Dr. Tadao Umesao’s View of the World

WesternEurope

JapanDry AreaDry Area

Russia

China

India

Mediterranean & Islamic States

Eurasian Continent

Japanese Real GNP 1885 - 2000

Log(Real_GNP)

Growth_Rate

1885

1889

1893

1897

1901

1905

1909

1913

1917

1921

1925

1929

1933

1937

1941

1945

1949

1953

1957

1961

1965

1969

1973

1977

1981

1985

1989

1993

1997

3.0

3.5

4.0

4.5

5.0

5.5

6.0

-5.000

-3.000

-1.000

1.000

3.000

5.000

7.000

9.000

11.000

13.000

15.000

•Source: Hayashi and Prescott (2008)

•     One of the most destructive  earthquake in history , struck the Tokyo area in 1923.

•     The earthquake and the widespread fires it caused resulted the deaths of over 100,000 people and damaged more than 650,000 building.

•     As many as 45 percent of surviving workers lost their jobs because so many business were destroyed.

        

•     Economic disaster fed the dicontent of the leading military officials and extreme nationalist, or ultranationalist.

• western industrial powers, they pointed out, had long ago grabbed huge empires.

•  Japanese nationalist were further outraged by racial policies in the United States, Canada, and Australia that shut out Japanese immigrants.

• Economic downturn during 1930-32• 1. Hamaguchi, finance minister Junnosuke Inoue,

and foreign minister Kijuro Shidehara) deliberately adopted a deflationary policy in order to eliminate weak banks and firms and to prepare the nation for the return to the prewar gold parity (fixed exchange rate with real appreciation)

•  Externally, Black Thursday

• Military and right-wing movements emerged

• "Shidehara Diplomacy" which to them seemed too soft on China. Their primary goal was to "defend Japanese interests in Manchuria and Mongolia [more precisely, eastern part of "Inner" Mongolia]).

•

Minsei Seiyukai

Main supportersIntellectuals, urban workers Big businesses, rural landlords

Economic policy

Small government, free market principle, eliminate inefficient units through macroeconomic austerity

Big government, fiscal activism, public investment for industry and rural development

Foreign policy

Cooperate with US, oppose military invasion of China (protect Japanese interests through diplomacy)

Supporting military expansion, cooperate with military, if necessary, to undermine Minsei Party

Finance minister & economic policy in the 1930s

<Junnosuke Inoue, until Dec. 1931>Intentionally generate deflationReturn to prewar gold parity

<Korekiyo Takahashi, Dec. 1931-Feb. 1936>End gold parity and depreciate yenFiscal expansion (later, tight budget)Easy money

• Conservative Forces• Liberal Party (Yoshida Shigeru) led the peace treaty and

the US-Japan Security Treaty.• Democratic Party (Hatoyama Ichiro) objected the

“subordinate independence.”

• Progressive Forces• Socialist Party (Left faction) sought a revolutionary

transformation of capitalism at home and opposed to the partial peace treaty. .

• Socialist Party (Right faction) sought partial reform of capitalism and accepted the partial peace treaty.

• Communist Party lost popular confidence since they took violent actions suggested by Stalin

• The two conservative parties merged to found the Liberal Democratic Party (LDP).

• LDP would remain in power in the following 38 years. • Business Leaders financially supported.• The bureaucrats offered policy expertise and manpower

to the party. Leading midcareer bureaucrats left their posts to run for political office under the LDP banner.

• The two factions of the Socialist Party reunited

• Arisawa Hiromi (Economist U of Tokyo) and Tsuru Shigeto • Japan should develop natural resources (coal and

hydroelectric powers) • minimize interdependence, fearing foreign conflicts that

might endanger oil supplies.

• Nakayama Ichiro • only sustainable choice was to join the global economy,

by importing raw materials and exporting manufactured goods

• The followers of Yoshida Shigeru followed the American lead in containing the communist bloc.

• Hatoyama and his allies sought independence from US. They succeeded in normalizing relations with Soviet Union in 1956 without Peace Treaty.

