Japan’s Rise and Fall... And Rise Again?

Just two decades ago Japan was the second-largest economy in the world and a decade before that economists were busy making predictions about when it could even exceed the economic dominance of the USA. Of course that never happened and since the start of the 1990s Japan's output has been mostly stagnant. It has since been massively surpassed by China and left well behind by the USA.

In retrospect this isn't surprising, the country had a lot of underlying issues and really not that many global advantages. Simon Kuznets once said that there are four types of economies in the world, undeveloped economies, advanced economies, Argentina and Japan. Argentina is an economy that has had every chance to be successful but still isn't, and Japan is an economy that has had every reason to fail but still hasn't.

What's even more shocking is that after more than three decades of economic stagnation Japan might be looking to make a bit of a recovery as a range of economic factors play out in its favor. This is a very exciting possibility that has the keen attention of a lot of economists because in many ways Japan is an economy ahead of its time, meaning that the stagnation experienced in Japan in the 1990s might not be a problem unique to the country but might instead be something that all economies can expect once they become sufficiently advanced, it's just that Japan was the first country in the world to reach that level. It's nice to think that the historic trend of limitless growth in a finite world will continue forever in our own economies but Japan shows a number of concerning warnings why the growth we've all enjoyed over the past two centuries may be an exception rather than the expectation and those factors are worth exploring in some detail.

It's also worth exploring how Japan and potentially our own economies might manage this stagnation to develop economies that aren't reliant on economic growth. Despite its problems Japan still gets praise for its living standards and handling of issues like housing affordability. So, what is indicating that Japan could finally be in for an economic recovery?

Does this mean that limitless growth could be possible in our own economies? And finally, what would happen to the country if it stagnated forever? Intro Add After they passed a vague and heavy-handed state secrecy law in 2013, Japan's media outlets have not really been able to criticise the government for fear of being censored.

It's very hard to talk about Japanese economics without an honest look at the information coming out of the island nation. That's why I am glad to be sponsored by Ground News, a website and app developed by a former NASA engineer on a mission to give readers an easy, data-driven, objective way to read the news. Every story comes with a quick visual breakdown of political bias, factuality and ownership of the sources reporting.

All backed by ratings from three independent news monitoring organisations. For a great example, I saw a recent story about the Japanese government lifting the ban on Tepco's operation of a nuclear power plant, which had been in effect since the Fukushima disaster in 2011. Right away I can see that 54 sources are reporting on this story, 32% lean left while 26% lean right, and 43% of the outlets reporting on this story are owned by media conglomerates.

For example, Japanese media, who are very careful not to criticise the government or risk censure, have merely reported the fact that this ban has been lifted. But international media outlets like Reuters have drawn attention to the fact that Tepco have had safety breaches that have not yet been fully addressed. Incredibly useful.

So go to ground. news slash explained or the link in the description and get 30% off an annual subscription on the vantage plan, which is what I use. Japan is a country that has stuck living in the year 2000, but they have been living there since the 1970s.

What that means is that during their boom, they were decades ahead of their time. Japan was technologically well ahead of all of their advanced rivals and they were producing cutting-edge gadgets and building world-class infrastructure, they adopted computers faster than the west, and they were using all of this to be some of the most productive people on the planet. Unfortunately, Japan is still living in the year 2000, only now that means that they are 23 years behind.

This is clearly visible in a lot of their most important industries. Japan used to be the defining example of high-tech, but now it is struggling with adopting new technologies. Its companies are falling well behind rivals in the USA.

Just Microsoft and Apple are together worth more than every single public company in Japan combined. That's inclusive of all of their other companies, not just their once-dominant tech companies, which apart from Sony, just really don't have nearly the global influence they once did. Mobile phones are one of the largest and most value-adding markets in the world.

Japan used to produce a massive share of the world's mobile phones, and having a phone from Japan was considered a big deal because they were normally more advanced and more valuable than regular mobile phones. Now this lucrative market is dominated by companies from the US, South Korea, and China. The decline of technological dominance has hurt the economy in more ways than just missing out on selling mobile phones as well.

Within an economy, technology can also be used to make existing workers more productive. A single worker digging with an excavator will be able to do the same work as 100 laborers digging with shovels. And the utilization of technology carries this idea forward to almost any industry in an economy.

