How Japan can make the most of new growth opportunities

With the passage of Trade Promotion Authority (‘fast track’) by the US Congress, the pathway for completion of the decade-long negotiations of the Trans-Pacific Partnership (TPP) has finally opened. TPP is a proposed agreement that would liberalise international trade and investment among 12 countries bordering the Pacific, including Japan and the US. Significantly, TPP would exclude China.1

TPP has been accurately described as the most important US trade negotiation since the North American Free Trade Agreement of 1994. Completion of TPP would shift attention to the Trans-Atlantic Trade and Investment Partnership, currently under negotiation by the US and the EU and also included under ‘fast track’. This would unify trade and investment agreements in North America and Europe, creating a free trade and investment area covering both continents.

In a recent paper (Jorgenson et al. 2015) we analyse trans-Pacific competition between US and Japanese industries over the period 1955-2012. This has provided powerful incentives for mutually beneficial economic cooperation. During the first half of this period, ending with the Plaza Accord of 1985, the yen was undervalued relative to the dollar and many Japanese industries became competitive with their US counterparts. This provided an opportunity for Japan to grow rapidly by mobilising its high-quality labour force, maintaining high rates of capital formation, and dramatically improving productivity.2

Double-digit growth in Japan ended with the first oil shock of 1973, but the Japanese economy continued to grow more rapidly than the US until the collapse of the ‘bubble economy’ in Japan in 1991. The overvaluation of the yen relative to the dollar reached a peak in 1995. This precipitated a slump in Japanese exports and a slowdown in economic growth. The slump began as a ‘lost decade’ and has stretched into two decades, marked by much lower capital formation, a decline in employment, and the disappearance of productivity growth.3

Japanese policymakers have spent the two lost decades since 1995 dealing with the overvaluation of the yen. The exchange rate approached yen-dollar purchasing power parity in 2007. However, the financial and economic crisis that originated in the US in 2007–2009 led to a second sharp revaluation of the yen. Under Chairman Ben Bernanke, the Federal Reserve vastly expanded its balance sheet through quantitative easing, but the Bank of Japan under Governor Masaaki Shirakawa failed to react.

In November 2011 the yen appreciated to historic highs relative to the dollar. Subsequently it depreciated modestly, but the yen was still substantially overvalued when Prime Minister Shinzo Abe assumed office in December 2012. Depreciation of the yen accelerated with the adoption of quantitative easing by the Bank of Japan after Governor Haruhiko Kuroda took office in April 2013. Japanese price competitiveness vis-à-vis the US was finally restored in February 2015.

Policies advocated by the Abe Administration to revive the Japanese economy have been dubbed the ‘three arrows of Abenomics’. The first arrow is fiscal stimulus, which has had a mixed record under Abe. The second arrow, by far the most successful, is easy money under the Bank of Japan. The third arrow of Abenomics is a growth strategy for Japan, which we discuss below.4

Price competiveness between Japan and the US has a real counterpart in the productivity gap between the two countries.  Japanese-US productivity gaps for 1955-2012 are shown in Figure 1. The white dots represent the overall productivity gap, while productivity gaps for manufacturing are shown in black and for non-manufacturing in white.

In 1955, almost immediately after Japan recovered sovereignty in 1952, Japanese productivity was more than 50% below that in the US. The gap closed gradually for more than three decades and Japan achieved near-parity with the US in 1991. Over the following two decades productivity growth in Japan languished, while US productivity growth slightly accelerated. As shown in Figure 1, the Japanese-US productivity gap reversed its long decline after 1991, rising by 2012 to levels of the early 1980s.

Figure 1. Japanese-US productivity gaps, 1955–2012

In our paper we have shown that productivity gaps for Japanese and US manufacturing industries, especially those involved in materials processing rather than assembly, are relatively small. As shown in Figure 2, the Japanese motor vehicles industry has had a higher level of productivity than its US counterpart since the 1970s, but the productivity gap almost closed after the drastic reorganisation of the US industry in the aftermath of the Global Crisis of 2007–2009.

