Saturday, September 27, 2014

The Korean Long Stagnation

1. INTRODUCTION
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As a strong contrast to the multi-decade long Japanese stagnation, there has been considerable academic (and media) interest in China’s rapid economic growth and also in its growing imbalances. For example, Michael Pettis has examined the sources of China’s rapid growth and analyzed its growing imbalances in great detail. Michael’s demand-side research provides clear insight into the origins of China’s growing imbalances, and suggests that China must correct these imbalances (i.e. rebalance) soon in order to avoid a debt-crisis. Michael’s research also shows that slower future GDP growth in China will be a necessary consequence of this rebalancing. 
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For the convenience of the reader, here is a quick summary of Michael's forecast for China from his insightful demand-side analysis:
(1) Landing: Unlike the case of the Japanese imbalance-bubble that burst in 1991, there will be no crash (i.e. Hard Landing) in China, as it is a semi-command economy. Instead, China will see a slow descent of growth-rates over a long period (i.e. Long Landing)
(2) Growth: GDP growth rates will come down as they did during Japan's rebalancing, but in China's case they will be 'front loaded', with each passing year showing slower growth, instead of a sudden collapse and subsequent stagnation as happened in Japan during the 1990s.
(3) Consumption: As we saw during Japan's rebalancing in the 1990s, consumption as share of GDP will rise, as China shifts to a consumption-led growth pattern in order to rebalance. As consumption-share of GDP rises, the savings-rate must necessarily fall, as they are merely the inverse of each other.
(4) Investment: As we also saw during Japan's rebalancing in the 1990s, investment share of GDP in China will fall, as it sharply reduces investment-growth to prevent the credit-driven investment bubble from getting out of control. In other words, slowing GDP growth will be accompanied by even slower investment growth, which will tend to 'drag it down' as it did in Japan.
(5) Surplus: The world cannot handle a country the size of China (i.e. world's second largest economy) running large (> 2-3% of GDP) current-account surpluses, so China's surplus as a share of GDP will not be able to grow much.
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Not only is Michael’s forecast for China logically-sound, but it is also backed up by the data from the historical precedent set by Japan during its own rebalancing in the 1990s. However, we will not dwell any further on China here. Readers should visit Michael's blog for additional information on his insights into China's economy.
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The point of great interest here is that when we consider East-Asia as a whole, everything that Michael has forecast for China from his demand-side analysis is exactly the same as the forecast for Korea that comes up when analyzed from the supply-side. Everything Michael describes in his forecast for China is exactly what is going to happen in Korea soon. In fact, the uncanny parallels are so exact that we need not even do much thinking on this issue; we could as well gather all of Michael's predictions for China and then almost blindly apply them to Korea-- and they would all be just as true.
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To see why, we must move beyond Michael's original demand-side research and also perform a supply-side analysis of the situation in Korea.
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2. SUPPLY SIDE ANALYSIS
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In order to understand the past-trajectory and future-direction of Korea’s economy, we should compare it to an economically-similar country that follows similar supply-side trends. By carefully observing the differences between their supply-side sources of growth, we can then elucidate the key-sources that have made Korea grow for the last 20-years and then extend them to analyze Korea’s growth prospects for the next 20-years. The natural comparison for Korea would be with its economic guru in the East-Asian Co-prosperity Sphere-- Japan. After all, in the famous “Flying Geese” paradigm, where the head goose leads, there the flock must follow. 

We will use a standard supply-side analysis as follows:
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(a) Comparative trends in total GDP
(b) Comparative trends in per capita GDP**
http://alturl.com/esund
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**Cautionary note: Nominal USD exchange rates for Korea's currency are still slightly suppressed, as seen here:
http://alturl.com/23da8
http://alturl.com/ovcup
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The supply-side sources of this ‘growth’ are:
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(i) Comparative trends in the Productivity
(ii) Comparative trends in the Participation-rates
(iii) Comparative trends in the Demographic Profiles
(iv) Comparative trends in the growth of Population
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Here are the tabulated end-point data for Korea extracted from the World Bank data linked above:
Similarly, here are the tabulated end-point data for Japan extracted from the World Bank data linked above:

Finally, here is the tabulated comparison between the supply-side sources of growth (expressed as Cumulative Annualized Growth Rates or CAGR) over the last 20-years between Korea and Japan:

Brief summary: Compared to Japan, Korea’s growth received a disproportionately larger contribution from productivity (3.5% > 1.0%), because Korea was still in the rapid ‘catch-up’ phase over the last 20 years. In addition, unlike Japan, which faced a ‘headwind’ from deteriorating demographics (negative 0.3% contribution), Korea had a good ‘tailwind’ from its still improving demographics (0.8% contribution) over the last two decades. Still further, whereas Japan’s population was mostly steady (0.1% contribution), Korea’s population actually grew quite well (0.7% contribution) over the last 20 years. This was because Korea’s population was rising as its society was still in its maturation phase over the last two decades.
