Back in 2019, the Economist wrote an excellent series on inflation in the present day, from which this article was very helpful (in my view) in explaining what exactly is going on in Japan. Though helpful against its stated wishes, curiously.
That article laid out a theory that inflation is non-linear, so “prices and wages could suddenly and quickly accelerate should unemployment fall beneath some threshold”. Later on there was a graph showing how employment in Japanese continues to rise, i.e. it hasn’t hit its peak and there’s still slack left. And then in a different section, it also explained that “in Europe profits are lower, but so is wage growth, because Europe’s labour market has not boomed as much as America’s. If it ever does, inflation will budge.”
My conclusion from these bits of information is that the European analysis also applies to Japan: once employment in Japan does hit its peak, wages will rise, and once this continues long enough to wear down corporate profits, then prices will rise and inflation will follow. As suggested by the graph below, consisting of some basic macro indicators I’ve cobbled together, pre-pandemic Japan was well on its way to fulfilling Step 1 of genuine full employment. These figures also suggest at least an association between rising unemployment and collapsing wages in the Lost Decade, and between full-speed employment growth and wage recovery in the Abenomics decade.
The Economist, though, hedges its bets: “Japan, with its entrenched deflationary mindset and unique labour-market institutions, is a special case”, it writes, and particular explanation is given for its culture of lifetime employment and the loss of social status from switching companies. None of which is… wrong, but it’s certainly more hand-wavy, less falsifiable, and less satisfying than the inferred conclusion from above.
In fairness to them, the Economist is an actual institution and not a random blogger (hi!). “Don’t worry, this is how inflation will finally return to Japan after thirty years” is a more daring prediction than they were willing to tolerate.
(I am concerned that I sound a bit like an econ undergrad who’s just learned about general equilibrium; maybe wages are low for deeper structural reasons, like that Japanese workers use outdated technologies and are less productive or something. But no, the country’s persistent and enormous current account surplus gives the lie to the idea that the country doesn’t have money in the aggregate; there is simply too much in the hands of those who need it least. Wage growth through a persistently tight labor market is a way of countering that. If there is a relevant cultural factor, maybe the Lost Decade looms in the collective consciousness and workers are less keen to demand wages as a result?)
What happens next, the classical theory goes, is that the virtuous cycle of more jobs, more disposable income, more demand for goods and services, and thus even more jobs will give higher wages and more power to workers, more investment in productivity-enhancing tools, and eventually overall inflation, at which point the Bank of Japan can finally start raising rates and the government can stop spending deficits.
But some might say this wouldn’t be remotely fast enough. Seven-year-long economic expansions seem nice, but this time around, it was just as workers finally saw glimpses of wage gains when it all came tumbling down. The government, by this view, must do everything it can to heat the economy even hotter. Shinzo Abe took office on a promise of massive fiscal and monetary expansion, which he did initially deliver but soon tempered due to concerns about the national debt. This perspective says, no more tempering.
And that brings up the real way that Japan’s economy is a “special case”, i.e. the scale of the consistent government deficits, and the complete lack of inflation that seems to result from them. The old secular stagnation hypothesis is a convincing one for this situation — as population declines, there’s less demand for goods in the future, so there’s less physical infrastructure being built, i.e. investment spending falls. Something needs to make up for that lack of investment spending, and that’s what the government’s been doing through deficit spending.
If government deficits are simply counterbalancing private hoarding, then, what precisely is the problem? I write here about how we should take one idea from functional finance (you might know it as “MMT” but you shouldn’t): Japan’s government should focus less on managing “deficits”, which mean little when the majority of it is owned by the Bank of Japan, and manage inflation instead.
Originally published at http://kojisposts.blogspot.com on March 13, 2021.
