The Myth about Japan’s Lacking Productivity Growth
Many pundits claim that the core of Japan’s economic malaise is low productivity. However, their view is compromised by the so-called “money illusion”. Data such as long-run real GDP growth per capita or per working age population show that Japan has been doing quite well in terms of productivity. A similar logic also applies to discussions of Japan’s corporate profits and profitability. When we make international comparisons, we must heed the fact that differences in inflation and deflation greatly affect these data.
Tokyo Station / Nihonbashi side construction projects, January 2020
Now that the reign of the longest-serving, post WW-II prime minister of Japan, Shinzo Abe, has come to an end, many observers, analysts and scholars have entered the race of assessing his legacy. Even as political scientists are now shifting to what the new Suga Administration may bring, economists are still concerned with how well “Abenomics” has really fared, and how we should evaluate the many economic policy measures the Abe program contained. And many of these economists draw one conclusion that strikes me as less than an objective evaluation. It is not a new claim, but it has been repeated so often that it now sounds like the truth. As this blog’s title says, it is about productivity. For years on end, many economists have claimed that Abenomics has failed because it has not brought any productivity gains. It is important that we straighten up the facts underlying this claim.
Why so many different assessments of Abe’s economic policies?
A first tell-tale sign that something is amiss is that evaluations of Prime Minister Abe’s domestic policies are so highly variegated. In contrast to, say, mostly positive evaluations of foreign policy, assessments of economic policies range from very positive to completely negative, including by well-trained economists who pay careful attention to Japan (example 1; example 2).
Why might that be the case? Whose analysis should we trust? To be sure, everyone has their own viewpoints and methods of assessing economic gains, so naturally at one level we should expect some variation. But in this case, to see economists so divided in their findings strikes me as a moment that critically involves an issue of "factfulness." That is, some people might carry such a strong, preconceived notion of Japan as a low-performing economy that they just can't see the facts any longer.
Of course, we all know that Japan's GDP has not been growing much for years, and that Japan endured the so-called "lost decade" (or even two), until Abenomics arrived in late 2012. Those who give Abenomics a favorable assessment place a lot of weight on Abe's efforts to boost economic activities by the "three arrows" macro policies. Those policies surely brought more steam to the domestic economic engine than any recent prior government was able to produce. And yet, the steady economy as a result of Abenomics — with the lowest unemployment rate in some 30 years, for instance still has some observers conclude that it "failed to deliver." In that view, what exactly did Abe fail to deliver?
For them, the answer is "productivity." In economics, this word refers to the ratio between the output volume and the volume of inputs. Thus, it measures how efficiently production inputs, such as labor and capital, are being used in an economy to produce a given level of output. In those pundits’ minds, what truly ails the Japanese economy is that given what Japan has – people, assets, etc. –, it is nearly producing enough. They look at macroeconomic data and see no growth, no increases in GDP. And unless they find evidence of visible growth, they will not budge in their negative assessment that Japan’s economy is going nowhere.
But regardless of how often this general image of Japan's productivity is repeated, it simply does not reflect the reality. It is not the truth.
Sleeping storekeeper, Kunitachi, Tokyo 2019
Wrong Evidence: The Money Illusion 貨幣錯覚（kahei sakkaku）
In fact, one must wonder whether the economists that make these claims have ever confirmed Japan's productivity data, or whether they are just repeating a lore. Have they ever looked how, in relative terms, Japan compares with other G7 countries? And note that this is not just foreign observers. Interestingly enough, it appears that a common source of this misconception actually comes from within Japan itself!
For example, on December 19, 2019, the Japan Times cited a report by the Japan Productivity Center, saying that “Japan's labor productivity still lowest among G7 members in 2018.” The article stressed that "Japan has remained the least productive G7 member since 1970, from when survey records are available. Of the OECD’s 36 members, Japan ranked 21st in 2018." While the Japan Productivity Center does very important work, in this instance their research is seriously misleading.
In the same 2019 Japan Times article, it is stated that "The 2018 productivity figure for Japan rose 1.5 percent from the previous year in nominal terms." Indeed, all this talk about productivity is nominal terms. And that means, it is subject to the money illusion! In this case, the analysts looked at the output value per hour of labor by using the so-called PPP (purchasing power parity)-adjustment. This is an attempt to turn the productivity figures into an “apples-to-apples” comparison across countries, which is perfectly fine. However, it still leaves the numbers in nominal terms. While this compares the average hourly output across countries, if we want to assess the true value creation, we need to look at the numbers in real terms. This is because a measurement of true productivity cannot be based on nominal monetary values, which are influenced by prices. In other words, if we measure productivity in nominal terms, the growth rate of productivity changes as the price of output changes. However, the price is irrelevant to the efficiency of production activities. Therefore, this is inappropriate.
Despite this basic principle, analyses of the Japanese economy often appear confused, or even compromised, by the money illusion. This refers to our tendency to ignore the effects of inflation, and think of currency in nominal, rather than real terms. This is not that big a deal in international comparisons as long as the countries we are comparing have roughly similar inflation characteristics. However, as any Japan observer knows, this does not apply to Japan. After 20 years of deflation, Japan is a huge global outlier now.