• Japan must focus on economic growth

• Japan must avoid international conflict

• Rely on US for security• Follow US lead in international relations• Focus all energy on economic development

Yoshida Shigeru

Yoshida Doctrine details:• Focus on Growth

• Grow through export, export, export• Protect domestic industry• Focus on market share and growth, not consumer

satisfaction

Export-led Growth• Protect domestic firms at first• Demand that they export• Provide government assistance to direct

investment and to support export• Brilliantly successful for Japan (& later Korea, Taiwan,

Singapore, Hong Kong, & now China)

Standard (not Japanese) 1940s development model• Import Substitution

• Protect domestic industries, produce for domestic market• Import only raw materials and capital goods• Fails miserably: leads to debt and weak domestic

industries that never “grow up”

• Administrative Guidance• Control of import licenses• Control of capital allocation• Encourage collaborative R&D• Amakudari (descent from

heaven)

Chalmers Johnson’s Classic Study of bureaucracy in

Japanese economic development

• Founded 1949• Responsible for

• Deciding on the structure of industries and their distribution activities

• Guiding the development of industries and their distribution activities

• Co-ordination of Japan's foreign trade and commercial ties• Managing specific areas such as raw materials

• The LPD has a central position between the bureaucracy and business• Its uninterrupted tenure of office for the past decades was

a necessary guarantee of the government-industry relationship in Japan (Reading 1992)

• It assumes a central position between the bureaucracy and business, co-ordinating their interests and playing their referee

• The business world is represented by a number of organizations• The most important ones are the

• keidanren (Federation of Economic Organization), • nikkeiren (Federation of Employers` Association), • keizai-doyukai (Committee for Economic Development)• the Japan Chamber of Commerce and Industry

• Formal and informal consultation among the three players

• The bureaucracy maintains good access to the communication networks by practicing amakudari (descending from heaven), which removes retired bureaucrats from MITI etc into the LPD or into corporations to benefit from their bonds

• Strong interdependence with a clear mission• Cooperation is not always harmonious and the

centre of many scandals

• The biggest keiretsus :• Mitsubishi,• Mitsui, • Sumitomo, • Fuji, • Dai-Ichi Kangyo (DKB)• Sanwa

• Asahi Mutual Life Insurance (DKB)

• The Dai-ichi Mutual Life Insurance Company (DKB)

• Daiichi Sankyo• Dentsu (DKB)• Fujitsu (Furukawa)• Hitachi (Hitachi)• Ishikawajima-Harima Heavy

Industries (IHI)• Isuzu (IHI)• ITOCHU (DKB)• JFE Holdings (Kawasaki)• Kawasaki Heavy Industries

(Kawasaki)• Kao (DKB)

• K Line (Kawasaki)• Kobe Steel (Suzuki)• Meiji Seika (DKB)• Mizuho (Mizuho Financial

Group)• Seibu Department Stores

(DKB)• Sojitz (Suzuki)• Sompo Japan Insurance (DKB)• Taiheiyo Cement (Asano)• Tokyo Dome (DKB)• The Tokyo Electric Power

Company (DKB)• Tokyo FM (DKB)• Yokohama Rubber Company

(Furukawa)

• Affiliated `brother and sister` companies spanning different industries

• A typical Japanese firm has about 70 per cent of its shares held by other companies

• The shares are held by a large number of firms in relatively small fractional parcels

• Firm has some kind of transactional relationship with these corporate shareholders (banking, insurance, lending, supply of inputs, purchase of outputs)

• Firm holds shares in many of the these firms: the sharefoldings are reciprocal

• Firms hold each other`s shares as “stable shareholders“ (antei kabunushi) (Sheard 1994)

• Takeover is impossible• Companies also have other strong relationships

with each other, they are trading with each other

• Inflexibility• Criticism among companies is not• possible either• Also prevents access to the market for many

foreign companies in Japan

• Close long-term relationship between• banks and firms in the same group.• Banks “rescue” affiliated firms.• Banks place insiders on firms’ board (interlocking

directorates - parson).• Banks hold some shares.

• “Main bank” is a dominant lender for its affiliated firms.

• Avoid free-rider problem and duplication of monitoring and screening efforts.

• Long-term relationship makes shirking costly to• borrowers.• • Keiretsu firms have easier access to external• funds.• • Empirical Evidence• • Keiretsu firms rely less on internal funds

• Good firm and bad firm

• Debt holders face fixed payout.• Equity holders hold residual claim.• When firms are close to insolvent,• Equity holders have nothing to lose from

taking excessive risk.• Debt holders do not reap the benefits of risk

taking.• Debt holders prefer conservative investment• strategy.• Liability mix might be important to firm value.

• To (partially) solve adverse selection, screening is• important.• To (partially) solve moral hazard, monitoring is important.• Banks might be in a better positive to do both.• Banks observe cash flow closely (provided that

borrowers’ profit and loss enter into their deposits.• Banks solve “free rider problem” and duplication of

monitoring efforts in case of borrowers’ financial distress.• Banks must have incentive to do this, though.• Government bailout or deposit insurance partly reduce

this incentive.