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The supply-side analysis above clearly shows that Korea has done very well in the previous two decades. But what lies ahead? What can we expect from Korea over the next twenty years?
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3. LOOKING AHEAD
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3.1 Productivity Projections
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It is clear from the data that Korea has matured in terms of productivity ‘catch-up’ and its productivity (capital and TFP) today has already reached the productivity levels of Germany, Netherlands, Denmark & Japan.
From this, it follows that Korea’s productivity-growth must already have slowed to the level of the mature industrialized-countries. As shown in the figure below, its productivity-growth trend-line has indeed almost converged with Japan's.
From here on, it follows that Korea’s productivity and its productivity-growth will only match that of its developed-country counterparts. It is very unlikely to cross beyond their general range, unless Korea becomes systemically more US-like, which is culturally impossible. Therefore, we can conclude that Korea’s days of productivity-driven fast-growth are now over.
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3.2 Demographic Projections
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The data indicate that Korea is almost exactly 20 years behind Japan in terms of its demographics (i.e. demographics are merely time-shifted by 20 years). As shown in the graphs below, this implies that Korea right now is demographically almost identical to the Japan of 1992.
In addition, as seen the graphs below, the five-year interval period (1992-1997) between the two demographic inflexion points for Japan is exactly equal to the five-year period (2012-2017) between the same two inflexion points for Korea. This implies that Korea’s tip-over into a demographic cross-over condition in which its old-age dependency ratio is higher than its young-age dependency ratio will occur very soon.
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In addition to the demographic profile effects, we further note that Korea already has a very low unemployment-rate compared to its equivalent advanced-economies.
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When this high-employment rate and Korea’s labor-peak (see figure below) are combined with its already-matured high-productivity, it follows that Korea’s total economic output is already at its maximum potential for the given demographic-profile.
From all the above, we can conclude that Korea’s days of fast-growth driven by the demographic ‘tailwind’ are also now over. The demographic tipping-point has now arrived in Korea, exactly as it did in Japan in 1992. From here on, Korea will be facing a demographic ‘headwind’ that will act as a brake on future growth.
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3.3 Population Projections
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Korea’s population growth-rate today, as seen in the graph below, is the same Japan’s was about 20-years ago. This implies that Korea’s population-growth profile over the next 20-years will likely imitate that of Japan’s over the last 20-years.
Looking at the measly contribution made by population-growth to Japan’s economic-growth over the previous 20 years, we can project that Korea will also experience see the same over the next 20 years. This implies that the boost that Korea’s GDP-growth received from a fast rising population over the last two decades is also now over. As we saw in Japan’s case over the previous two decades, very slow population growth now lies ahead for Korea.
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4. CONCLUSIONS
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Even though Japan's wave arrived earlier than Korea’s, Korea’s approaching negative-demographic wave will be a lot steeper. This is because the speed of the demographic ascent in the younger days of a society is generally proportional to the speed of its demographic descent in its older days. In other words, the stronger the demographic ‘tailwind’ (lifting growth-rate up) an economy experiences when its demographic profile in improving, the stronger will be the demographic ‘headwind’ (pushing growth-rate down) it will experience when its demographic profile changes direction and begins to deteriorate. Given that Korea’s demographic ascent has been much faster than Japan’s, we can project that its demographic descent over the next 20-years will also be faster than what Japan experienced over the last 20 years. This leads us to the conclusion that Korea’s demographic headwind over the next two decades will be worse than the -0.3% CAGR contribution we saw in Japan’s case over the last 20 years.
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Combining all the listed factors, here are the projections that follow from the supply-side analysis for Korea’s growth statistics over the next 20 years. Compare the numbers projected for Korea over the next 20 years with the actual numbers for Japan from the past 20 years (i.e. the 'stagnant' decades) in the following table:

 In final conclusion, then, here is the forecast for Korea that arises from the supply-side analysis, and should be juxtaposed with Michael’s demand-side forecast for China (listed at the top) to see the uncanny similarities:
(1) Landing: Unlike Japan in 1991, Korea will not see a sudden and violent crash. Instead, Korea will see a slow descent in GDP growth-rates over the next 20 years.
(2) Growth: GDP growth-rates will be 'front-loaded', implying growth-rates will show a secular downward-trend for the next 20 years, as the demographic 'headwinds' grow stronger and stronger. Average GDP growth rates (or CAGR) over the next 20-years are unlikely to be much higher than a meager 1% or so.
(3) Consumption: As we saw in Japan over the last 20-years, consumption share of GDP will rise (typical of demographic headwinds) as more and more people retire to consume without producing. In other words, like Japan over the last 20 years, Korea will become a consumption-driven economy over the next 20-years. Savings rate will naturally decline, as an aging Korea begins to consume a larger share of what it produces. We note that the savings-rate is merely the inverse of the consumption-share of GDP, and so the savings-rate must decline for consumption-share of GDP to rise.
(4) Investment: As is also typical of demographic-deterioration, investment share of GDP will also fall, exactly as seen in Japan during the last 20 years. In other words, slowing GDP growth over the next 20-years will be accompanied by even slower investment growth.