The more that an individual worker can make in a given amount of time, the more productive they are. And since economies are usually measured using gross domestic product, the collective productivity of all workers in that economy is very important, because there are really only three ways to improve GDP, or total economic output. The first is by getting workers to work for longer.

If 1 million workers in an economy can produce $30 worth of output in an hour, and they work 1000 hours per year, then that economy will have a GDP of $30 billion. If that economy instead got all of its workers to work for 2000 hours a year, then it will have doubled its GDP to $60 billion. Another way to do the same thing is to get more people in an economy to work.

This is measured using the workforce or labor force participation rate, which takes the total number of people over 16 who are working or are looking for work, and then divides it by the total number of people of working age, minus those that are imprisoned or otherwise institutionalized, which in some countries can make a big difference to these calculations. Labor force participation rate in a country like the USA and Japan is only around 63%, which means almost 40% of people of working age don't work. This can be because they don't need to, they can't because of a disability, or because they are supported by a partner or other family.

If a theoretical economy with 1 million workers doubled its labor force participation rate to 2 million workers, all other things being equal, it would also double its economic output. One of the most efficient ways to do this over the last 5 decades has been to encourage women into the workforce, as historically they have made up a large share of non-participating labor in paid positions. Now getting more people to work for longer only, well, works up until a point.

Eventually there may not be enough jobs to go around which can still produce as much value per hour as the economy expects. If Japan doubled its labor force and then doubled how many hours everyone was working in a year, it should theoretically quadruple its economic output. But what is more likely to happen is that overworked people fighting for fewer jobs end up producing something like $10 worth of value an hour, so only a very marginal improvement in total output is achieved, with a policy that will probably have huge social costs.

Today Japan's labor force participation rate is down from its all-time high, but only by around 5%, and that's from a time when work in the country was a lot more basic, so it was easier to just get a job without a specialized education. The USA by comparison has seen a much sharper decline in participation rate over just the last decade. Japan is also already notorious for overworking its people, as the country has a culture of putting in long hours even if they are not particularly productive.

It's good for impressing the bosses, but not particularly good for impressing the macroeconomists because it's going to be impossible to get the Japanese economy to achieve growth by asking people to work more if they are already working more than almost every other country in the world. Another option for achieving economic growth is just to have more people overall. More people means more workers, and it still means proportionally the same amount of labor participation can be maintained if people want to stay at home to raise a family or for whatever other reason.

The options for growing a population are having more children or bringing in people from abroad. Again, unfortunately, Japan sucks at both of these. Partially because of how overworked everyone is, Japan has one of the lowest birth rates in the world.

This problem is also past a tipping point now where a large enough share of the population is too old to have children, and they are putting more pressure on the younger generations to either directly or indirectly take care of them as they are too old to work or look after themselves, which leaves less time and resources to raise a young family. Now, a low birth rate is not unique to Japan. Most advanced economies in the world today are not having enough children to maintain their population, but they are instead relying on migration from countries with higher birth rates, which typically tend to be poorer to keep their population level steady or even drive controlled population growth.

This can cause a lot of problems for the poorer economies with higher birth rates that those migrants are coming from, because it's usually the best and brightest from those countries that are offered opportunities to live and work in advanced economies, which means that the countries that are least able to afford it are losing their best workers right after they've already invested resources into raising and educating them. We've already made an entire video on the potentially crippling effects of brain drain, so I don't want to repeat too much here, but for advanced economies, all of the harmful side effects are reversed, and for the most part, they only get the upside. Advanced economies get highly productive, tax-paying workers right as they enter the workforce, and they didn't even need to invest anything into raising them as children or educating them to become such a valuable worker in the first place.

Achieving economic growth by just bringing in more workers can often lead to a result that's better than the sum of its parts. All other things being equal, just adding equally efficient workers won't do much, because sure, production is increasing, but it's spread out over more people. An extreme example of this is that China has a much larger economy than Norway, but realistically most people would prefer to live in Norway because the quality of life there is much better, because each individual person is much more productive.

Now that is true, but migration can still increase economic output by a larger margin than the comparative increase in population, because most migrant workers will be, well, workers, as opposed to roughly 40% of the population that isn't involved in paid work in places like the USA and Japan, and they also tend to be more productive than the average overall. Skilled migrant workers in the USA for example earn significantly more than the national average, because the USA has the luxury of only picking the very very best workers that apply to live and work there, because a lot of people from around the world want to live there because the opportunities to live a great life are far more abundant than they would be in their home countries. So increasing the total population of skilled workers is also an effective way to increase total economic output.

