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The Japanese tragedy

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The Japanese tragedy

BRAD DELONG posts a question:

“Japan is now 40 to 50 percent below what the world in 1991 would have estimated their GDP to be in 2012.

Do we attribute this to:

The forecasting community was just wrong–Japan was having adverse technology shocks that few foresaw, and so no matter what macro policies they followed and no matter what antibubble policies they followed their GDP today would be about what it is, for the prevailing potential estimates back in 1991 were just wrong?

If Japan had avoided its bubble and the resulting financial crisis, it would today have far higher GDP–but once the crisis happened, it ruined into an adverse supply shock and most of what has happened since was then predestined.

If only Japan had followed the Posen plan rapidly after their bubble burst, their world would be very different today and GDP in Japan would indeed be 30-40% higher than it is.

What is the best way to think about this?”

Noah Smith says there is no problem:

“Basically, by 1990, Japan had caught up to the richest large nations in terms of per capita GDP. The only way for Japan to have continued at its previous high rate of growth post-1990 would be for either A) an unprecedented technological boom to power a rapid expansion among all the world’s rich countries, or B) for Japan’s productivity to significantly exceed that of the other rich countries. In other words, anyone who forecasted continued rapid Japanese growth in 1990 was predicting that Japan was capable of doing far better than the other countries of the world, and indeed that this was the most likely outcome.

Now, let’s look at Japan right now. Wikipedia tells us that Japan’s per capita GDP, in nominal terms, is $45,900. That compares with $44,500 for Germany, $43,100 for France, and $39,600 for the UK…I suspect that what difference exists is due to labor inputs, since Japan does not force its citizens to take lots of time off of work the way Germany and France do.

At purchasing power parity, the numbers are a little less favorable for Japan – $34,300, compared with $38,400 for Germany, $35,900 for the UK, and $35,000 for France. However, I am suspicious of these numbers, since PPP does not take into account quality differences between similar products across countries…

So the “real” level of Japanese GDP, if such a thing can be said to exist, is probably somewhere right around that of Germany, France, and the UK. “Lost decade” or no, Japan in 2012 is right where the Solow Model says it should be.”

Mr Smith has this wrong. It is very misleading to look at nominal per capita GDP due to the enormous swings in the Japanese yen. In 2007, Japan’s nominal output per capita was 74% of America’s. Then the dollar fell 38% against the yen, and now nominal Japanese output per capita is 96% of America’s. Even if nominal GDP per capita is the focus, Japan still suffered a lost decade and then some; only in 2010 did its economy regain a level of income last attained in 1995.

PPP adjustments aren’t perfect, but they’re heavily favored for these sorts of comparisons precisely because of the wild swings induced by currency moves. Looking at the PPP-adjusted figures Japan’s decline is difficult to miss. In 1991, its real output per capita was 87% of that in America; in 2011 that figure had fallen to 72%. For most of the 1990s, Japan was the second richest large economy in the world—richer than Canada, Britain, Germany, France, and Italy. It is now poorer than all of those economies except for Italy. In 1987, Japan’s real output per person reached 98% of Germany’s, and from 1988 to 1998 its income was higher than that in Europe’s strongest economy. In 2011, its real GDP per capita stood at 92% of that in Germany. Japan has underperformed and fallen behind Western Europe, and it has badly lagged North America. And neither Western Europe or North America had a very good decade in the 2000s! Certainly neither of those economies was a principal member of the supply chain centered on the world’s growth juggernaut.

That actually suggests a useful comparison. Australia is another large, rich economy with high levels of human capital and located in close proximity to China. Unlike Japan, however, Australia’s macroeconomic policy making is typically singled out for praise, and its annual inflation over the past two decades has typically been between 2% and 4% as opposed to 2% and -1%. Between 1988 and 1997, Japan’s annual output per capita, in both nominal and PPP terms, was above Australia’s. Real output per capita in Japan peaked at 114% of the Australian level in 1991. But by 1998, its real output per capita had fallen even with Australia’s. As of 2011, real Japanese output per person was just 86% of the Aussie level. Nominal output per capita, by the way, dropped to 70% of the Australian level.

I’m more than willing to accept that structural factors played a role in this shift (especially as a large, sustained output gap will, over time, erode potential). But this evidence strongly suggests that Japan’s economy has significantly underperformed reasonable expectations over the past two decades, and that this is partially, and perhaps mostly, attributable to macroeconomic policy failures.


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