This is the final part of the dialogue between Toyo Keizai special correspondent Richard Katz and famed economist Noah Smith. It was done on the occasion of the simultaneous publication of the Japanese translation of Katz’s book The Contest for Japan’s Economic Future: Entrepreneurs Vs. Corporate Giants and Smith’s book, Weeb Economy: The Weebs Will Save Japan. Weebs are fans of Japanese culture. Toyo Keizai journalist Misa Kurasawa moderated the discussion.
Katz: We've talked a lot on the supply side of things. That is, how to elevate the growth rate at full employment. However, economies cannot reach their potential without enough demand for all the goods and services being produced. Consequently, output per work-hour and real hourly wages must grow in tandem in the long run. Otherwise, the economy will increasingly depend on big chronic budget deficits or a weak currency to artificially generate demand.
This sort of “economic anorexia” is Japan’s problem. Real hourly wages have barely grown in the last quarter century, even though GDP per hour has grown substantially (albeit more slowly than in the US or Europe). Japan has the worst gap between productivity and wage growth in the OECD. This is partly due to the rise of low-paid non-regulars, but real wage growth has been tiny even for regulars. Nominal wages are still growing less than prices.
So Japan’s chronic budget deficits are not the cause of Japan’s problems, but a symptom of poor private demand.
Smith: The idea that wages have not kept pace with productivity is a myth perpetuated by a union-funded think tank in America called the Economic Policy Institute (EPI). Their report drew some very misleading graphs that have since gone viral.
The truth is that to produce the apparent divergence between productivity and wages, they made a few errors. They use different inflation numbers for the two series: overall inflation for GDP vs. consumer price inflation for wages. That’s a simple accounting error. There are two other errors as well. Once you eliminate these errors, you see absolutely no divergence between wages and productivity.
Katz: It’s not just the EPI. The OECD has report after report on the wage-productivity gap in most OECD countries, but worst in Japan. The OECD and Japanese government both compare GDP per hour using the GDP deflator and average real wages per hour using the consumption deflator. So, the method you call an error is standard.
Smith: The OECD is wrong. The OECD is making the same mistake.
Katz: Recognized authorities like the Japanese government and the OECD disagree with you, as do most economists. The mainstream debate is over what caused this problem.
Kurasawa: What should be done to raise wages?
Smith: Increasing productivity is the main way to increase wages. We wish that some sort of redistribution could get around the constraint imposed by slow productivity growth. But it’s not true.
Katz: Of course, better productivity growth is indispensable. If you don't catch four fish, your family can't eat four fish. Still, if one person eats three of those fish, the rest of the family is stuck sharing just one fish. In Japan, that “someone” is the corporate sector. Most of the profit increase over the past few decades has come from wage suppression.
Let me suggest three solutions. Firstly, keep doing something that has worked: raising the minimum wage by 3% a year. It should now be 3% adjusted for inflation. Over the past 15 years, this has lifted incomes for 20 million of Japan’s poorest workers, a third of the workforce.
Secondly, the non-regular workers who make up almost 40% of the workforce are paid a third less per hour, even for the same work. Japan’s law mandates equal pay for equal work, but the law is not enforced. France enforces its equivalent law, which is one reason the wage-productivity gap is not a problem there.
Thirdly, overall household income has been stagnant due to cuts in social security per senior, near-zero interest rates, and the rise in the consumption tax. I say: reduce the consumption tax. Pay for that by rolling back some of the tax cuts on big corporations. Corporations promised to use the tax cuts to finance more investment and wage hikes. But they have not done so. They’re hoarding the extra profits.
Smith: The way to raise wages is for companies to invest, invest, invest. Investment creates demand for labor, and that raises wages. Japanese companies are hoarding cash instead of investing in Japan.
The financial system needs to direct money toward companies trying to grow. I believe that restrictions on bank finance since 2002 have been a factor in this. Smaller companies don't have a giant pile of retained earnings cash, so they need bank loans to finance growth.
The financial system needs to focus on growing companies. The giants will not invest that much, given the shrinking number of people. Wages need to rise, but they can only slightly overcome the problem of population decline. Immigration is not big enough to solve that problem. So the answer is exports, exports, exports. Japan has to sell to the global market; that's the only growth market that Japan realistically has.
Japan’s exports account for just 22% of the GDP, compared to 44% for Korea and 50% for Germany. If Japan could export 40% of its GDP, that would provide a big growth market. Then companies will take that cash and invest it at home. That demand will feed wages. And then a virtuous cycle will be created. So, you get more domestic demand on top of it. It might take 15 years to get to that level.
Katz: I agree with you except that the last few decades have shown that we cannot assume that more investment would automatically solve the wage problem.
Then there’s Donald Trump. His policies will shrink global trade. How does Japan multiply its exports in that kind of world?
Smith: Trump’s actions will prompt Japan to realize that America is a shrinking share of the global export market, and it is shooting itself in the head. It will not be a big source of export growth even if the tariffs go away tomorrow. But look at India. Not too long into the future, Indians will be twice as rich as they are now and it has four times as many people as America. Its economy will be number three in the world. It is open to imports and wants good ties with Japan.
Europe really strongly disapproves of China's subsidies to its companies. What if they could buy Japanese stuff instead? Then there’s Southeast Asia. Everybody there is a weeb (a fan of Japanese culture). It, too, is growing rapidly.
So, even if China closes off its economy, and even if America declines, many other markets are out there. They've just got to change the orientation of companies to be a little more like Germany and Korea.
Katz: I expect Japan will do some of this. It really has no choice, because, even if the Democrats return to the White House in 2029, I don’t think the US will go back to normal so easily.
Here’s my concern. For the world economy to be stable economically and to address security issues, you need a benign hegemon. We’ve had three financial crises in recent decades, which would have been much worse except for the role America played, including enlisting China’s cooperation. What happens in the next crisis, especially if Trump’s trade war provokes it? Trump may let Putin seize much of Ukraine. If so, what will Putin do next? Poland is rapidly rearming out of fear that Putin may attack. China is trying to take advantage of growing distrust of the US. What does that portend? All those countries that you say Japan should export to will be growing more slowly due to Trump’s trade war.The world is becoming more anarchic, and that cannot be a good thing.
Smith: Let me point out that the world was anarchic in the late 1800s and early 1900s. There was no hegemon in 1870. The British had their empire, but weren't a global hegemon. They didn't police the seas and ensure freedom of trade. Japan did well during that time until the late 1920s.
There's almost never been a global hegemon the way there was in America in the 80 years after World War II. So, that’s been a very unusual time.
Moreover, an anarchic world favors smaller countries with more stable governments. And I think a hegemonic world favors large countries like China, the United States, and India. In an anarchic world, small countries that can act more purposefully will thrive. And I think that Japan is well-positioned there.