(5) Surplus: In order to maintain its growing elderly-share of the population, Japan will convert from its historical structural current account surplus to a structural current account deficit in the next 5-7 years. Korea will naturally follow this same pattern 15-20 years thereafter, as its own elderly-demographic follows Japan's with a 20-year time-lag. Therefore, on average, there will be no growth in Korea's surplus over the next two decades.
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The only wild-card in this analysis is immigration. Immigration is the only thing that can pull Korea out of its upcoming demographic-decline triggered stagnation. However, given that Korea, as an ethnically-pure country, has never accepted immigrants and does not view itself as a society that can ever accept immigrants, immigration is not an option for Korea. Once we accept this as an iron-clad fact, we arrive at the inevitable conclusion that Korea is going to enter into a state of slowing growth (initially) and then finally end-up in an indefinite secular-stagnation pattern. Korea will then slowly, but inexorably, enter into a high-income trap, and will never be able to escape it.
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The Korean ‘Miracle’ is over. Its ‘Long Stagnation’ has now begun.
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Friday, September 26, 2014

Japan and the Long Sleep


1. INTRODUCTION
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Much has been said about the stagnation in the Japanese economy and a variety of interesting reasons have been put forth for the reason Japan continues its secular stagnation more than 20 years after its bubble burst in 1991. Michael Pettis, for example, has examined this issue in great detail from the demand-side. His demand-side research provides clear insight into Japan’s growing imbalances in the 80s, its efforts to correct those imbalances (i.e. ‘rebalance’) in the 90s, and the resulting stagnation in Japan that was but a necessary consequence of this rebalancing.
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For the general reader, here is a quick synopsis of Michael’s demand-side analysis of Japan’s stagnation:
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A) Imbalances keep growing during the 80s
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In the 80s, particularly after the credit-binge response to the Plaza Accord, investment grew faster than GDP while consumption was suppressed such that GDP-growth exceeded consumption-growth (i.e. Japan had investment-driven growth in the 80s).
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This led to a growing imbalance in the economy, with consumption-share of GDP falling and investment-share of GDP rising in an unsustainable fashion during that period.
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B) The Inflexion Point arrives
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The Bank of Japan, which had dropped interest rates in response to the Plaza Accord in 1984, raised interest rates sharply in 1990 to ‘cool-off’ the credit-binge driven investment-bubble. As seen in many other cases all over the world, the sharp-increases in the interest-rate finally burst the bubble in 1991.
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C) Imbalances are corrected during the 90s
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The collapse of the credit-bubble led to a collapse in investment-growth, leading to a sharp slowdown in over-all GDP-growth, and was accompanied by a smaller slow-down in consumption-growth during the 90s. During this 'rebalancing' period, therefore, investment-growth was lower than GDP-growth and consumption-growth was higher than GDP-growth (i.e. Japan shifted to consumption-driven growth in the 90s).
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This led to a slow rebalancing of the economy, with consumption share of GDP rising to more sustainable levels and investment share of GDP falling in a corrective fashion (i.e. rebalancing) in the 90s.
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D) The stagnation was a natural result of rebalancing
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Just as the credit-bubble induced investment-binge had ‘pulled up’ GDP-growth (i.e. created imbalance) during the 80s, the collapse of investment growth-rates after the bursting of the credit-bubble ‘pulled down’ GDP-growth (i.e. rebalanced) during the 90s. This was the cause of the lost-decade in Japan in the 1990s and this low growth continues to this day.
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Michael's rigorous demand-side analysis has certainly revealed good insights into Japan’s imbalances, its efforts at rebalancing and the resulting stagnation there. However, his demand-side research does not shed any light on the famous “Two Japanese Puzzles”.
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2. THE FIRST JAPANESE PUZZLE
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When the terms ‘bursting of a debt-bubble’, ‘lost decade’ or ‘stagnation’ are used, most economists immediately think about what happened in Latin America (e.g. Brazil, Mexico) during the 1980s. They recall the pain & misery they saw across the continent after the bursting of the petro-dollar debt bubble in 1981, with high unemployment, falling productivity, stagnant economies and falling living standards in what came to be called the ‘lost decade’ of Latin America.
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And yet, when the same economists travelled to Japan during the 90s, they saw no such pain or misery. This left them ‘scratching their heads’ and they spoke of a Japanese ‘puzzle’ which they just could not understand. How was it possible for Japan to ‘stagnate’ into a ‘lost decade’ without any pain and misery? This is called the First Japanese Puzzle.
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In order to understand this issue, it is first important to go over what happened in Latin America during the 1970s & 80s.
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2.1 The Latin American Example
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We note that Michael has already explained the Latin-American example from his demand-side viewpoint, and so the following overview is merely a brief synopsis (or quick recap) of his previous work for the convenience of the hurried reader.
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As in Japan, we can divide the critical period of the Latin American crisis into three phases: (a) the growing of the imbalances, (b) the inflexion point, and (c) the correcting of the imbalances.