If Japan was able to attract skilled migration at the same rate and at the same quality of the USA, it would very likely solve their economic stagnation within a decade. But Japan has been incredibly resistant to this strategy, and the real question is why? Well, Japanese is not a widely spoken second language, which makes it difficult for most people looking for a better opportunity to live and work to pick it over an English-speaking country, which is far more widely spoken.

The country is also just not as attractive in terms of opportunity. Their reputation for overwork is widely known, and that's not exactly the way of life that highly productive people are going to move countries to pursue. Thanks to ongoing stagnation, average salaries in Japan are also now significantly lower than in places like the USA, Canada, Australia, and Western Europe.

They were once comparable, or even higher, but that was three decades ago. Quality of life is also generally not as high, and it's important to address a potentially controversial side note here, Japanese housing. Japan, and Tokyo in particular, is often praised for its affordable housing, an incredible feat considering that despite all of the challenges we've already explored in this video, it's still the largest and most productive metropolitan area in the world.

Despite that though, homes in Tokyo are far more affordable than places in most other world cities, including those that are in countries that are poorer overall. The way that they've achieved this is a great case study into the factors that determine the price in an economic market. One thing the country has got right over cities that are notorious for unaffordable housing, is that development is a lot less restricted.

Housing can be built right alongside offices and factories, and there are few limits on how tall a building can be, so where a freestanding home might exist in a city like Sydney, a dense apartment building would most likely take its place in Tokyo. That has meant that there's an abundance of very cheap housing all over the massive city, and all throughout the country. The cost of comparable goods is one of the main things that determines the price of any good.

If a Toyota Corolla costs $100,000, but a Honda Civic costs $20,000, then Toyota wouldn't sell too many Corollas because most rational consumers would pick a comparable car that costs $20,000. The same thing would happen if a C-class Mercedes costs $50,000, but a Civic still costs $20,000. Most consumers just want a car that will get them from point A to point B reliably.

So Mercedes would really have to provide some alternative value to justify their car being worth more than two times another car that could achieve the same end results. That makes sense for cars, but most major cities around the world fail to provide the equivalent of that Honda Civic, which is cheap basic housing that will reliably provide convenient accommodation to workers, even those on a tight budget. Strict zoning laws and the huge value of land close to city centers means that it's just not worth it to build cheap housing, because expensive luxury apartments or freestanding homes would sell just as well and make more money, and in turn the reason that they will sell so well is because people don't have any other option.

Tokyo with its loose regulations around zoning and development has an abundance of cheap housing, which in turn pulls down the price of more premium options as well, because it gives buyers a cheaper comparable good. Another factor that determines price, which is particularly important to a lot of unaffordable homes around the world today, is the expectation of future value. Tokyo and by extension the rest of Japan was not always making headlines for its comparatively affordable housing, quite the opposite, it once had some of the most expensive real estate on the planet.

At the height of the Japanese real estate bubble a 10,000 yen note, worth around $200 USD today, would be worth less than the ground it would cover if it was laid on the streets of central Tokyo. The imperial palace at the heart of the city was said to be worth more than all of the real estate in California combined, which even back then was not a state famous for its affordability. The primary driver of these prices was the expectation that the prices would be even higher in the future.

This pressured people to buy either because they were afraid they would miss out on their opportunity to ever be able to afford a home, or because they wanted to profit from future price increases. Eventually the Asian financial crisis hit the country and burst this bubble as people quickly realised that Tokyo wasn't ever going to be home to 100 million people like was expected back then, and a surge of housing development was flooding the market with affordable homes. Japan also has incredibly high inheritance taxes with as much as 55% of someone's estate being taxed by the government for all of the passed down value over the equivalent of around half a million US dollars.

Big, expensive family homes or luxury apartments are therefore now seen as a burden, or at the very least something that is ultimately disposable, like a fancy car. The final factor that is worth mentioning that determines the price of a good like housing is the cost of complementary goods. Petrol is a complementary good to a regular internal combustion car.

If petrol cost $100 a litre there wouldn't be that much demand for cars. To stretch this, one of the most important complementary goods to housing is access to high-paying jobs. If workers in a particular region earn significantly more than anywhere in the world, then naturally demand for housing in that region is going to be higher, and people with their higher incomes will be able to afford houses that are worth more.