In Figure 2 two industries stand out as opportunities for improvement in productivity. Medical care in Japan has had a stable level of productivity since the mid-1970s, while the medical care industry in the US has had consistently declining productivity. No doubt substantial improvements are possible in the measurement of medical care in Japan and the US. However, the measured decline in US productivity is unlikely to disappear. A revival of productivity growth would require major institutional reforms, but this would help to relieve budgetary pressure from spiralling health care costs at every level of the US government.

Figure 2. Productivity levels in selected industries, 1955–2012

Turning to opportunities for Japan, Japanese agriculture has had no productivity growth since the mid-1970s, while its US counterpart has achieved consistently high rates of productivity growth. Agriculture has been targeted by the Abe Administration as a potential opportunity for rapid productivity growth. However, this would require major institutional changes, beginning with the Japanese system of agricultural cooperatives. These cooperatives have added enormously to the costs of agricultural production and distribution in Japan and have undermined growth in Japanese standards of living.

Our paper also shows that additional opportunities for productivity improvements in Japan can be found in six industries that are largely insulated from international competition – real estate, electricity and gas, construction, other services, finance and insurance, and wholesale and retail trade. These industries are also protected from domestic competition through government regulation of pricing and entry. Exploiting opportunities to improve productivity would require lowering barriers to entry, eliminating regulations that limit price competition, and encouraging both inward and outward foreign direct investment.

The two lost decades in Japan and the Global Crisis that began in the US in 2007–2009 have created important untapped opportunities for economic growth in both countries. Moran and Oldenski (2015) have shown that TPP could help to revive economic growth in the US by stimulating trade and investment. The greatest payoffs for Japan would come from combining TPP with domestic reforms and encouraging foreign direct investment.  This would provide a growth strategy for Japan that could end the lost decades – the long-awaited third arrow of Abenomics.

References

Fukao, K (2013), “Explaining Japan’s Unproductive Two Decades”, Asian Economic Policy Review8(2), pp. 192-213.

Government of Japan (2015), “Abenomics is Progressing”, Tokyo: Cabinet Office of Japan, June.

Hufbauer, G. C. (2015), “TPP Now in Sight”, VoxEU.org, June.

Jorgenson D W, K Nomura and J D Samuels (2015), “A Half-Century of Trans-Pacific Competition: Price Level Indices and Productivity Gaps for Japanese and US Industries, 1955-2012”, RIETI Discussion Paper No. 15-E-054, Tokyo.

Moran, T H and L Oldenski (2015), “TPP Will Promote Investment as Well as Trade”, Trade and Investment Policy Watch, Peterson Institute for International Economics, Washington, DC.

Petri P A, M G Plummer and F Zhai (2012), The Trans-Pacific Partnership and Asia-Pacific Integration: A Quantitative Assessment, Washington, DC: Peterson Institute for International Economics.

Petri P A, M G Plummer and F Zhai (2014), “The TPP, China, and the FTAAP: The Case for Convergence”, in Tang, G and P A Petri (eds), New Directions in Asia-Pacific Economic Integration, Honolulu: East-West Center.

Footnotes

1 For more details on the TPP, see Hufbauer (2015). Petri et al. (2012) have quantified the benefits of TPP to the participating countries. In a more recent paper Petri et al. (2014) have identified the substantial additional benefits of including China in the Partnership.

2 Productivity is defined as output per unit of all inputs; this definition can be contrasted with labor productivity or output per hour worked.

3 For more details see Fukao (2013).

4 A current summary of Abenomics is provided by the Government of Japan (2015).

This article is published in collaboration with Vox EU. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Dale W. Jorgenson is a Samuel W. Morris University Professor, Harvard University. Koji Nomura is an Associate Professor, Keio University; Faculty Fellow, RIETI. Jon D. Samuels is a Research Economist at the Bureau of Economic Analysis and Associate at the Institute of Quantitative Social Science, Harvard University.

Image: A woman walks past an electronic stock quotation board outside a brokerage in Tokyo. REUTERS/Issei Kato