Post “Ford” industrial model• Dr. W. Edwards Deming:

• Focus primarily on QUALITY• Use statistical analysis to measure and improve quality

• Empower shop floor workers to control and guarantee quality

• First presented ideas to US Automakers but was rejected

• Took his ideas to Japanese industrial leaders and they adopted them, leading them to become the world’s leaders in QUALITY

Dr. W. Edwards Deming

• There was another major political protests in Kyushu: The Mitsui Corporation’s Miike Coal Mine in 1960.

• Since then the conservative government deemphasized the drive for constitutional revision and confrontation with unions.

• The result was a new politics of high growth of the economy.

• Prime Minister Hayato launched the “Income Doubling Plan” to commit economi growth to double GNP by 1970.

• Chemical pollution-related diseases appeared in 1950s.

• Mercury poisoning struck and killed residents in southern Japan (Minamata-

• Kumamoto) and northern Japan (Niigata).

• Other notable protests:• Air pollution (Mie)• Cadmium (Jinzu River-

Toyama)

• Part 1• Part 2• Part 3• Part 4

• Postwar business cycles in Japan. One complete cycle consists of a period of expansion and a period of contraction.

Expansion RecessionTrough Length Average Peak Length Average(month) (months) growth month (months) grwoth- - - Jun, 1951 4

Oct, 1951 27 13.5% Jan, 1954 10 -3.7%Nov, 1954 31 10.1% Jun, 1957 12 5.0%Jun, 1958 42 14.0% Dec, 1961 10 3.7%Oct, 1962 24 13.3% Oct, 1964 12 4.1%Oct, 1965 57 14.4% Jul, 1970 17 3.9%Dec, 1971 23 7.5% Nov, 1973 16 -1.5%Mar, 1975 22 5.9% Jan, 1977 9 4.2%Oct, 1977 28 5.6% Feb, 1980 36 3.2%Feb, 1983 38 6.3% Jun, 1985 17 4.2%Nov, 1986 46 (as of August 1990)

• Most Japan's economic fluctuation were triggered by fluctuations in the international balance of payments.

The Bretton Woods Regime (1945) 1 dollar = 360 yen

Mechanism Japan's foreign reserves were relatively scarce. Japan had to keep the balance of trade (EX - IM)

positive. In boom, IM rose faster than EX. The Gov'nt raised interest rates and cut expenditure. Boom ended and contraction started.

• Postwar business cycles in Japan. One complete cycle consists of a period of expansion and a period of contraction.

• Source: The Japanese Economy, Takatoshi Ito

Expansion RecessionTrough Length Average Peak Length Average(month) (months) growth month (months) grwoth- - - Jun, 1951 4

Oct, 1951 27 13.5% Jan, 1954 10 -3.7%Nov, 1954 31 10.1% Jun, 1957 12 5.0%Jun, 1958 42 14.0% Dec, 1961 10 3.7%Oct, 1962 24 13.3% Oct, 1964 12 4.1%Oct, 1965 57 14.4% Jul, 1970 17 3.9%Dec, 1971 23 7.5% Nov, 1973 16 -1.5%Mar, 1975 22 5.9% Jan, 1977 9 4.2%Oct, 1977 28 5.6% Feb, 1980 36 3.2%Feb, 1983 38 6.3% Jun, 1985 17 4.2%Nov, 1986 46 (as of August 1990)

• Most Japan's economic fluctuation were triggered by fluctuations in the international balance of payments.

The Bretton Woods Regime (1945) 1 dollar = 360 yen

Mechanism Japan's foreign reserves were relatively scarce. Japan had to keep the balance of trade (EX - IM)

positive. In boom, IM rose faster than EX. The Gov'nt raised interest rates and cut expenditure. Boom ended and contraction started.

Floating Exchange Rate (1973) Two Oil Crisis (1973, 1979)The first oil crisis:

A sharp decrease in productivity due to high oil price. A delay in the restraining of demand => wild

inflation. One of worst postwar recession.

The second oil crisis:

Monetary policies were conducted carefully. Recession was long but not as acute as the 1st one.

Business cycles are caused by aggregate supply shocks rather after 1973.

