ＮＳＡＭ RESEARCH REPORT 10-2E
Aug. 2010
Understanding Japan’s Economic Stagnation
- Beyond Two Lost Decades David Moss
Harvard Business School
At NSAM Reunion (July 28, 2010)
ｃ David A. Moss
○
Nomura School of Advanced Management (NSAM) is a public interest incorporated foundation established by Nomura Research Institute, Ltd., and Nomura Securities Co. Ltd in 1980 to contribute to business community by offering high-quality
open education programs for Japanese executives in cooperation with top-ranked business schools here and abroad.
This report is the transcript of a remark made by Professor David Moss at NSAM Reunion on July 28th, 2010 . It is made
available at the NSAM website (http://www.nsam.or.jp) as a part of the foundation’s mission.
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Understanding Japan’s Economic Stagnation
－Beyond Two Lost Decades－
David Moss
Harvard Business School
Remark at NSAM Reunion – July 28, 2010
I.
Introduction
Thank you Imai-san for that kind introduction. It’s a great pleasure to be here
today, with so many distinguished alumni of the Nomura School of Advanced
Management.
I started teaching at the Nomura School in 1998, and quite a bit has happened in
the world since then: The collapse of tech bubble. The terrorist attacks on
September 11th. Several wars in the Middle East. The global financial crisis.
Clearly, a great deal has changed.
But one thing that has not changed, at least not much, is Japan’s GDP per
capita. Real GDP per capita – probably the best single measure of standard of
living – has grown by well under 1 percent per year in Japan (actually, 0.73%/
year) since 1998. And, in fact, about the same is true (0.78%/yr) since 1990! In
fact, if you look in nominal terms (not correcting for inflation or deflation),
GDP per capita is actually lower now than it was in 1998 (negative 0.46%/year)
and only marginally higher than in 1990 (0.26%/year). So in economic terms –
in terms of both aggregate output and aggregate income per person – Japan has
barely grown at all over the past 20 years.
My goal today is to offer some possible explanations for this unfortunate
economic performance. Let me be clear: I am not a scholar of Japan or the
Japanese economy. I am an economic and policy historian, mainly of the
United States. But I’ve thought a lot about Japan and its economy, particularly
since I started teaching here, twelve years ago. And so I wanted to share a few
thoughts, and I am also looking forward to hearing your thoughts and getting
your input.
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Certainly, it’s hard to think of any more important topic for business leaders
here in Japan. So, if you’ll permit me, I’ll lecture for about 45 minutes (with
translation into Japanese) and then open the floor for discussion.
II.
The Demand Side: Keynes, Coordination, and Stimulus
When we think of poor macroeconomic performance, it’s common to focus on
weakness on the demand side of the economy. In fact, shortfalls in demand are
the most common causes of economic recessions and slowdowns.
The great economist John Maynard Keynes taught us that for an economy to
grow, we all need to stay positive and believe it will continue growing. If a
substantial part of the population believes, whether rightly or wrongly, that the
future is bleak, then they will begin to hold back on consumption and
investment. The rest of us will then observe their pessimism and decide we’d
better scale back also; and pretty soon the whole economy is contracting. This
is a classic Keynesian (demand-side) downturn. It’s not that the productive
capacity isn’t there. There’s still plenty of plant and equipment and qualified
labor. It’s just that no one wants (or demands) all of the potential supply,
because of pessimism. It’s a coordination problem.
Now, to fix this giant coordination problem – where everyone has coordinated
their expectations in a negative direction rather than a positive one – someone
has to show some confidence. Keynes believed it had to be the government,
that the government had to send a signal that things would improve. He
suggested that monetary policy (low interest rates) could send a fine signal in
times of moderate trouble, but that expansionary fiscal policy (deficit spending)
was the best signal in times of severe trouble.
The critical thing to remember is that Keynes viewed expansionary fiscal policy
(deficit spending) as a positive signal – a signal of future demand that would
get all of us to start thinking positive and to begin coordinating upward, rather
than downward. The key, of course, is that the signal has to be believable, and
credible. People have to believe that new government spending will translate
into more demand and a brighter future.
In the case of Japan, it seems clear that a shortfall in demand contributed to the
country’s slow growth over these past two decades – a shortfall that was
initially triggered by the bursting of the asset bubble around 1989 and the weak
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condition of the banks that followed.
Three standard measures of inadequate demand – high unemployment, low
capacity utilization, and falling prices (deflation) – all presented themselves
over this post-bubble period. Since 1990, for example, monthly unemployment
averaged 4.0% in Japan (as compared to 2.4% from 1978-1990). Similarly,
manufacturing capacity utilization averaged less since 1990 than before 1990.
And the most comprehensive price index, the GDP deflator, has been
consistently falling in Japan since 1998 – a sharp departure from consistently
rising prices before 1990.
There is also no question that macro policy responses – both fiscal and
monetary – were far from ideal in Japan over the past two decades. Many
critics insist that Japanese policymakers were slow to react after the bubble
burst. And it’s common to blame policymakers for tightening too early – in
particular, raising taxes (including the consumption tax) and cutting spending in
1997, just as a new round of financial failures was underway.
