Japan's slow growth needs no explanation beyond demographics

18 Jan 2011 by Jim Fickett.

FT Alphaville points to an interesting article on Japan's “lost decade” in the Guardian. The main point is that (1) GDP is produced mainly by those of working age, and (2) GDP per person of working age has grown faster in Japan than in the US or in most European countries. Thus demographics, not policy mistakes, are the main explanation for Japan's slow growth.

Policymaking is often dominated by simple “lessons learned” from economic history. But the lesson learned from the case of Japan is largely a myth. The basis for the scare story about Japan is that its GDP has grown over the last decade at an average annual rate of only 0.6%, compared with 1.7% for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6% qualifies as a lost decade.

According to that standard, one could argue that a good part of Europe also “lost” the last decade, since Germany achieved about the same growth rates as Japan (0.6%) and Italy did even worse (0.2%). Only France and Spain performed somewhat better.

But this picture of stagnation in many countries is misleading, because it leaves out an important factor, namely demography.

How should one compare growth records among a group of similar developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population represents an economy's productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ.

When one looks at GDP compared with WAP figures (defined as the population aged 20 to 60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan's overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population.