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A) Imbalances grow during the 70s
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The rise in oil prices in the 1970s led to trade surpluses in OPEC countries and these petro-dollars surpluses were then recycled into Latin America as debt.
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This petro-dollar debt created a debt-driven investment bubble that resulted in spectacular GDP growth in Latin America during the 1970s.
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Rapidly-rising debt-financed investment led to investment-share of GDP rising spectacularly during the 1970s, partly driven by the rise in the petro-dollar current-account deficit.
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B) The Inflexion Point arrives
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Once oil-prices began to fall from 1980 onwards, the petro-dollar oil-surpluses of the OPEC countries vanished.
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With the vanishing of the ‘oil-savings glut’, international interest-rates rose and lenders began calling in the previous loans issued to Latin America so that they could lend to Paul Volcker who was offering amongst the highest interest-rate at that time.
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Faced with the demand for repayment, Latin America was caught without sufficient foreign-exchange reserves, and a textbook balance of payment (BOP) crisis followed, forcing the IMF had to bail everybody out.
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C) Imbalances are corrected during the 80s
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The Latin-American countries began to correct the imbalances (i.e. rebalance) by switching to current account surpluses during the 80s. This surplus was used to pay-back the IMF and the remaining lenders for the petro-dollars that had been lent to Latin America in the previous boom-decade.
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In order to run this surplus, either investment growth, or consumption growth, or both, had to collapse such that capital could be exported to retire the debt.
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D) Stagnation is a natural consequence of the Rebalancing
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This export of capital from a capital-starved Latin-America naturally resulted in a severe reduction in GDP growth after 1981, thus leading to its ‘lost decade’ in the 90s as it slowly paid back the debt from the previous decade.
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Almost overnight, Latin-America switched from being a growth-leader of the world in the 70s to being a growth-laggard that trailed the rest of the world in the 80s.
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2.2 Why Japan is different from Latin-America
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When we look at the ‘lost decade’ of the 1980s in Latin America from the supply-side, we can see the pain & misery that resulted from rising unemployment, falling productivity, falling living standards during the decade of low GDP-growth.
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On the other hand, when we examine these same ‘misery index’ parameters in Japan during its own ‘lost decade’, we see no such pain & misery. The rise in unemployment was modest, and neither productivity nor living standards fell during the 1990s.
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These differences are the symptoms of the underlying essence of the “First Japanese Puzzle”. To resolve this puzzle, we need to further understand the differences between Japan and Latin America and explain the underlying reasons behind why Japan’s ‘lost decade’ was not as painful as Latin America’s. In order to do this, we need to go beyond Michael’s excellent demand-side analysis of Japan and also look at things from the supply-side.
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3. A SUPPLY-SIDE ANALYSIS OF JAPAN
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In order to determine the supply-side cause(s) of Japan’s stagnation, we should compare it to an economically-similar country that is known to be not stagnating. By carefully observing the differences between the supply-side sources of growth between them, we can then isolate the underlying cause(s) of Japan’s stagnation. The natural comparison for Japan would be with the other economic powerhouse in Eurasia-- Germany.

We will use a standard supply-side analysis as follows:
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(a) Comparative trends in total GDP
(b) Comparative trends in per capita GDP
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The supply-side sources of this ‘growth’ are:
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(i) Comparative trends in the Productivity
(ii) Comparative trends in the Participation-rates
(iii) Comparative trends in the Demographic Profiles
(iv) Comparative trends in the growth of Population
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Quick summary: On the whole, it looks like Japan’s productivity growth matched (or slightly surpassed) Germany’s and so productivity (unlike in Latin America in the 80s) cannot be said to be the cause of Japan’s ‘stagnation’. Japan’s population was as steady as Germany’s, with Germany actually having slightly lower population growth, and so population cannot be said to be the cause of Japan’s ‘stagnation’. It appears that the only real difference between Germany and Japan lies in their composite demographics. Japan had worse demographics than Germany, and this is the only reason that Japan is said to be ‘stagnating’ and Germany is not.
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Using this supply-side analysis, we are now is a position to explain why the Latin American stagnation of the 1980s was so painful, whereas the Japanese stagnation of the 1990s (and often said to continue to this day) was not:
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1) Latin-America had a favorable demographic profile when it entered into its ‘stagnation’ period in the 80s. This implied that even as the stagnant economy in the 1980s created very few jobs, a large number of workers were entering into the workforce due to the falling age-dependency curve. This is what led to the misery of very high and rising under-employment (or unemployment) in Latin American during its ‘stagnation’ in the 1980s.
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On the other hand, Japan had a deteriorating demographic profile when it entered into its ‘stagnation’ period after 1991. This implied that even as the stagnant economy in the 1990s created very few jobs, a large number of workers were retiring from the workforce and fewer were entering due to the rising age-dependency curve. This is what led to the relatively modest rise in unemployment rates (which are still below that of its European counterparts) in Japan during its ‘stagnation’ in the 1990s.
