In my last post on the policy agenda of Shinzo Abe, I took issue with both the Japanese prime minister’s choice of economic growth as almost the sole goal of government, but more importantly his ability to achieve such growth. Indeed, it is my contention that Japan has a post-growth economy, the principal reasons for which are twofold: demographics and diminishing returns to technology.
The above statement can be put in the context of growth accounting. From the OECD Compendium of Productivity Indicators 2012 we see a summary statement on growth drivers:
Economic growth can be increased either by raising the labour and capital inputs used in production, or by improving the overall efficiency in how these inputs are used together, i.e. higher multifactor productivity (MFP). Growth accounting involves decomposing GDP growth into these three components, providing an essential tool for policy makers to identify the underlying drivers of growth.
Next, let’s look at the headwinds to growth cited by the last governor of the Bank of Japan, Maasaki Shirakawa, who hardly ever stepped onto a podium to give a speech without including the following slide in his presentation pack (click for larger image):
As you can see from the chart above, labour inputs—the red section of each bar—have become a strongly (and increasingly) negative component of growth. The blue section of each bar—which encompasses both capital deepening and multifactor productivity (innovation and efficiency)—has also shrunk substantially.
So if Shinzo Abe wishes to bolster growth he has to do one of three things when he shoots his three policy arrows: 1) increase labour inputs, 2) expand capital inputs or 3) encourage multifactor productivity growth (innovation, creativity and organisational efficiency).
Now we know that changing labour inputs is an uphill task, since Japan’s demographics are already predetermined by decades-old fertility trends:
At the margin (taking as given that a large jump in immigration is politically impossible), a government can try to raising the participation rate of the elderly or women to secure a great labour input. Indeed, such actions were recognised as a source of growth in the speeches of former Bank of Japan Governor Shirakawa. Here are two slides from his last presentation (click for larger images).
But increasing female and elderly participation in the labour force will only secure a marginal gain in growth—perhaps one or two tenths of one percent. (As an aside, I would argue that one has to be very careful equating greater female and elderly participation with greater societal happiness; for example, pushing people out of the informal care and voluntary sector into the formal sector may show up as greater GDP, but the actual service provision may not have changed—caring for one’s own relative for free becomes caring for someone else’s relative for a fee.)
Shirakawa also left out the fact that annual hours worked by Japanese employees fell from a truly crazy 2,000 per annum in 1991 to a more normal 1,700 in 2011 (and that is ignoring the unrecorded hours of Japan’s legions of salarymen). Former Prime Minister Nakasone’s drive in the 1980s to make Japan a ‘lifestyle superpower has started to come true. Thus, some of the productivity loss was a deliberate choice to substitute leisure in the place of income. The interplay between labour participation and hours worked can be seen in a very good Financial Times article on labour productivity and demographics, from which the chart below is taken (click for larger image).
Given the demographic constraints referred to above, growth must come through capital deepening or through raising multifactor productivity. Multifactor productivity, in turn, has at times been dubbed ‘manna from heaven’ since we don’t quite know how to secure it. Increasing R&D may be a necessary condition for greater MFP, but it is not a sufficient one. Indeed, securing MFP appears an increasingly difficult task as transformative technological breakthroughs are difficult to find. Look at the table below from the Federal Reserve Board of Chicago’s Chicago Fed Letter (here) titled “Where Has All the Productivity Growth Gone” (click for larger image):
As can be seen from the table, there has been a marked slowdown in multifactor productivity growth in the 2000s compared with the 1990s. Moreover, the slowdown was taking place before the Great Recession. In fact, it was taking place even as the global economy experienced a stupendous financial bubble under which anyone with a vaguely sane investment story could have obtained funding (and in the case of NINJA loans—no income, no job and no assets—even sanity was not a prerequisite).
Moreover, Japan’s MFP record has been broadly in line with its advanced-country counterparts as can be seen from 1995-2010 OECD chart below taken from the Compendium of Productivity Indicators I referenced earlier in the post (click for larger image). Again, it is demographics, through the channel of labour inputs, that have made the country a growth laggard (click for larger image).
If we take out labour input growth and MFP growth, then what we are left with is capital growth. However, we can also see from these charts that Japan’s capital deepening record is in the middle of the pack over the 1995-2010 period, especially if we focus on information and communications technology (ICT) capital. Note that with regard to non-ICT capital (traditional plant and equipment) those countries with a much better productivity record are either a) at an earlier stage of development than Japan or b) were experiencing a resources led boom (countries such as Canada and Australia).
We can now bring all these statistics together to create a methodology for measuring the likelihood of success of Abenomics. In particular, we can see list some stylised facts about Japan’s falling growth rate.
First, by far the greatest factor behind the fall in Japan’s growth rate is due to a reduction in labour inputs. Most of this, in turn, is because of the country’s ageing demographics, although a smaller part can be attributed to a choice by society to increase its welfare by reducing annual working hours. Second, multifactor productivity growth has declined; that is, growth stemming from innovation and efficiency gains has been harder to come by, a trend seen across all advanced economies not just Japan. Third, Japan’s growth stemming from capital deepening has been broadly in line with the OECD average, particularly in respect of information and communications technology (ICT). None ICT capital deepening has been meagre, but this is constituent with Japan’s level of development and comparative advantage.
So will Shinzo Abe’s three arrow policy of unconventional monetary policy, fiscal stimulus and structural reform make a difference? Critically, to do so, it must operate through one or more of the growth avenues delineated above—there aren’t any others.
Let’s take monetary policy as an example. The incoming Bank of Japan governor Haruhiko Kuroda has a) targeted a massive expansion of the monetary base, b) pledged to purchase bonds with longer durations, c) promised to expand the purchase of more risky assets such as real estate investment trusts (REITs) and d) vowed to raise inflation expectations of the Japanese general public. These are all intermediate goals. None of them in and of themselves raises growth, let alone human welfare. So the key question to be asked is how any of these actions will a) raise labour inputs, b) increase capital inputs or c) lift multifactor productivity (technological innovation). I will return to this question in my next post.
Risk and Well-Being 