Saturday, November 03, 2012

How not to criticize Japan

I will be the first to tell you that Japan has serious problems. Chief among these, in my estimation, are A) a dysfunctional labor market, B) institutional support for unproductive companies and company divisions, C) poor corporate governance, D) a dysfunctional political system, E) underemployment of women, and F) the large national debt. Obviously these tend to reinforce each other, leading to a bad equilibrium.

But the way to untie this Gordion Knot is not to simply start wringing our hands and flailing about in every direction, blaming any trend or story upon which we happen to lay our eyes. Unfortunately, this approach to Japan analysis is relatively common in the Western business press. For example, consider this article in MarketWatch. "Once a powerhouse, [Japan is] withdrawing from the world stage," the subheading laments. Here are some excerpts:

“That’s about right,” [a friend living in Tokyo] said, “battered by deflation and a overly strong currency, the Japanese have concluded that they can’t compete with a rising China and are withdrawing into themselves.”... 
Japan’s 27-year long dominance in machine-tool production came to an end two years ago. China, where production costs are 40% lower, has seized the top spot even though the Japanese emphasize that they continue to lead in quality. 
Pummeled by a strong currency and two decades of deflation, Japanese companies are shifting production to China and elsewhere. Japan’s industrial core is eroding and threatened with being hollowed out... 
What went wrong? How did a nation with world-class companies, a highly educated work force, and a well-deserved reputation for efficiency and discipline descend into protracted decline? 
Since Japan’s asset bubbles burst over 20 years ago, policy makers have persistently fiddled with the levers of monetary and fiscal policy but their efforts have spectacularly failed... 
Meanwhile, the exchange rate of the yen, regarded as a reflection of the nation’s economic health, has steadily appreciated from the 227 to the dollar that prevailed in 1983 to a mere 78 yen today...At any rate, the currency’s rise has done little to reduce Japan’s chronic balance of payments surplus... 
Meanwhile, the brutal deflation that accompanied the bust persists. Falling prices have translated into massive wealth destruction... 
Japanese officials counter that they’ve tried monetary stimulus, including zero interest rates and quantitative easing, but had meager results... 
The most troubling aspect of Japan’s malaise may be psychological...Japan seems to have its lost its self-confidence along with its drive for economic leadership.
A few points.

1. Why do people think Japan ought to "compete" with China? Just because they are both East Asian countries? Why does the growth of China's economy threaten the health of Japan's economy?

And what does "compete" even mean in this case? Does it mean - as the author hints when he talks about machine-tool manufacturing market share - that Japan ought to try to make sure its companies hold dominant global market share positions over China in every conceivable industry? That would go directly against the strategy advocated by Michael Porter, Hirotaka Takeuchi, and Mariko Sakakibara in their book Can Japan Compete?, in which they identify lack of specialization and blind pursuit of market share as flaws in the Japanese corporate model.

2. Machine tools? Why machine tools? Is a country's economy on the wrong track if it doesn't have the #1 global market share in machine tool manufacturing? Can there only be one successful economy in the world at a given time, defined by who is manufacturing the most machine tools? If so, the U.S. and Germany and Canada and Singapore are all out of luck.

Or is it just because Japan used to be the #1 machine tool manufacturer? Does loss of marketshare leadership in one industry indicate general economic decline? Should be worried that Japan is no longer the world's leading manufacturer of paper doilies?

I just don't get it.

3. Why is a "strong" yen bad? OK, it hurts exporters. But it helps importers and consumers. Don't we always hear people saying that a "strong dollar" is an indicator of America's economic strength? Why should Japan be exactly the opposite?

(Note: although this author cites a study claiming that the yen is overvalued, most studies say that it is fairly valued.)

And if Japan's balance-of-payments surplus is a problem, why should the yen weaken? That makes no sense, since a weaker yen would tend to increase the balance-of-payments surplus.

4. Monetary policy did nothing? Well, maybe. But from where I'm sitting, it sure looks as if Japan's quantitative easing in the early 2000s was quickly followed by a burst of good economic performance (the "Koizumi boom" in 2004-7). Now, correlation does not equal causation, but to conclude that monetary policy is ineffective seems a bit ridiculous to me, especially when sustained low real interest rates will be necessary to erode Japan's mountain of debt.

5. Deflation causes wealth destruction? Well, maybe it does, by restricting economic activity. But I don't think that's what this author is talking about. I think what he's doing is identifying consumer price deflation with asset price deflation. In fact, the two are completely different things. The U.S. experienced low inflation in the 1990s, but asset prices soared. Deflation may cause wealth destruction via macroeconomic effects, but it does not equate to wealth destruction.

