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May 2, 2005

Stage for Current Growth Decline Set in '70s

Yutaka HARADA (Chief Economist, Daiwa Institute of Research)

Japan's real economic growth rate declined sharply in the 1990s. The growth decline has been called the "Lost Decade," the "Great Recession" and the "Heisei Depression," and there are a lot of arguments about why it occurred.

Of course, there is no agreement on the reason, but there is at least agreement that economists have to analyze the problem. My interpretations of the problem were covered in earlier articles. (Note)

The growth decline in the 1990s was not Japan's first experience with decline. In the 1970s, Japan's real economic growth rate dropped from 10% to 3%. The magnitude of the decline was greater than in the 1990s because decline in the 1990s was from 3% to 1%. But Japanese economists did not seem to think they had to analyze the reason. Many thought the decline was caused by the oil shock of 1973. Increasing oil prices, however, cannot explain it.

First, only Japan experienced a major decline of real economic growth in the 1970s, while other countries did not experience as great a decline. Of course, almost the whole world, except for oil exporting countries, experienced shocks from the oil price increase, but their magnitudes were much smaller than Japan experienced. Other Asian economies, such as Singapore, Hong Kong, Taiwan and South Korea, did not see their economic growth decline in the 1970s.

Second, if increasing oil prices were the reason for declining growth, lower oil prices would have to raise growth rates. Japan's real economic growth rate, however, did not increase in 1990 when oil prices returned to the level of 1970 in real yen terms.

Third, the effect on the Japanese economy of increasing oil prices is the same as a tax by oil exporting countries. The negative effect of the "tax" is estimated to be 3% of gross domestic product, according to the Economic Planning Agency's Economic Survey of 1981. The tax effect is too small to explain the actual growth decline of the Japanese economy. The Japanese economy, which had been growing at 10%, should have grown at 7% (10% minus 3%) only in 1973 and 1974, when the oil shock occurred, and should have returned to the 10% growth path after 1975.

There was no argument about the growth decline in the 1970s, and no search began for the reason. Only recently have some economists started to raise the subject.

Monetary policy increased the economic fluctuation around 1970. Monetary policy was too expansionary at the end of the 1960s, and caused hyperinflation in the early 1970s. This inflation reduced the growth rate in the 1970s.

Institutional changes in the 1970s, however, had a greater and more sustainable effect on the Japanese economy. Institutional arrangements introduced in the 1970s made Japan's economic system rigid, and caused a decline in the growth rate. These were new regulations such as the Large-Scale Retail Store Law, which impeded development of an efficient distribution system, and institutions that impeded the internal migration of people.

Chart 1:

One economist has argued that declining internal migration is the main cause of growth decline (Etsuke Masuda, "Rebirth of Cities is the Key to the Revitalization of the Japanese Economy," Economics, No. 7, spring 2002). Masuda notes that public investment in rural areas increased in the 1970s, and he asserts that this allowed people to live in inefficient economic areas because the public investment generated jobs. Before the 1970s, people moved to efficient areas in search of higher wages. But people became too dependent on public investment in the 1970s, so internal migration declined in the 1970s, as did the economic growth rate. The chart shows the movement of the real economic growth rate and internal migration. The decline in migration occurred at the same time as the decrease in the growth rate.

Japan's economy was widely praised around the world at the end of the 1970s, but the nation's current problems, such as the overly regulated economy, were already being created at that time.

(Note: Earlier articles are in The Nikkei Weekly's Jan. 31 and March 7 issues.)

(Originally appeared in the April 25, 2005 issue of The Nikkei Weekly, reproduced here with permission.)

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