen was undervalued by about 17%, based on a comparison between our output-based PPP for GDP and the yen–dollar exchange rate. In the late 1980s the rapid strengthening of the yen relative to the US dollar reversed this relationship, leading to an overvaluation of the yen by 25% in 1990. The revaluation of the yen continued through 1995, leading to an overvaluation of 78%! This was followed by a gradual devaluation through 2004, leaving the yen overvalued by 24%, very close to the 1990 level. The Japanese economy spent more than a decade overcoming the huge overvaluation of the yen that followed the Plaza Accord. This was accomplished mainly by domestic deflation, rather than devaluation of the yen. The price of GDP in Japan, relative to the US, declined by 4% annually through 2004 from the peak attained in 1994. The decline in the PPP for GDP at 2.5% per year was the result of modest inflation in the US of 1.4% and deflation in Japan of 1.1%. In addition, the yen–dollar exchange rate fell by 1.5% per year. Jorgenson and Nomura, 2007

PPPs AND PLIs FOR GDP AND KLEMS

PPPs FOR GDP AND KLEMS, 1955-2012

INDUSTRY-LEVEL PLIs FOR GDP, 2005 Source: Jorgenson, Nomura, and Samuels (2015). Note: PPP for GDP-output based (our estimates) is 124.9 yen per dollar and the PPP for GDP-expenditure based (Eurostat-OECD) is 129.6 yen. The average annual exchange rate is 110.2 in 2005.

THREE CHALLENGES FACING THE JAPANESE ECONOMY Since the 1970s Japan has been unable to export its domestic savings in excess of domestic investment. In the mid-1980s yen appreciation resulting from the Plaza accord made Japanese exports much less competitive. Bursting of the real estate and stock market bubbles in 1990 and 1991 led to stagnation through 2004 (lost decades).

THREE MAJOR ISSUES CONFRONTING JAPAN Productivity Growth In Japan Has Stagnated since 1995 with a Brief Revival from 2004-2008 Before the Financial and Economic Crisis. Japan’s Labor Force Has Fallen in Size since 1999 and the Japanese Population Began to Decline in 2010. Government Revenues Will Rise in Relation to the GDP to Finance Needed Expenditure and Support an Aging Population.

FIRST PHASE OF ABENOMICS First Arrow: Aggressive Monetary Policy Second Arrow: Flexible Fiscal Policy Third Arrow: Growth Strategy

GROWTH STRATEGY The Traditional Approach to Growth Strategy in Japan Is to Subsidize Favored Industries. When Industries Mature They Try to Block Competition through Government Regulations. The New Industrial Policy Is to Drill through “Bedrock” Regulations to Stimulate Competition.

IMPLEMENTING THE GROWTH STRATEGY Reform Agriculture by Diminishing the Influence of Agricultural Cooperatives and Participating in Free Trade Agreements Increase Competitiveness for Current Energy Sources While Exploring New Energy Sources Stimulate Competition by Eliminating “Bedrock” Regulations for Wholesale and Retail Trade, Other Services, and Finance and Insurance

PRODUCTIVITY GAPS BETWEEN JAPAN AND THE U.S.

SUMMARY OF THE FIRST PHASE OF ABENOMICS Deregulation of entry in trade and services is necessary to stimulate innovation and investment in information technology. Japan already has the highest quality labor force in the world in terms of workplace skills measured by literacy and numeracy. Japanese labor laws for employment protection have resulted in an inefficient allocation of a shrinking labor force. Trade agreements reduce protection and increase incoming and outgoing foreign investment.

WORKING-STYLE REFORM TO PROMOTE EFFICIENCY The Traditional Japanese Employment System Freezes Labor Mobility in Japan through Salaries Based on Seniority and Lifetime Employment The Efficient Deployment of Japan’s High-Quality Labor Force Is Undercut by Wages that Do Not Reflect Productivity Incentives for Women to Postpone Marriage to Pursue a Career and for Families to Postpone Having Children Reduce Fertility

ADOPTING A SUSTAINABLE FISCAL POLICY Financing of Social Insurance Obligations, Especially Support of the Elderly, Will Require an Increase in Government Revenue in Relation to the GDP A Shift in the Tax Burden from Investment to Consumption Will Stimulate Private Investment and Promote More Rapid Productivity Growth Revenue Enhancements Must Be Introduced Gradually to Maintain Aggregate Demand as the Growth Rate of the Japanese Economy Accelerates

SUMMARY OF PRODUCTIVITY AND JAPAN’S REVITALIZATION Eliminate Bedrock Regulations to Promote Productivity Growth and Create a Robust Economy Reform the Traditional Employment System to Enhance Efficiency and Raise Fertility Reform Taxation to Stimulate Private Investment and Meet Social Insurance Obligations

GROWTH STRATEGY 2017 (Adopted June 9, 2017) 1. Boost Productivity. 2. Drive Innovation and Trade. 3. Energize Corporate Activities

PRODUCTIVITY GAPS BETWEEN JAPAN AND THE U.S.

PRODUCTIVITY GAPS BETWEEN JAPAN AND THE U.S.

BOOST PRODUCTIVITY Reform the Traditional Work Style Invest in Human Resources Embrace Diversity in the Labor Force

DRIVE INNOVATION AND TRADE Provide Personalized Medical Care Provide Faster Distribution Services for Business Increase Productivity in the Infrastructure Business Promote Development of Financial Technology in Japan

ENERGIZE CORPORATE ACTIVITIES Corporate Tax Reduction Strengthen Investor Confidence in Corporate Governance Drive Inward Foreign Direct Investment

SUMMARY OF THE SECOND PHASE OF ABENOMICS