At the broadest level, expansionary fiscal and monetary policy probably helped
fend off a sharp contraction, which might otherwise have occurred. But it does
not appear that policymakers ever truly got ahead of the problem, particularly in
the early years.
What’s worse, policymakers have been employing
expansionary fiscal policy for so long that it seems to have lost its punch – it is
no longer the credible signal of future expansion that Keynes hoped it would be,
at least not in Japan. Meanwhile, public debt in Japan climbed and climbed,
with gross public debt now at about 200% of GDP.
Thus, demand management on the part of policymakers – through fiscal and
monetary policy – has been far from ideal. There’s little question about this.
But even so, it’s hard for me to see 20 years of slow growth as fundamentally –
or exclusively – a demand side issue. Weak demand is undoubtedly part of the
problem, stemming in particular from wounded banks that are reluctant to lend,
pessimistic households and firms, and poorly executed macro management
policies on the part of government officials. That said, it’s impossible for me to
believe that problems on the demand side are the whole story.
Given the length of the slowdown and the high level of fiscal and monetary
stimulation over the vast bulk of the period, it seems clear that something else is
going on. And that brings us to the supply side of the economy.
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III.
The Supply Side: Frozen Productive Capacity?
Although demand can certainly fall short in an economy, so too can supply.
And by supply, I mean productive capacity.
In the extreme, imagine a terrible earthquake that destroyed a large proportion
of the country’s buildings and capital equipment; or a terrible epidemic that
weakened (or even killed) a large part of the workforce. In either of these
horrific scenarios, the nation’s productive capacity would obviously drop
sharply. And GDP would fall, as a result of the collapse in supply.
Fortunately, Japan’s economic troubles are not the result of a natural disaster or
the spread of disease. But some observers claim that Japan is nonetheless
suffering from problems on the supply side – that is, from an inability to grow
productive capacity.
Some claim, for example, that Japan has been slow to adopt new technologies,
and that this has compromised overall economic growth. Others (including me)
have highlighted problems in the financial sector, which may have undermined
the efficient allocation of capital across the economy. If capital is allocated
poorly, this will obviously undercut productive capacity – it will undercut
supply. I’ll return to this problem later in the talk. But suffice it to say that
proper use of technology and financial capital are critical for any economy.
And weaknesses in both of these areas have been significant problems in Japan.
Still, in my view, that’s probably not the heart of the matter. Technology and
financial capital are important. But far more important is human capital.
People. People are at the root of all productive capacity.
As a result, as I see it, there is no way to talk about Japan’s economic problems
without talking first and foremost about the nation’s workforce and how it is
utilized. We need to focus on human capital.
IV.
The Heart of the Supply Side: Human Capital
Demographic Challenges
Of course, some of the issues relating to human capital are well known. Take
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Japan’s rather considerable demographic challenges, for example. Although
Japan isn’t suffering from an epidemic, its labor force is declining, almost as if
it were. In fact, the nation’s labor force peaked in 1998, at 67.9 million, and has
basically been declining ever since. That obviously creates a problem for
productive capacity. You can’t produce without workers. And, as you know,
the problem is only going to get worse as the population continues to age. So
that’s one element of Japan’s human capital problem, the demographic piece.
Misallocation of Human Capital
A second element has to do with the allocation of labor – allocation across jobs
and industrial sectors. One important way to increase supply – to increase
productive capacity – is to shift resources (and particularly to shift labor)
toward higher productivity firms and sectors. In theory, this should happen via
the price mechanism. Higher productivity areas should pay higher wages and
attract more workers. However, it’s possible that in Japan, various labor market
rigidities (which you know all too well) end up restricting the flow of labor, and
therefore impede the shift from lower to higher productivity firms and sectors.
The point is that it’s not just how many people are in the labor force that
matters, but also how labor is positioned – and how efficiently it’s positioned –
in the economy.
Underutilization of Women in the Workforce
Beyond that, as you well know, there is also a dramatic – even scandalous –
underutilization of female workers in the Japanese economy. Although this is
probably not a cause of the slowdown in growth (since it is a problem that has
been there for a very long time), it does represent an important source of
economic weakness and, at the same time, an opportunity for creating new
productive capacity and reviving growth in the future. Certainly, if the gender
breakdown at this reunion is any indication, the representation of women in
senior management at major Japanese firms is virtually nil. And this is
indicative of a profound problem of human resource utilization – and inclusion
– throughout the Japanese economy.
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I realize, of course, that fixing this problem – that is, reaching toward gender
balance in Japanese business – will require a substantial culture shift, in
addition to very significant changes in business practice. But surely it will be
worth it, bringing to bear an extraordinary pool of talent – an extraordinary pool
of human capital.
Misallocation of Human Capital in the Financial Sector
By the way, this human capital lens is useful for understanding not only
weaknesses at the aggregate level, but also within a specific sector. Take
Japan’s financial sector, for example, particularly its banks. In my view, the
problem at Japan’s big banks starting in the 1980s stemmed in large part from
having the wrong people – the wrong talent – in several key places.