6. And now we get to the part at the end when the author finally answers his own question of "What went wrong?". "The most troubling aspect of Japan’s malaise," he declares, "may be psychological."

That would play well in a 1980-vintage Ronald Reagan stump speech. But how the heck does this author (who lives in Washington and works for a Hong Kong newspaper, by the way) have any idea that this is the case? How does he know that Japan's psychological pessimism is a cause of poor economic performance rather than an effect? I'd be pretty bummed if my economy was stagnating! (Actually, that is not exactly an "if" at this point.)

The idea of persistent psychological malaise - a lack of "animal spirits" - is an old one, and a tempting one. Wouldn't it be neat if macroeconomics were all about national will? If all we had to do to bring back robust growth was to turn that frown upside down, chin in, chest out, nose to the grindstone, when the goin' gets tough the tough get goin', get busy livin' or get busy dyin'? Maybe if Japan had a Ronald Reagan to stand in front of a flag and tell them that everything was going to be OK, then their dysfunctional labor markets, corporate governance, and politics would vanish like so much smoke on the breeze?

OK, obviously I kid. But explaining Japan's problems in terms of the "national mood" doesn't seem very helpful to me. (And in fact, some of my own research indicates that happiness probably doesn't exert much of a pull on the economy at all!)

Basically, writers like this analyst are speaking to a very particular audience: foreign investors looking for a simple story to tell them whether to pull their money out of Japan. The dominant narrative coming out of Japan is one of general doom and gloom, and people like to read things that reinforce the dominant narrative, because people like to feel sure about things. So articles like this thrive because they pick out random facts - machine-tool market share! - and buzzwords - psychological malaise! - that seem to support the narrative. The problem is, this sort of reporting doesn't help anyone think carefully about what Japan's problems really are, or how to fix them. All this hand-wringing does is to encourage the very malaise that it decries.

Not that I think that articles like this are taken seriously by members of the policymaking elite, of course. But they still annoy me.


  1. Anonymous8:38 PM

    "Maybe if Japan had a Ronald Reagan to stand in front of a flag and tell them that everything was going to be OK, then their dysfunctional labor markets, corporate governance, and politics would vanish like so much smoke on the breeze?"

    You laugh, but my guess is this is going to happen. I live in Tokyo. If Ishihara and Hashimoto really pair up and wind up getting elected, you don't think this is what they'll do? Problem is this it will also end up ruffling more feathers abroad. However, it feels recently that Japan is pulling more to the right.

    I work in a Fortune 500 company with lots of well educated people--a lot of Todai types. I'm surprised how many are in denial that there are any fundamental problems at all. I've been told life isn't that bad (and that may be true) and that Western economics have a tendency to exaggerate the bad in everything for their own game.

  2. I envy business journalists. Their job is so easy--find something that happened in the financial markets, find something else that happened somewhere in the world, then vigorously assert that the latter caused the former. Economists waste so much time tinkering with regressions and worrying about logical consistency...

  3. Noah asks, Why does the growth of China's economy threaten the health of Japan's economy?

    Noah, business is winner take all. It is first place or the highway. There is no such thing as comparative advantage (due to location economics) or coming in second, for second means you didn't make the sale.

    You need to watch glengarry glen ross

    1. I really hope you're just trolling! But just in case you aren't...

      First, read this:

      After that:
      If China starts manufacturing stuff domestically that Japan used to make, Japanese exports to China drop, the Japanese currency declines in value, and Japan becomes more competitive vis a vis China and stuff where China was marginally cheaper than Japan to make stuff in suddenly moves from China to Japan. (That's if China and Japan are the only two countries on Earth. If you add more countries, you can have a slightly more contorted version of that effect, but it all works out the same way.)

    2. (1) Nation-states do not compete for absolute but instead for relative wealth.

      This is due in part to human psychology. The famous example: If my neighbor builds a mansion, my modest house becomes an intolerable hut. And what goes for me goes for the sovereign.

      Psychology aside, sovereigns compete not just economically but also militarily, and in that military competition, the winner takes all. Because the manufacturing sovereign is the militarily more powerful one, as manufacturing moves from Japan to China, Japan faces a growing risk of losing everything.

      (2) Much human behavior is not rational, not even intendedly so. Instead of looking to the future, it looks to the past. The Chinese remember Manchuria; at the first opportunity, they will even the score. The Japanese know this and they're rationally terrified of China's manufacturing-military rise.

    3. Jeffrey and Jan,

      I am very familiar with the false theory of comparative advantage and the theory is wrong.