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2) Latin-America had a rising population (i.e. higher population-growth at 2.25%) when it entered into its ‘stagnation’ period in 1981. This implied that even as the stagnant economy in the 1980s created very little additional wealth, a large of new “mouths” entering into society needed to get fed. This is what led to the misery of falling per capita GDP (or falling living-standards) in Latin American during its ‘stagnation’ in the 1980s.
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On the other hand, Japan had an approximately steady population (i.e. minimal population growth of 0.3%) when it entered into its ‘stagnation’ period in the 1991. This implied that even as the stagnant economy in the 1990s created additional wealth more slowly, it did not face the problem of a large number of new “mouths” to feed. This is what allowed the per capita GDP to keep from falling (or prevent falling living-standards) in Japan during its ‘stagnation’ in the 1990s.
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3) Latin-America was a capital-poor deficit-continent when it entered into its ‘stagnation’ period in the 80s. When it was forced to pay-back its lender during its ‘stagnation’ period by running a surplus, it was effectively ‘starved’ of capital. This is what led to the falling productivity in Latin American during its ‘stagnation’ in the 1980s.
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On the other hand, Japan was a capital-rich surplus-country, and the debt-problem created by its post-Plaza credit-boom was entirely internal. Therefore, it was not forced to payback foreigners and was hence not starved of capital during its ‘stagnation’ in the 1990s. This allowed Japan’s productivity to keep rising (and keep pace with its European counterparts) even during its ‘stagnation’ in the 1990s
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Having used the supply-side analysis to explain the underlying reasons why the Japanese stagnation has not been as painful as that experienced in Latin-America, we have now resolved the much-mentioned “First Japanese Puzzle”.
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4. ANALYSIS OF DATA
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Here are the tabulated end-point data for Japan extracted from the World Bank data linked in Section 3 above:
Similarly, here are the tabulated end-point data for Germany extracted from the World Bank data linked in Section 3 above:
Here is the tabulated comparison between the supply-side sources of growth over the last 20-years between Germany and Japan:

Observations: From the data, we can see that non-stagnant Germany grew faster than stagnant Japan over the last 20 years only because Japan had a ‘headwind’ due to its deteriorating demographics, while Germany had a ‘tailwind’ because its demographics had not deteriorated to the extent of Japan. In every other respect, Japanese growth outperformed German growth over the last 20 years and this is an astonishing achievement for a country that is universally-derided for being in ‘stagnation’.
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If Japan’s stagnation was caused only by its deteriorating demographics, as the supply-side analysis indicates, how does this tie up with Michael demand-side explanation that the stagnation was caused by rebalancing? Clearly, GDP is GDP, whether we examine it from the demand-side or the supply-side. Therefore, both explanations must simultaneously be correct. In fact, it is only when we combine this supply-side explanation with Michael’s demand-side explanation that we are finally able to explain why Japan’s rebalancing stagnation has been so much less painful than Latin America’s rebalancing stagnation in the 1980s.
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5. CONCLUSIONS
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Japan has now been in a very long period of stagnation and is the subject of numerous studies. Some economists have argued that Japan should run higher fiscal-deficits (Keynesianism), while others say that it should reduce its fiscal-deficits and contain the rise in government debt (austerity). Some economists have suggested that Japan should increase QE (unorthodox Friedmanism), while others argue that it should stop debasing its currency (classical). Some economists have recommended the throwing of the kitchen sink at the problem, while others suggest allowing that sink to remain where it is in the kitchen. Regardless of the approach, however, it has been observed that nothing seems to work. Regardless of what action Japanese government takes, the secular-stagnation trend just seems to continue. Why does the Japanese economy not respond to anything? Why does it continue sleeping the Long Sleep? This is the known as the Second Japanese Puzzle.
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5.1 The Futility of being Abe
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Shinzo Abe wants to bring Japan out of its stagnation by using the ‘Three Arrows’ of (1) Fiscal stimulus, (2) Monetary Stimulus, and (3) Structural-reforms. Let us examine these Arrows of Abe closely:
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A) Fiscal-stimulus and monetary-stimulus are policy methods used to pull an economy out of a low-equilibrium trap in which a high structural-unemployment rate keeps employment below the natural full-employment level (implying that output stays below maximum potential). But Japan’s stagnation is not being caused by high structural-unemployment. Japan does not have an unemployment problem at all, as its unemployment-rates are amongst the lowest in the world.
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B) Structural-reforms (e.g. flexible labor-laws, minimal regulation) are policy methods that are used to raise productivity via efficiency-increases and so bring an economy out of a lower-productivity equilibrium trap. But productivity-deficiency issues are clearly not causing Japan's stagnation. Japan does not have a productivity problem at all, as its productivity-growth has matched or exceeded most of its counterparts in the developed world. Japan today has the same productivity as most of its equals in the industrialized world.
