Underestimated Growth Potential of Japan

Seiichi TOSHIDA  (Professor, Senshu University)

Despite some reports showing recovery, people still feel the future of Japan's economy to be gloomy. This is due to the pessimistic sentiment caused by issues such as the aging population and dwindling birthrate, or fiscal consolidation with no solution in sight.

But one element blurring the outcome of Japan's economy is the fact that discussions on growth power often muddle the two aspects of an economy: supply and demand. Discussion of growth potential should be based on production power of a country and the assessment of its growth.

What is needed, therefore, is an analysis of the supply side, and the "growth accounting" method is often used here. It starts out by examining the growth record of the past. Levels of contributions of the increases of capital stock and labor input are calculated, and the difference between the sum of these elements and the actual growth rate is assumed to be a contribution of technological development, which recently has come to be called "Total Factor Productivity (TFP)." In order to match actual growth, fluctuations of capacity utilization on capital stock and fluctuations of unemployment and actual working hours on labor input must be considered.

Potential Growth Rate Higher

According to the government report, the average rate of growth of Japan's economy during the 1990s was 1.3% p.a. Though it depends to a certain extent on predefined assumptions, it could be said, in general terms, that the increase of capital stock and decrease of labor input during the period balanced out, which means technological development, or the TFP increase, was 1 to 1.5% annually during the decade. Considering the period from 2000 to 2010 along these lines, the decline of labor force population can be supposed to be compensated by lower unemployment and recovery of the number of standard workers, while capital stock is expected to rise due to the increase of capital investment. Thus, assuming that the level of TFP does not change, the potential growth rate for the coming decade might be somewhere in the range of 1.5 - 2.0%.

However, there is a possibility of underestimation in the calculation of TFP. First, in order to analyze the actual performance, such factors as capacity utilization and unemployment are included in acquiring the figures for capital and labor. Therefore there is a question as to whether the growth potential had been fully incorporated, indicating the possibility that if the potential had been put to full use, the growth rate could have been higher.

Looking from a different perspective, in 2000 the problems being talked about were overemployment and overinvestment. If such was the case, growth potential was not being employed fully because the capacity was in "excess." If, assuming that at the time only 90% of the potential was being commissioned, simple calculation shows that through the 1990s, the growth rate could have been higher by 1% p.a.

The growth accounting method is formulated on a thesis that an economic cycle is a fluctuation centered on a medium-term growth path. Accordingly, using the productivity growth figures derived from the period dubbed as the "lost decade" or "decade of stagnation" for predictions onward could be misleading, as it assumes the continuance of the slow economy.

Observations from the supply side thus suggest that the growth potential of Japan may be higher then what has been generally acknowledged. If the growth of the US is to be 3 - 4% p.a. for the coming decade, there is no reason to reject the possibility of Japan's potential growth rate being around 3%.

The question, then, is why the potential could not be realized during the 1990s. As the rate of productivity growth has been low during the past few years, it is generally claimed that the enhancement of productivity is the most important policy challenge for Japan. But changing the point of view reveals that as far as the supply side is concerned, potential efficiency and productivity has been improving. The issue is to realize that potential.

Accordingly, it is not a promotion of efficiency of the supply side, but rather creation of demand which is the most vital policy objective that needs to be considered.

(The original Japanese article appeared in the March 13, 2004 issue of Weekly Toyo Keizai)