Monetary policy is based (in part) on the theory that interest rates affect the level of savings and investment and produces a so-called ‘IS Curve’ (IS for Investment Savings). In theory this line should slope down from left to right on a chart where interest rates are the left hand side and GDP is along the bottom. So the higher the level of interest rates the lower the level of GDP (because of higher savings among other things) and vice versa. Which sort of makes intuitive sense. Until we get into the real world.
The authors of the paper highlighted today identify a) what’s wrong with Japan [Where to begin? Ed.] and b) what to do about it. The problem they highlight above all is that Japan’s IS Curve is vertical i.e. it doesn’t seem to matter what the level of interest rates is the economy is stuck in a 25-year recession it can’t break free from. Mr. Paul Krugman has said Japan is in a liquidity trap but the authors disagree; the problems are structural issues none seem to know what to do about; but they have some useful suggestions.
This matters for China as some of Japan’s problems today will most likely be China’s in the future.
First the problems:
Seniors. Japan has too many of them who are economically under-performing as they don’t spend (much) and they don’t work. Despite the increased longevity of Japanese retirement age is still 60 (it’ll rise to 65 by 2025) but the real problem is a seniority system that makes older employees more expensive so firms are especially keen to see these people go when the magic age comes up.
Small companies’ access to credit. SME’s, who employ 70% of the workforce in Japan, have had a hard time borrowing as the reduced capacity in the banking system since the end of the bubble era causes banks to favor bigger customers.
Too much money goes to the provinces. This is a product of pork-barrel politics and money that goes to the provinces produces a very poor return. It’d be far better spent in big towns where it’d generate more reliable, and higher, returns.
What to do about this:
Base wages on productivity not seniority, increase female participation rates in the workforce, find a stable financing solution for SMEs, reduce central government transfers to the provinces, lower the target inflation rate to acknowledge cheaper commodity prices (especially oil) and encourage energy diversification. If only!*
China has some way to go before their seniors are a real problem. In fact it’ll take another 40-years before 1/3 of the population are over 65; but that day will come and it’s good to be have a model that can be studied to begin thinking about policies that’ll be necessary to prevent China going down the Japan road.
The paper is by Naoyuki Yoshino of the ADB Institute and Farhad Taghizadeh-Hesary of the Keio University and can be accessed in full via this link Japan’s Lessons for China.
Happy Sunday
[*Not a chance! I lived and worked in Japan from 1984 to 1990 and then (as it remains now I sense) inflexibility was a hallmark of all Japanese enterprise. If you took a Japanese to task on some of these issues the discussion would usually terminate with some version of ‘You don’t understand; this is Japan’. We gaijin shortened this to ‘This is Japan’ or just TIJ. Why don’t bank ATMs work on weekends? TIJ. Why can’t I have the soup from set menu A with the steak from set menu B? TIJ. Why can’t I have a chequing account? TIJ; and so on. Then (as now?) Japanese used the words ‘change’ and ‘reform’ to indicate jolly good ideas but something that somebody else should do. As for the whole corporate governance overhaul/Abe-nomics thing? Friends tell me things are changing; I remain deeply skeptical. Jolly good ideas for sure but, at the end of day; this is Japan.]