Economic Development of Japan

1. Economic Development of Japan TRADE YEN OIL No.11 Economic Maturity & Slowdown

2. TOPICS – 1970s & 80s • Macroeconomic overview • End of catching up, economic maturity • Growth and 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)

3. Real GDP Growth(Fiscal Year – April to March) Average 1956-73 9.1% Average 1974-90 4.2% Average 1991-2010 0.9% Source: The System of National Accounts site, Cabinet Office.

4. P.187 Monetary Growth and Inflation (12-month change) Bubble 1st oil shock 2nd oil shock Bubble collapses Bretton Woods fixed dollar system ends General float begins Plaza Agreement

5. PP.188-90 The Cause of 1970s Stagflation P AS 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. AD Y World Money Growth Source: McKinnon (1979), p.264

6. 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 US W.Ger. France Japan UK Italy

7. Speed of Catching Up: East Asia Per capita real income relative to US(Measured by the 1990 international Geary-Khamis dollars) 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).

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

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

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

11. Russia & Eastern Europe Per capita real income relative to US(Measured by the 1990 international Geary-Khamis dollars) 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).

12. 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

13. High Growth & Inequality • Japan, Korea and Taiwan narrowed internal income gaps (personal, sectoral, regional); but in China, Thailand, Philippines, Thailand, Vietnam, etc. income has remained (increasingly) polarized. • To sustain growth to high income, three policies are needed. In principle, they can be implemented separately—cf. “pro-poor growth,” “inclusive growth” (1) Constant creation of growth sources (industrial policy) (2) Coping with new problems caused by high growth—income gaps, pollution, migration, congestion, traffic, crime & corruption, cultural change… (3) Macroeconomic management under globalization, including coping with global business and price cycles and huge capital inflows & outflows

14. 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

15. Separability of Growth & Social Policies in E.Asia’s Successful Latecomers Economic growth START New social problemsMacro instability under integration Developmental policies Generation of growth sources Political stability Supplementing policies A few decades later END - Social policies- New macro management Exit to a richer & more democratic society (examples: Korea, Taiwan)

16. PP.190-91 The Japan System: Delayed Reform? Long-term relations Official intervention Open markets Private initiative • 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.

17. The 1940 Regime: Farewell to the War Economyby 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.

18. 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 current Democratic Party government 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.

19. Mercantilist Pressure on Surplus Countries Komiya (1994), McKinnon-Ohno (1997), McKinnon (2005) When a country emerges as a new industrial power, it is often criticized for unfair trade and undervalued currency. Trade and exchange pressures mount. But the trade gap cannot be eliminated by currency appreciation or trade liberalization. Ronald McKinnon

20. PP.191-94 Elasticities Approach vs. Absorption Approachin Financially Open Economies Conventional 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

21. Our unconventional view (syndrome of the ever-higher yen) • Thanks to wrong economics and Washington lobbying, the yen-dollar rate has been manipulated for mercantile purposes. • But yen appreciation cannot reduce Japan’s surplus and US deficit, because they are structural (US savings < US investment). The real solution is increasing US savings.Current account = Y – A = S – I • Intermittent yen appreciation only destabilizes the Japanese economy through recession, deflation and depressed interest rates. American responses 1971-73, 1977-78, 1985-87, 1993-95 Pressure to appreciate yen Persistent trade gap Japan’s surplus with US Bilateral trade negotiations Reinforcement through failure

22. Exchange Rate Impacts Are Complex... Subject to M-L condition & J-curve Relative price effect Competi- tiveness (+/?) Price channel Yen appreciation E (-)offset Pass-through Inflation Trade balance Engi-neered Reverseabsorption effect Quantity channel Absorption (-) Monetary expansion “Endaka fukyo” orhigh-yen induced recession LM curve shifts

23. International Reserves --Countries with large F/X 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

24. “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.

25. Estimates of Japan’s Net Liquid International Asset Holdings(% of GDP) Source: R. McKinnon, “Japan’s Deflationary Hangover: The Syndrome of the Ever-Weaker Yen,” April 2007.

26. P.178 The 1955 Regime (LDP political dominance) • The Liberal Democratic Party (LDP) formed in 1955, held power until 2009 (except 1993-96). • 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 fields) • 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 LDP Factions & zoku-giin Other parties

27. Full democracy Democratic institution(Form) Showa2 US rule 1960 2009 LDP dominanceLack of policy debate 1945-51 ConstitutionLawsParliamentElectionCourt DemocratizationNew constitution Military rises 1931 Democracy movement, Party cabinet 1937 Defeat War Male suffrage 1925 Showa1 Taisho ConstitutionParliament 1889 Fascism 1937-45 Meiji Edo (Content) Political fights Pure dictatorship Reform vs conservatism, big vs small government, other policy debates Political competition