Economics Misbelieves – Part 1

Rehabilitation of the Lost Decade(s)

As in the case of most developing scientific fields, it is also true that economic models and metrics should only be examined alongside their historical contexts. The usage of the notion of gross domestic product (GDP) in economic models and decision making processes, was indisposed during the Great Depression and the ensuing war period. Decision makers needed an overlook of their economies to understand how to divide resources between the war effort and the civil sector. However, the metric gradually lost its political spotlight during the period of Cold-War in the second half of the twentieth century. The growing inequality, the foreign investment, or the relative size of the public sector, all made comparison more difficult through a single metric.

In the light of modern econometrics, I must label some ‘economic news and facts’ as sensationalist, as long as they merely built on one-dimensional, outdated metrics. If these economic tabloid news only existed for the entertainment or thought-provocation of people, they would cause no harm. Unfortunately, most of these facts can capture people’s attention so they become a part of the mainstream thinking.

The modern economic history of Japan is often labelled as an economic miracle followed by the Lost Decade. Indeed, the bursting real estate bubble, the related banking crisis, and later, the Asian financial crisis, left their mark on the growth trends, at least if we look at the headline numbers.

It is a very interesting parallel to compare Australia’s economic development throughout the same era starting from the ‘90s. As the developed world is currently experiencing one of the longest uninterrupted economic cycle, experts keep guessing how long it would last. Several fingers point at Australia as a proof, that business cycles have no natural time limit, because that country enjoyed 28 years of growth without recession.

The early ‘90s are marked as a milestone in both Japanese and Australian history. Considering only the headline GDP numbers, it is understandable why people call this time the lost decade in Japan and why they marvel at Australia’s performance. The two countries have reached 0.8 and 5.2 percent annualized growth since 1991 respectively. Can we then actually declare that Japan’s decades are lost?

The overall growth numbers might suggest so. Aggregating economic output certainly has some relevance even today. They play a crucial role to calculate national debt levels, or debt servicing burdens on the entire economy. However, these headline numbers could also be misleading without context, but let’s not drift from our original topic. As usual, to get a clear picture about economic performance we will have to look behind these numbers.

One of the most crucial differences between the two mentioned economies, is their respective demographic trends. While it is a well-known fact about Japan that its overall and working population are both shrinking, Australia’s demography receive less international attention. It is common to characterise Australia’s immigration policy as strict, however, during the last ten years the country accepted one new citizen in every minute on average. Due to the combination of the massive rate of immigration and the natural growth rates, the country’s population grew with an annual rate of 3 percent. Additionally, we must note that since most immigrants are at working age or younger, the local labour market have enjoyed an astonishing boost since 1991. Conclusively, if we were to account for these trends and adjust our growth numbers by measuring output per worker, we will get a different picture about relative growth rates. Australia’s growth shrinks to a solid 2.4 percent annually, while Japan’s figure improves to 1.2 percent per year.

Besides the demographic trends, there is another labour market trend we should also consider. Even though both countries experienced a decrease in working hours, the reduction of time spent at the workplace is almost three times higher in Japan. The average Japanese worker spends 14.5 percent time less at work than she did in 1991. Once we further refine our GDP growth figures by adjusting the working hours, we will find that Australia increased 2.8 percent annually in its productivity, while Japan’s performance improved to 2.2 percent.

It is hard to conclude that those notorious decades on Japan’s history are certainly lost. Firstly, the weak overall growth numbers are explained by a headwind of negative expansive growth, not by the lack of innovation. Secondly, when the overall growth trend broke down in the early ‘90s, the nation was already at its demographic peak. In order to change its faith Japan’s policymakers were already in decades late with any attempt to prop up population growth numbers. Additionally, it is not clear whether this was a policy mistake given the concerns about sustainability. Finally, the other major negative contributor to overall growth are the hundreds on annual hours what the citizens are spending freely. Even though it is not a clear cut from the headline numbers whether this reduction of hours was voluntary or a result of lower demand of labour, it is straightforward that they are a missing piece of GDP measurements. Either if these hours are consumed as leisure, or spent with household production, their value is positive for the individuals. Moreover the value should not be neglected on a macroeconomic scale, as it is a relevant question how much excess resources are needed in order to take care of the elderly in an aging population.

All in all, the unsophisticated headline numbers gave an undeserved, bad image to Japan’s experience with the ‘90s. In the next part I will examine the measurement of income, inequality, and the consequent misbelief guiding today’s policymaking.