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Clearly, given that Japan already has technical full-employment and high productivity, the Japanese economy is at its maximum potential-output by definition. It follows, therefore, that the ‘Three Arrows’ of Abe will only be trying to solve problems that Japan does not even have. None of his Arrows will have one iota of effect on the stagnation problem, because they will have no effect on the core cause of Japan’s stagnation: deterioration in its demographics factors. Therefore, it follows that anything that Abe does with his ‘Three Arrows’ will merely be an exercise in futility.
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5.2 The Second Japanese Puzzle
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This explains why Japan’s economy has not responded to all the various things that have been tried for the past 20 years. All those actions were based on a bouquet of economic theories that were developed in order to solve classical problems that Japan currently does not have. The problem Japan does have today is one that has never been encountered in history, and so no economic theory has ever been developed to handle it. Faced with a historically-unknown problem, Japan has responded over the last 20-years by desperately trying a variety of old solutions, none of which is actually relevant to the problem at hand. This is why Japan continues to sleep the Long Sleep.
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Having understood the common reason behind the failures of the plethora of policies tried over the last 20 years, we have now resolved the much-discussed “Second Japanese Puzzle”.
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5.3 The Fat Lady Sings
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Given that deteriorating demographics are the sole reason for Japan’s continuing stagnation and that Abe’s ‘Three Arrows’ cannot possibly help with that, we see that the only thing that can bring Japan out of its stagnation is immigration.
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Immigration is the only solution that can pull Japan out of its long stagnation. As seen in Germany, the arrival of working-age immigrants immediately increases the participation-rate. If they do not bring their dependent families with them, they also immediately improve the demographic age-dependency profile. In addition, if they come from countries with a culture of higher birth-rates, as seen in the US amongst Hispanics, their eventual family-formation helps prevent population growth-rate from falling too quickly and hence prevents the age-dependency profile from skewing excessively to the ‘old’ side too fast. Still further, arrival of immigrants and their families can also prevent the overall population from falling, as is now seen in Germany.
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However, given that Japan, as an ethnically-pure country, has never accepted immigrants and does not view itself as a society that can ever accept immigrants, immigration is not an option for Japan. Once we accept this as an iron-clad fact, we arrive at the inevitable conclusion that Japan is going to stay in a state of secular stagnation indefinitely. Japan is now inexorably entering into a high-income trap, and will never be able to escape it.
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It is over, because the Fat Lady is singing.
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Thursday, September 25, 2014

An Analysis from the Supply-side

1. INTRODUCTION
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In his blog, Michael Pettis examines the sources of GDP growth from the demand-side. He has frequently pointed out, and correctly so, that there are only three sources of GDP growth, namely, (a) increase in Consumption, (b) increase in Investment, and (c) increase in Net-Exports. By way of specific example, Michael has often mentioned the following:
(a) Consumption is the main source of growth in the US
(b) Investments are the main source of growth in China
(c) Net-exports are the main source of growth in Germany
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Michael's careful and insightful demand-side analysis has revealed enormous problems with imbalances in Asian, European, North American economies. His demand-side research, however, does not say much about the Latin American and Sub-Saharan African economies. In the aggregate, they do seem more or less balanced from the demand-side. So are they home free? Should they be patting themselves on the back for having avoided the demand-side imbalance problems Michael has exposed?
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Interestingly enough, when we do a complementary supply-side analysis of the situation, the position completely reverses. The Asian, European  & North American economies seem more or less balanced when examined from the supply-side. On the other hand, it is the Latin American and Sub-Saharan economies that reveal massive problems when examined from the supply-side. In order to get a complete picture, therefore, it is necessary for us to go beyond Michael's demand-side research and also have a look at supply-side sources of growth in economies across the world.
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2. ANALYSIS
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Let us begin with an examination of the inner components of Per Capita GDP:
.....Per Capita GDP = Output/Population
.....Per Capita GDP = (Output/Workers) X (Workers/Population)
.....Per Capita GDP = (Output/Workers) X (Workers/Workable) X (Workable/Population)
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Using standard World Bank definitions of terms, we can express the above relation as:
.....Per Capita GDP = Productivity X Participation Rate X Demographic Profile ----(I)
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Therefore, it follows that there are only three sources of per capita GDP growth, viz.,
.....(i) Increase in Productivity,
.....(ii) Increase in Participation Rate, and,
.....(iii) Improvement in Demographic Profile.
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For those who are in the habit of using total GDP growth (instead of per capita GDP growth) as the measure for tracking economic growth, the extension of (I) is quite straightforward:
.....GDP = Per Capita GDP X Population ----(II)
.
Inserting (I) into (II), we get:
.....GDP = Productivity X Participation Rate X Demographic Profile X Population ---(III)
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Therefore, it follows that that there can be only four sources of GDP growth, viz.,
.....(i) Increase in Productivity,
.....(ii) Increase in Participation Rate,
.....(iii) Improvement in Demographic Profile, and,
.....(iv) Increase in Population.
.
Having delineated the supply-side sources of GDP growth, we are now fully-equipped to go on a global expedition and see what is actually happening in the various economies of the world.
.
3. CASE STUDIES
.
3.1: Brazil (from 1980 to Present)
.
