13 December 2018
Japanese firms have seen their productivity growth wane in recent years, mirroring the nation's economic woes. Photo: Reuters
Japanese firms have seen their productivity growth wane in recent years, mirroring the nation's economic woes. Photo: Reuters

Japan’s lost years: The supply-demand debate

Japan has been suffering sluggish economic growth for over 25 years. The island nation enjoyed scorching expansion for several decades until the 1990s, when bubbles burst in the real estate and stock markets.

As banks had to deal with a huge amount of bad loans, a financial crisis broke out in the country in 1997 and 1998. Although the lenders managed to “stand up” in 2005, they took a hit again due to the 2008 global financial crisis.

In previous articles, I attributed Japan’s long-term suffering to a constantly shrinking labor market. But there are also other reasons.

The business community and academics in Japan have two different explanations for the nation’s pain. Some say it’s due to weak aggregate demand, while others believe low aggregate supply is to blame.

The “demand” side believes that deflation in Japan reflects the outcome of insufficient demand, while the “supply” side believes it is the low growth of productivity that drags down the supply.

Now, why has the productivity barely increased?

Firstly, corporates invested less on research and development (R&D), hampering innovation efforts.

Secondly, there’s a shift in corporates’ collaboration model.

Traditionally, large consortia have led industry development in Japan, while numerous small and medium-sized vendors follow through with their long-established partnerships.

But in recent times, as more Japanese firms moved their production overseas, their bonds with the big consortia have weakened. As a result, productivity growth has slowed.

Thirdly, the allocation of resources is not economically efficient.

The best example is Japan’s labor market, in which the seniority-based wage system (nenkō joretsu) had gone hand in hand with lifetime employment. Such arrangement is outdated.

In my opinion, the root cause of Japan’s lost years is weak demand and high deposit ratio (which means low consumption). But I do agree that lack of supply also matters.

In the case of companies’ investments, less input on R&D resources will lead to slower aggregated supply growth. And it also means less investment activities and decrease in aggregated demand.

If there’s no sufficient demand, corporates will be more passive about the market outlook and be unwilling to devote more resources on R&D, which in turn will lead to slow growth in aggregated supply.

This article appeared in the Hong Kong Economic Journal on April 26.

Translation by Myssie You

[Chinese version 中文版]

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Professor, Department of Economics, HKUST Business School; former senior research economist and advisor, Federal Reserve Bank of Dallas

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