The Consumer Price Index (CPI) for the U.S., Germany and Japan, 1999-2019
constructed by author from OECD data
To make this point graphically, the chart above compares the CPI inflation in Japan, Germany, and the U.S., with setting the year 1999 as 100. Over these past two decades, the US CPI inflation was 2.2% per annum (or 53.5% in total). Germany recoded the second lowest average rate of inflation among G20 countries, at about 1.5% per annum (35.6% in total). The only OECD country with a lower inflation rate than Germany was Japan – and with a huge differential at 0.1% per annum, or just 2.1% in total.
Japan really stands out uniquely among major countries. Inflation of course has many far-reaching implications for an economy, but so does deflation. And if you want to compare the economic activities of two or more countries, you must consider this difference. Still, even the pundits seem to keep forgetting about the money illusion for Japan.
The Reality of Japan's Productivity
So, what are the facts? First, let’s consider real GDP per capita growth, which is a reasonable reference point for productivity growth. Granted, the constraint is that this measures growth, not the level. However, the long-run growth rate offers a good indication on how the country has done for its productivity. The table below presents my own calculations of the change in real GDP per capita for G7 countries, for four different periods, based on IMF data (with the respective end-period being all 2019).
Real GDP per capital in G7 countries, over various time periods, with 1999 as base year
calculated by author from IMF data
While Japan does not rank at the top of the list in any of these periods, it fares reasonably well within G7 countries. At the very least, there is no evidence that Japan's productivity performance is poor.
The next chart below, taken from the BIS Quarterly Review 2015, supports this finding, and may make it even more compelling [1]. This chart shows real GDP per capita as well as real GDP per working age population (i.e. all people between 15 and 64 years of age as the workforce). One might say that it is even more relevant as a productivity measurement than GDP. The chart compares these two measures for Japan and the U.S., which ranked at the top two for all periods in the above real GDP per capita table. What we see here is that in terms of GDP per working age population, Japan is ahead. If anything, the chart bespeaks of steady productivity increases over recent years!
Relative economic performance: Real GDP per capital and Real GDP per working population, U.S. (blue) and Japan (red) in comparison, 1980-2014
from Claudio Borio et al., BIS Quarterly Review, March 2015
Corporate Profits, Too, are Subject to the Money Illusion
I could stop here with the conclusion that any claim of Japan's productivity being poor is unwarranted. However, for the sake of interesting discussions, let me add another important point closely related to this theme, albeit perhaps even more controversial. Japan's alleged low productivity problem is often attributed to the corporate sector, which is accused of having made no notable achievement in terms of profits and profitability, and this is often said to be due to poor corporate governance. Is this really so?
I submit an identical challenge to this issue as I made above. Just as much as analyses of Japan's productivity often succumb to the money illusion, so do those on Japan's corporate profits. People claim that the profitability of Japanese companies continues to be low in comparison with the U.S.. While that may well be true, the problem arises when pundits relate this outcome with the general theme of corporate governance. If you have followed my arguments so far, you can already guess the point I am going to make next. If you compare macro aggregate corporate profits for Japan's largest companies with, say, their U.S. counterparts, and if you do so in real terms, using the respective CPI data, Japan's numbers fare quite well. In the long-run contest similar to my GDP per capita exercise above, Japan shows better performance with a significant improvement in the last several years into the Abenomics.
Once you are aware of the money illusion (i.e. not factoring in deflation in your analysis), you can only conclude that Japanese companies have been doing fine in terms of profitability, relative to the deflationary macro environment of their home country. Moreover, if you also consider that U.S. macro aggregate corporate profits have lately been driven by a small number of mega tech companies, you would have to agree that, once the comparisons are made carefully, Japanese large companies may have actually fared better than U.S. companies on average, in real terms. Then one can no longer claim that Japanese companies have been managed poorly, with their management simply acquiescing the low profitability for years.
This last point is where the critics of Japan’s corporate governance reforms are called to the table. Indeed, the money illusion means that a reexamination is in order, namely of the question "Is the low profitability of Japanese companies really a direct result of poor corporate governance?" It is of course always good to address governance matters to improve corporate management. And, all governance systems can always get better. However, an entering premise that Japan requires better corporate governance to improve low profitability is misplaced.
I realize that this proposition is likely to cause even more controversy than the productivity point above. But at a minimum, the macro logic should now be clear.
Beware the Money Illusion!
Finally, to avoid misleading the readers, I emphasize that my conclusion is not that the Japanese economy is just fine. The Japanese economy does have lots of problems, and indeed, the biggest of all is the low inflation rate and continuing deflation that is causing the money illusion in the first place. As I argue in my book (in Japanese only), ending the deflationary environment is the first order of needed change. This requires a well-balanced mix of aggressive macro policies, and fiscal policies in particular.
There is also a plenty of room for Japan's corporate governance to improve. However, this should probably be addressed at the individual firm level. While I appreciate investor efforts of engagement in governance, I would urge everybody to keep that discussion appropriately separate from the general low level of nominal corporate profits and profitability, as those are not necessarily proportional to the quality of governance. Beware the money illusion.
Watch out what you are comparing!
The author thanks Ulrike Schaede, the Director of JFIT, for valuable comments and editing suggestions.