Through the “miracle years” after WWII, the big banks took a good deal of
direction from MITI and the MOF in allocating credit, and therefore didn’t need
sophisticated and highly skilled credit assessment and risk assessment
operations. Much of the talent for these tasks, if you will, was sitting at the
government ministries. However, once the government planners began to
recede starting in the late 1970s, and core capital-allocation decisions were left
increasingly to the banks themselves, the banks did not always allocate capital
well because their risk assessment capabilities were underdeveloped.
And this helps to explain why so many terrible loans were made and why the
aggregate return on investment ended up being so incredibly low. Again, it was
– fundamentally – a human capital problem that accounts for the misallocation
of national savings, via the banks.
Harnessing the Creativity of the Young
Now, before concluding, let me suggest one final problem – again connected
with human capital. This one is based mainly on my own observation and
reasoning. It’s not a common or widely held explanation, as far as I know. I
haven’t heard it espoused before. That said, I want to take some time to walk
through it, because I think it could be one of the most important factors – and
perhaps the most important factor – in explaining Japan’s two decades of
economic stagnation.
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So what is this mystery problem? It has to do with the way creativity is
harnessed in the Japanese corporation. Now, as I’m sure you know, one of the
stereotypes of Japan in America (and elsewhere in the world) is that the
Japanese people lack creativity – that Japanese are very good at incremental
improvement but not very good at original, creative work.
Let me first be absolutely clear that I disagree with this characterization. It’s
not what I’ve seen at all. Japan is full of creativity – from the arts to animation.
In fact, all you have to do is walk outside in Tokyo – particularly at night – to
see an incredible display of creativity and individuality in the nation’s young
people.
I like to call this the purple hair factor. When people tell me that Japanese kids
lack creativity and are all conformists, I tell them to go to Tokyo and count the
number of kids with red or purple hair.
And it’s not just the hair. Japanese young people are not only very well
educated (scoring near the top in many international tests), but are also full of
creativity. They’re incredibly original. At least, that’s been my experience
based on my informal interviews, if you will, with young people here in Tokyo
over the past few years.
In my view, the problem isn’t the kids. It’s the corporation! As soon as these
kids are old enough to work, it seems that the hair gets cut and the red or purple
dye somehow goes away. In fact, their creativity and originality and
individuality are somehow muted – even suppressed – within the walls of the
Japanese corporation.
Now, I realize I’m exaggerating here. I’m presenting a caricature. But it is
nevertheless broadly consistent with what I’ve seen, heard, and learned here in
Japan.
Once upon a time, this may not have been a problem. It may have been a
strength. When heavy industrialization was the name of the game, a focus on
core products with continuous, incremental improvement may have worked
great. And Japanese firms, so skilled in these areas, came to be admired around
the world.
But more recently, in an information economy, where change is much more
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rapid and discontinuous – where disruptive innovation is king – it’s not clear
that the rigid hierarchical culture of the Japanese corporation is optimal
anymore.
What I’m saying is that the creativity needed to compete in the information age
is here – it’s here in the nation’s young people – but that it’s not being fully or
appropriately absorbed and utilized in the Japanese corporation. In fact, of all
the problems I’ve mentioned, this could well be the most fundamental of all –
the biggest drag on the growth of productive capacity in Japan.
Entirely consistent with this, when the Nomura School asked its alumni in a
recent survey, “What is the most important issue for future growth of your
company?,” the response that tied for first (being named by over half of
respondents) was “human resource development.”
The simple point is that at the end of the day, production and growth are all
about people – how they work, how they manage, how they innovate, how they
create. And if the Japanese corporation is systematically muting or squashing
creativity, particularly among younger workers, then that’s a very serious
problem indeed.
V.
Conclusion
Okay, so that’s my summary of the most important impediments to growth in
Japan, both on the demand side and the supply side. Clearly, there is a broad
range of problems and challenges, including several that might be characterized
as policy mistakes.
But, in the final analysis, I wonder if the main reform or change that’s needed is
inside the Japanese corporation itself, and that much of what needs to be done
rests with you and other senior managers.
Now, you might be surprised to find that I have a somewhat similar diagnosis of
what’s gone wrong in the United States. I think it’s a problem that such a large
proportion of America’s young talent – coming out of all of the top universities,
including Harvard – is going into the financial sector. This unprecedented
diversion of talent is, in my view, starving the rest of the economy of vital
human capital.
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So, I’m not just coming to Japan and simply saying that you should be more
like the United States. That’s not my point. On the contrary, I believe that in
different ways, both countries are suffering from a similar problem: they’re
wasting an enormous amount of talent.
But since we’re in Japan, I’ve focused on the Japanese challenge. I hope
you’ve found it useful, or at least provocative.
How about if we now open this up for questions and comments? What, in your
view, are the biggest reasons for Japan’s slow growth over the past two
decades? Is the problem, as you see it, more on the demand side or the supply
side? And if it’s the supply side, do you agree that the Japanese corporation
itself is part of the problem? Do you agree with my focus on human capital?
What exactly should be done?
Of course, I’d be glad to try to answer any questions you might have. But I’d
be particularly interested in hearing your comments and insights about Japan’s
two lost decades … and what needs to be done to revive economic growth here
in Japan. So let’s now open the floor for discussion.
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