The Japanese Economy: Past, Present, and Future Edward C. Prescott April 4, 2006 Japanese Center, Stern School, NYU

Current and Recent Past

Japan Recently Lost A Decade of Growth  Period  WHY?  Productivity growth almost stopped  What growth there was was due to deepening of capital – just as theory predicts given productivity growth slow down  Productivity growth recovered and Japan has regained a little of its lost ground.

Basic Growth Accounting  Production function  All numbers are per capita.  K is capita and H is hours

 With a little algebra  The first term is trend; the second is productivity; the third is capital intensity; the last is labor supply intensity

 GDP per working age person about 73% of U.S. value  This is higher than the EU-15, which is about 67% First correct for trend, Why?

U.S. Per Capita GDP

Detrended Advanced Countries’ GDP per Capita Source: Maddison and IMF U.S. Japan EU15

But, EU doing better than Japan  EU has more non market time  In terms of welfare, lifetime consumption equivalents, EU about 83% of U.S. level  While Japan is only 73%  On margin, value of market time twice that of non- market time.

 Japan’s problems is not hours  EU’s problem is hours

Annual Hours Worked per Pop Relative to US

Japan’s Problem is Productivity

GDP per Hour Relative to US

Future  First why did productivity growth almost stop in the period?

Future  First why did productivity growth almost stop in the period?  Answer: The Japanese through the bureaucratic financial sector subsidized inefficiency businesses

Future  First why did productivity growth almost stop in the period?  Answer: The Japanese through the bureaucratic financial sector subsidized inefficiency  Why did productivity resume under Koizumi?

Future  First why did productivity growth almost stop in the period?  Answer: The Japanese through the bureaucratic financial sector subsidized inefficiency  Why did productivity resume under Koizumi?  He reformed the banking system  Banks stopped giving new loans to their customers so that they could pay the interest on their old loans

Financial Sector Key for the Future  New Prime Minister, Shinzo, is backing down on Koizumi reforms, in particular privatizing the postal savings and life insurance system  This leads me to be pessimistic about future Japanese prospects

Financial Sector Key for the Future  New Prime Minister, Shinzo, is backing down on Koizumi reforms, in particular privatizing the postal savings and life insurance system  This leads me to be pessimistic about future Japanese prospects  Why does Japan have this problem and neither the EU or the US has this problem?

Answer  Japan is not a member of an economic union of states  Which have a considerable degree of economic sovereignty with respect to taxes and spending  But are prohibited from blocking other member states multinationals from locating in their borders  Let’s look at the past

Membership in EU leads to Productivity Catch-Up

Pre War Japan  About 20% less than Western Europe because of its policies that keep people on the farms  50% of population rural in 1950  Less than 5% rural in 1970

Conclusion  Japan will not be catching up to the EU-15 and the U.S.  Neither will Australia, which is a lot like Japan  Why? Neither is a member state of a U.S. or EU like economic union  Recovery in productivity growth in Japan had nothing to do with China  It was a change in Japanese policies