Average GDP growth rate: 5.8% Exchange rate:$1.00 = ￥ 168 (1986)

$1.00 = ￥ 134 (1991)

Real estate price went up Stock price wend up: Change of the Nikkei Stock Index

=> Bubble Economy People buy stock and real estate at high prices because they

believe that other people believe that prices are going to increase =>Self-fulfilling mechanism

year 1986 1987 1988 1989 1990 1991index price (yen) 13136 18820 21217 30243 38712 24069

Average GDP growth rate: 1.3% Pretty Low! Exchange rate:$1.00 = ￥ 126 (1992)

$1.00 = ￥ 106 (2008)

Serious recession: ’90s as “Lost Decade” Real estate price went down Stock price went down: Change of the Nikkei Stock Index

Efforts to get out of the recession Zero interest rate policy by the Bank of Japan Aggressive fiscal policy

year 1992 1996 1998 2000 2002index price (yen) 23801 20612 19002 10825 14691

Firm's Bankruptcies and Total Debts of Bankrupt Firms

• Question: How can we explain the Lost Decade in Japan?• Old Keynesian Demand shocks cause recessions. Price and wage are sluggish. So, monetary policy must be done correctly. IS curve: Y = C(Y) + I(r) + G LM curve: M/P = L + k*Y – c*rY: Aggregate income, C: Consumption, I: Investment

G: Government expenditure, M: Money supply, P: Price,

r: Real interest rate

Fiscal policy and monetary policy increase GDP??

• Recent Agreements ”Real disturbances are an important source of economic

fluctuations; the hypothesis that business fluctuations can largely be attributed to exogenous random variations in monetary policy has few if any remaining adherents.”

Michael Woodford (2008)

Doubt on the effect of government spending: 'Multiplier effect' is not so big. Increase government's debts, which consumers have to

pay by tax in future. Monetary policy for stabilization by controlling people's

expectations.

Caballero, Hoshi and Kashyap (2006) Hayashi and Prescott (2002)

Japan's long recession could be attributed to a problem of Japanese financial system.

In the recession period, Japanese banks misallocated credit by supporting zombie firms.

Zombie firms – Low productivity firms, which should exit the market.

Non-zombie firms – High productivity firms, which should operate or start to operate in the market.

The existence of zombie firms interfered new entries by non-zombie firms.

Why banks kept lending to Zombies? Basel capital standards (International standards governing banks' minimum level of

capital) When banks wanted to call in non-performing

loan, they have to write off existing capital. The fear of falling below the capital standards led

many banks to continue to extend credit to insolvent borrowers, gambling that somehow these firms would recover or that the government bail them out.

Caballero, Hoshi and Kashyap (2006)

What accounts for Japan's lost decade? Neo-classical growth model:

Y = AKө(hE)1-ө

where A is aggregate TFP (Total Factor Productivity),

K is aggregate capital accumulation,

h is hours of work per employee,

E is aggregate employment.

Which component of Neo-classical growth model cause Japan's slow down over 10 year.

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

Source: Hayashi and Prescott (2002) What's the cause of the decrease in GNP, then?

Hayashi and Prescott (2002): Model Fit

Was the slow down caused by a break down of the financial system?

Hayashi and Prescott's (2002) answer is 'NO.'

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

• Choose one theory you like, explain why you think your choice is better than the other thoery.

Caballero, Hoshi and Kashyap (2006) Hayashi and Prescott (2002)

Business cycles in the prewar period was relatively large, and the balance of trade often triggered recessions.

After WWII, business cycles became relatively stable, and recession were mainly due to aggregate supply shocks.

Through 1990s, Japan experienced severe recession started with the burst of the bubble.

Caballero, Hoshi and Kashyap (2006) attributed the cause of the long recession to a problem in financial markets.

Hayashi and Prescott (2002) explained the slow down by negative productivity shocks.

Floating Exchange Rate (1973) Two Oil Crisis (1973, 1979)The first oil crisis:

A sharp decrease in productivity due to high oil price. A delay in the restraining of demand => wild

inflation. One of worst postwar recession.

The second oil crisis:

Monetary policies were conducted carefully. Recession was long but not as acute as the 1st one.

Business cycles are caused by aggregate supply shocks rather after 1973.

Average GDP growth rate: 5.8% Exchange rate:$1.00 = ￥ 168 (1986)

$1.00 = ￥ 134 (1991)

Real estate price went up Stock price wend up: Change of the Nikkei Stock Index

=> Bubble Economy People buy stock and real estate at high prices because they

believe that other people believe that prices are going to increase =>Self-fulfilling mechanism

year 1986 1987 1988 1989 1990 1991index price (yen) 13136 18820 21217 30243 38712 24069

Average GDP growth rate: 1.3% Pretty Low! Exchange rate:$1.00 = ￥ 126 (1992)

$1.00 = ￥ 106 (2008)

Serious recession: ’90s as “Lost Decade” Real estate price went down Stock price went down: Change of the Nikkei Stock Index

Efforts to get out of the recession Zero interest rate policy by the Bank of Japan Aggressive fiscal policy

year 1992 1996 1998 2000 2002index price (yen) 23801 20612 19002 10825 14691

Firm's Bankruptcies and Total Debts of Bankrupt Firms

• Question: How can we explain the Lost Decade in Japan?• Old Keynesian Demand shocks cause recessions. Price and wage are sluggish. So, monetary policy must be done correctly. IS curve: Y = C(Y) + I(r) + G LM curve: M/P = L + k*Y – c*rY: Aggregate income, C: Consumption, I: Investment

G: Government expenditure, M: Money supply, P: Price,

r: Real interest rate

Fiscal policy and monetary policy increase GDP??