(a) Total GDP shows reasonable growth
(b) GDP per capita also shows some growth
.
But from where did this growth come? What were its sources?
.
(i) There was really no increase in Productivity (Alarm bell!)
(ii) There was only a small increase in the Participation rate
(iii) There was an excellent improvement in the Demographic Profile
(iv) There was a strong increase in Population.
.
Summary: We note that (ii),(iii) & (iv) are one-off or exhaustible sources. Once these are exhausted, Brazil will enter into a zombie-like state of eternal stagnation, unless it starts doing something right now to address its lack of increase in productivity.
-------------
.
3.2 Zambia (from 1980 to Present)
.
(a) Total GDP shows some growth
(b) GDP per capita shows no growth (Alarm bell!)
.
Clearly, if GDP per capita is not growing, but total GDP is growing, then the only source of growth is, by definition, an increase in population.
.
(i) There was really no increase in Productivity (Alarm bell!)
(ii) There was really no increase in the Participation rate
(iii) There was no improvement in the Demographic Profile (Alarm bell!)
(iv) There was just a strong increase in Population.
.
Summary: We note that (iv) alone is not a sustainable source of growth. If left uncontrolled, it will lead to disaster, and Zambia will enter into a state of social & political chaos, unless it starts doing something right now to address, at the very least, its demographic profile.
-------------
.
3.3: China (from 1980 to Present)
.
(a) Total GDP shows spectacular growth
(b) GDP per capita also shows astonishing growth
.
But from where did this growth come? What were its sources?
.
(i) There was a strong rise in Productivity
(ii) There was really no increase in the Participation rate
(iii) There was an excellent improvement in Demographic Profile
(iv) There was a strong increase in Population.
.
Summary: Clearly, China's problems are not the same as the one Brazil is facing with its almost complete absence of productivity growth. China's problems lie elsewhere, and since Michael has been blogging extensively about them by way of his excellent demand-side analysis, we will dwell on them here no further.
-------------
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3.4 United States (from 1980 to Present)
.
(a) Total GDP shows excellent growth
(b) GDP per capita also shows strong growth
.
But from where did this growth come? What were its sources?
.
(i) There was a very strong rise in Productivity
(ii) There was really no increase in the Participation rate
(iii) There was really no change in Demographic Profile
(iv) There was a good increase in Population
.
Summary: Clearly, the problems of the US are neither the ones Brazil is facing, with its almost complete absence of productivity growth, nor the ones China is facing, with its problems well-described in Michael's blog. The problems of the United States lie elsewhere, and since Michael will (I guarantee it) be blogging about them about 4-5 years from now, let us discuss them some other time.
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4. SYNOPSIS OF DATA
.
I picked Brazil, Zambia, China & the US, not because there is anything inherently exceptional about these countries, but because I thought that they were economies that are representative of their type of economy. For example, in the case studies above:
.
(A) Brazil represents most Latin-American economies, with perhaps Chile being an exception. Therefore, once we have understood the sources of growth in Brazil, we would approximately have understood the sources of growth in almost all countries of Latin America. Here are the general trends in Latin-America that Brazil typifies:
.....(1) Stagnant Productivity: http://alturl.com/myfrm
.....(2) Improving Demographics: http://alturl.com/appvb
.....(3) Increasing Participation-rates: http://alturl.com/bo69a
.....(4) Managed Population-growth: http://alturl.com/43syf
.
(B) Zambia represents a lot of the economies of Sub-Saharan Africa (minus South Africa), with the some of the major commodity-exporters countries, like Botswana, being exceptions. Therefore, once we have understood the sources of growth in Zambia, we would approximately have understood the sources of growth in many of the countries of Sub-Saharan Africa. Here are the general trends in Sub-Saharan Africa that Zambia typifies:
.....(1) Stagnant Productivity: http://alturl.com/a6ufj
.....(2) Stagnant Demographics: http://alturl.com/fn7vw
.....(3) Flat Participation-rates: http://alturl.com/ob957
.....(4) Unmanaged Population-growth: http://alturl.com/c99wg
.
(C) China represents most developing Asian economies, including India & ASEAN, with perhaps Philippines being an interesting exception. Therefore, once we have understood the sources of growth in China, we would approximately have understood the sources of growth in almost all the Sinitic, Indo-Sinitic and Indic developing-countries of Asia. Here are the general trends in developing Asia that China typifies:
.....(1) Rising Productivity: http://alturl.com/u58so
.....(2) Improving Demographics: http://alturl.com/p7wqr
.....(3) Flat Participation-rates: http://alturl.com/fnpzr
.....(4) Managed Population-growth: http://alturl.com/umi7n
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(D) The United States represents most developed economies, with perhaps rapidly-aging Germany & Japan being slight exceptions in some ways. Therefore, once we have understood the sources of growth in the US, we would approximately have understood the sources of growth in almost all fully-industrialized countries. Here are the general trends in developed countries that the US typifies:
.....(1) Rising Productivity: http://alturl.com/3vj6n
.....(2) Stagnant Demographics: http://alturl.com/9n2or
.....(3) Stagnant Participation-rates: http://alturl.com/e6yod
.....(4) Slow Population-growth: http://alturl.com/fax84
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5. CONCLUSIONS
.