Today, a big reason why Japanese housing is cheap is because wages have been mostly stagnant for three decades. This was a very long side note already, but it also must be recognised as it relates to attracting skilled migrants into Japan to try and boost its economic output. Affordable housing might look like a great bonus on the surface, but another reason why this housing is so budget-friendly is because it's tiny and totally lacking the luxuries that most people enjoy in even developing economies around the world.

To a skilled migrant looking for a new place to call home, they could get established in a city where they could earn more, live in a nice big house and build wealth for themselves and future generations. Or they could live in Japan, where they'll be expected to work 80 hours a week, live in a tiny home built wherever there was room, and know that most of what they work for won't make it to their children. There are very strong economic and even moral arguments that what Japan is doing is the right thing here, but for people looking out for their self-interest it's just not a particularly enticing place.

Not that it matters anyway, because Japan has historically made school migration very difficult, and even workers who are able to make it in will find it difficult to integrate into a very insular culture that is not overly fond of outsiders. So if Japan can't improve its economic output through working its people harder or bringing in more workers, the last option is to increase how much its workers can make in a given hour of work. Increasing worker productivity is really the best way to increase economic output, because the other two strategies obviously have eventual limits.

People can only work so many hours, and an economy can only accommodate so many people before things get worse rather than better. Now as we explored earlier, the best way to increase worker productivity is by giving them access to better tools and technology, and that's really where Japan has failed. So the next question is, how did they lose their technological lead?

Japanese companies have been identified by economists as being incredibly conservative with any kind of new processes. The only reason they developed so quickly after the second world war was because that represented such a big shake-up that they were effectively starting from scratch, and resistance from established norms hadn't had time to work its way into new industries yet. Now industries across the country are right back to it, and leadership, which is mostly quite old, still thinks the best way to do stuff is exactly how they've been doing it since their peak in the late 1980s.

Again, Japan is a country that's been living in the year 2000 since the 1970s. Ahead of their time then, but way behind it now. Japan has also had very low inflation, which means that companies have found it incredibly difficult to raise the prices of domestic products, which in turn makes it harder for them to create goods that are going to compete globally.

The government of Japan has tried to fight this by basically doing what other governments around the world have been doing during covid, only they've been doing it since the early 2000s. But even despite massive increases in the money supply, Japanese households just chose to save the money rather than consume or invest. That is looking to finally be starting to change, as countries around the world had to correct for the inflation their covid stimulus measures caused, Japan welcomed it because it's exactly what they've been after for years.

Their companies had to, in the past, make public apologies for raising the price of their product by a few yen, the equivalent of a few cents. Now they have the opportunity to raise prices to levels that made more sense, so they could make a profit by making better products, rather than by cutting expenses and working their employees as hard as possible. The pandemic was just another shake-up, obviously not one nearly on the scale of the second world war, but it did shift the status quo enough for some significant changes to take place in a country that has otherwise been very resistant to change.

Beyond all of that, even if it didn't create these circumstances directly, the Japanese economy will be the beneficiary of new technologies and shifts in global geopolitics. The elephant in the room is that China is now doing a lot of the manufacturing that Japan used to do, but with the rise of friendshoring and onshoring and the relative slide of Japanese wages and currency value, it's once again looking like a very competitive alternative, especially when considering the reputation that Japan now has for producing goods of high quality. The Nobel laureate economist Paul Krugman, potentially the most influential economist alive today, said that in the short term, productivity isn't everything, but in the long term it's almost everything.

That was just a really cryptic way of saying that economists often spend too much time looking at output figures either on a national or individual level over the course of months or years, and those kinds of metrics won't have much of an impact on people's actual everyday lives. But over decades, the country needs to be aware of how productive its people are because it determines everything from the quality of life they enjoy to their global competitiveness. Japan has maintained strong living conditions despite its stagnation, and it's even doing certain things in its economy arguably even better than the west.

But if its productivity stalls endlessly, the world is going to grow up around it, and not only will it struggle to remain competitive, its own people could start to look for better opportunities abroad. Nobody can predict the future, least of all economists, but hopefully the projections are right and the economy of Japan can start maintaining long-term growth again for the good of its people and the global economy as a whole. In this video we talked about the stagnation of Japan's economy, but how did it get to be such an impressive economy after the devastation of world war 2 despite not having much in the way of natural resources?

Our sister channel epic economics explored this in a recent video which you should be able to click to on your screen now. Thanks for watching mate, bye.