• Recent Agreements ”Real disturbances are an important source of economic

fluctuations; the hypothesis that business fluctuations can largely be attributed to exogenous random variations in monetary policy has few if any remaining adherents.”

Michael Woodford (2008)

Doubt on the effect of government spending: 'Multiplier effect' is not so big. Increase government's debts, which consumers have to

pay by tax in future. Monetary policy for stabilization by controlling people's

expectations.

Caballero, Hoshi and Kashyap (2006) Hayashi and Prescott (2002)

Japan's long recession could be attributed to a problem of Japanese financial system.

In the recession period, Japanese banks misallocated credit by supporting zombie firms.

Zombie firms – Low productivity firms, which should exit the market.

Non-zombie firms – High productivity firms, which should operate or start to operate in the market.

The existence of zombie firms interfered new entries by non-zombie firms.

Why banks kept lending to Zombies? Basel capital standards (International standards governing banks' minimum level of

capital) When banks wanted to call in non-performing

loan, they have to write off existing capital. The fear of falling below the capital standards led

many banks to continue to extend credit to insolvent borrowers, gambling that somehow these firms would recover or that the government bail them out.

Caballero, Hoshi and Kashyap (2006)

What accounts for Japan's lost decade? Neo-classical growth model:

Y = AKө(hE)1-ө

where A is aggregate TFP (Total Factor Productivity),

K is aggregate capital accumulation,

h is hours of work per employee,

E is aggregate employment.

Which component of Neo-classical growth model cause Japan's slow down over 10 year.

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

Source: Hayashi and Prescott (2002) What's the cause of the decrease in GNP, then?

Hayashi and Prescott (2002): Model Fit

Was the slow down caused by a break down of the financial system?

Hayashi and Prescott's (2002) answer is 'NO.'

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

Hayashi and Prescott (2002)

• Choose one theory you like, explain why you think your choice is better than the other thoery.

Caballero, Hoshi and Kashyap (2006) Hayashi and Prescott (2002)

Business cycles in the prewar period was relatively large, and the balance of trade often triggered recessions.

After WWII, business cycles became relatively stable, and recession were mainly due to aggregate supply shocks.

Through 1990s, Japan experienced severe recession started with the burst of the bubble.

Caballero, Hoshi and Kashyap (2006) attributed the cause of the long recession to a problem in financial markets.

Hayashi and Prescott (2002) explained the slow down by negative productivity shocks.

GDP (or GNP): The market value of all final goods and services

produced within a country in a given period of time.

Plus income earned by its citizens abroad, minus income earned by foreigners in the country.

- Is Satoshi's salary at U included in Japanese GNP? GDP?

- Auto parts to make a Toyota car?

GNP = Aggregate Supply= Aggregate Demand in the long-run. (AS = AD)

Growth of GNP = Growth of AS = Growth of AD. AS : Ys = F(A, K, L), A: Technology, K: Capital, L: Labor. AD : Yd = C + I + G + (EX – IM)C: Consumption, I: Investment,

G: Government's expenditure, EX: Exports, IM: Imports.

Which components of AS and AD did contribute to the Japanese growth?

AS : Ys = F(A, K, L), A: Technology, K: Capital, L: Labor. Which components did contribute to the growth of AS?

Decomposition of Growth in Japan and US

Source: Denison and Chung 1976a, pp.98-99

Country Japan U.S.Period 1953-1971 1948-1969Average Growth Rate 8.81% 4.00%Contribution by FactorLabor 1.85 1.30Capital 2.10 0.79Technological Progress 4.86 1.91

• Decomposition of the Growth in Japan of the 60s and 70s

• Source: Shinohara, 1986, p.17.

Country Japan JapanPeriod 1960-1970 1970-1980Average Growth Rate 10.62% 4.84%Contribution by FactorLabor 1.59 1.01Capital 3.40 1.29Technological Progress 5.53 2.54

• Investment/GNP and Export/GNP in Real Terms

• Real Investment/GNP (solid line) and Real Export/GNP (broken line)• Source: The Japanese Economy, Takatoshi Ito.

The Japanese growth in 50s and 60s was investment-led growth.

Exports had been increasing continuously.