Michael's original demand-side analysis had clearly divided the world into three distinct camps:
(I) 'Over-consuming' economies (i.e. Consumption-driven economies). Examples of this type of economy are the United States, the United Kingdom and Greece.
(II) 'Under-consuming' economies (i.e. Investment and/or Net-Exports driven economies). Examples of this type of economy are China, Germany, Singapore, Netherlands and Saudi Arabia.
(III) 'Balanced' economies (i.e. economies that are not a major part of the global imbalances revealed by Michael's analysis). Examples of this type of economy are Mexico, South-Africa and Egypt.
.
This complementary supply-side analysis, on the other hand, indicates the world could alternatively be divided in a different way and into four distinct camps:
(I) Productivity-driven economies. This type of economy is found in advanced, developed or fully-industrialized countries, some of whom may well be heading into a high-income trap* soon. Examples of this type of economy are the United States, the United Kingdom, Spain, Greece, Germany, Italy, Netherlands, Korea and Japan.
(II) Demographics-driven economies. This type of economy is found in middle-income countries that have low productivity-growth and have hence become caught in a middle-income trap. Examples of this type of economy are Brazil, Mexico, Philippines, South Africa, Ecuador and Guatemala.
(III) Productivity and Demographics driven economies. This type of economy  is found in developing countries that are rapidly-industrializing. Examples of this type of economy are China, Vietnam, Indonesia, India and Thailand.
(IV) Stagnant economies.  This type of economy  is usually found in under-developed countries with stagnant per capita income, where GDP-growth comes from population growth alone. Such countries are said to be caught in a low-income trap and include countries like Zambia, Kenya, D.R. Congo, Senegal and Niger.
.
Comparative Visualization: The following graphs compare the various supply-side sources of growth between three of the camps, with Brazil representing Camp (II), China representing Camp (III) and Zambia representing Camp (IV):
.....1) Comparing Productivity trends: http://alturl.com/kqdde
.....2) Comparing Demographic trends: http://alturl.com/nkttp
.....3) Comparing trends in Participation-rates: http://alturl.com/f3v48
.....4) Comparing trends in Population-growth: http://alturl.com/6evhw
.....5) Comparing trends in per capita GDP: http://alturl.com/fbypo
.
*What is a high-income trap? Whereas the terms 'middle-income trap' and 'low-income trap' are widely used and well-understood, the term 'high-income trap' is a bit unusual. In light of this, it would help to elaborate on this term a bit further. To put it succinctly, a 'high-income trap' is a demographics-triggered trap, in which any increase in productivity is negated by a deterioration in the demographic-profile. As seen in equation (I), they may well cancel out each other, thereby leading to a stagnation of per capita GDP (i.e. a state of zero growth in per capita income). In addition, as seen in equation (II), if this stagnation of per capita GDP is further accompanied by either a stagnant population or a declining population, then it would additionally lead to either zero GDP-growth (i.e. a stagnant economy) or negative GDP-growth (i.e. a shrinking economy), respectively. A preliminary analysis of the available data indicate that Japan is about to enter into this high-income trap and Germany may well follow in 5-10 years time. If Italy were also to follow Germany & Japan into this trap, then the final humiliation of the Axis-powers would be complete.
.
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APPENDIX
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In the examples cited, we have just covered and categorized Brazil, India, China & South-Africa ('BICS') from Jim O'Neil's much-ballyhooed 'BRICS' group. But where is the 'R' of Russia? Where does Russia stand in this supply-side analysis? What are Russia's sources of growth? What type of economy does Russia have?
.
Special Case: Russia from 1998 (End of Post-Soviet Depression) to Present
.
(a) Total GDP shows strong growth
http://alturl.com/t4rqn
(b) GDP per capita also shows strong growth
http://alturl.com/i6fjw
.
But from where did this growth come? What were its sources?
.
(i) There was a very strong rise in Productivity (partly due to rising oil & gas prices)
(ii) There was a tiny increase in the Participation rate
(iii) There was a small improvement in Demographic Profile
(iv) There was a unusual decrease in Population (Alarm bell!)
http://alturl.com/ct9ai
.
Summary: Clearly, the problems of Russia are neither the ones Brazil is facing, with its almost complete absence of productivity growth, nor the ones China is facing, with its problems well-described in Michael's blog. The problems of the Russia lie in the vodka-induced collapse of health statistics for men (i.e. a social depression), which in turn is leading to a decimation of the population, as seen here:
1) Probability of living past 65 for men: http://alturl.com/n92h2
2) Life expectancy at birth for males: http://alturl.com/u8hmh
3) Birth-rate (compare to death-rate): http://alturl.com/sx5pb
4) Death-rate (compare to birth-rate): http://alturl.com/2udmt
5) Results in shrinking population: http://alturl.com/4h2s9
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