      My POV is location economics, not macro.

      Location economics teaches us that people and firms move to the action and that the force is stronger than comparative advantage.

      This is why cities form, etc. Look at the US. All our new wealth is being created in a few select cities/regions, which have no comparative advantage but do have all the forces of location economics going for them.

      Subject to its political institutions, China is where the action is taking place. More and more people and firms are moving to China and will continue to do such. The same forces explain all the problems in Europe, where all the action has moved to Germany.

      From the tone of your response it is clear that you wouldn't listen so I am not going to say more, but the principle is really simple: location economics plus the fact that in business is is winner takes all means that Japan and the US are screwed, subject to China's political problems.

    4. JohnR9:52 AM

      I love the image this creates - hordes of lemming-like industrialists unpegging their tents, leaping astride their camels, and vanishing over the horizon in a cloud of dust obscuring a jostling, screaming mob after a newspaper blows into the camp with a 40-point headline that "China is the New Japan!". For lack of a better term, perhaps Alex could be the proponent of a new "Warner Brothers" school of economics. Or, perhaps I am simply entranced by the apparently cartoonish version of economic theory that he presents, and hobbled by my own sketchy understanding of the field.

    5. Alex could you post some links which would shed some more light on location economics and that it trumps the comparative advantage? it's something i'm interested in, but i barely scratched location econ in uni

  4. Anonymous1:26 AM

    Hi Noah. I would be really interested in learning more about the 6 main problems you list regarding Japan's economic performance. Can you write posts about them, or can you direct me to various articles/analyses which discuss them? Thanks.

    1. Anonymous2:46 AM

      I second this request

    2. Yeah, I'll eventually write a big post about this. Or maybe an Atlantic column.

  5. Anonymous3:34 AM

    Surely also G) a demographic time-bomb of epic proportions?

  6. All your machine tools are belong to us.

  7. Ben Johannson8:25 PM

    Japan's GDP growth corresponds better with a rapid increase in budget deficits than it does with the stockpiling of excess bank reserves due to quantitative easing. The program simply does not increase banks' capacity for making loans as banks are not reserve constrained, nor was there any acceleration of credit expansion during that period. The reality ia effecta of monetary policy are poorly understood and evidence for its ability to stimulate aggregate demand is less than convincing. For example it is rarely taken into consideration that QE reduces interest income to households and firms that choose to save.

  8. Anonymous3:24 AM

    Interestingly, at the same time this was written, the always fascinating SpikeJapan blog pointed out that one problem in Japan may be too much optimism:

    (this blog is always very wordy, but very worthwhile too for an insight into the 'hidden' Japan).

    The notion of Japan having had a fatal loss of confidence goes back at least to the early 1990's and the Kobe Earthquake and the Sarin attacks in the underground (Haruki Murakami has written some very interesting essays on the topic in 'Underground' and elsewhere. But of course its very difficult to see if this results in a measurable economic impact.

    I'm curious though about Noah's comments on womens work participation. I don't think its a simple as low female participation rates - many demographers would say its too high, there is little doubt that Japan's intense work ethic along with inflexible work practices and a lack of public childcare provision is a prime cause of the staggeringly low birth rate which is a huge potential problem for the country.

  9. I've seen two versions of the famous "If .., then.." statement - the first goes "If you can't convince them with facts, ..", and the second and more familiar goes "If you can't dazzle them with brilliance,.." Either way, the end result seems to be what the cited article is aiming for. Does the composer of that opus also moonlight as a political pundit? It shows many of the traditional signs. Lots of "He said .. She said"; lots of "everyone knows" claims; some numbers and 'facts' presented, but with little or no attempt to link anything beyond a faith-based set of assertions. Well, maybe the original column was dense with strong arguments, and elegantly erudite, yet clear and concise, but has been eviscerated by a team of monkeys at typewriters masquerading as an editorial staff. Stranger things have happened. Look at this past year's Presidential campaigning.

  10. Bill Ellis1:18 PM

    When examining "How not to criticize Japan" I can't believe Noah left out an examination of the "Asian Hive Mind" !
    Can you really understand anything about Japan without taking the Asian hive mind into account ? *

    I mean, some economist think the Asian Hive Mind it is a really big deal... a key to understanding Asia... and that there is nothing racist about it at all.

    *100% snark ... please forgive me.

  11. Anonymous1:30 AM

    Ok now you're deleting comments. Yet again, not cool. #freespeechsavesdemocracy

    1. Anonymous1:31 AM

      You just lost a big fan.

    2. Who, me?

      I haven't deleted any comments in months. It must be your browser.