Japan badly needs structural reforms, but not more than the rest of the G7 countries

A key critique of monetary easing in Japan is that Japan’s real problem is not monetary, but rather a supply side problem. I strongly agree that the Japanese economy is facing serious structural challenges – particularly an old-age population and a declining labour force. However, I also think that there often is a tendency for commentators to overstate these problems compared to supply side problems in other developed economies.

In this post I will therefore try to compare Japan’s structural problems with the structural problems of the other G7 economies – the US, UK, Canada, Germany, France and Italy.

The conservative US think tank Heritage Foundation every year produces an Economic Freedom Index. Even though one certainly can discuss the methods used to calculate this index I overall believe that the Index gives a pretty good description of the level of economic liberalization in difference countries. And yes, I do equate the level of economic liberalization with less structural problems.

The graph below shows the ranking of the G7 countries in the 2013 Index of Economic Freedom.

Economic Freedom Index G7

The picture is pretty clear. The Anglo-Saxon countries Canada (6), USA (10) and the UK (14) are significantly more economically free than particularly the interventionist South European countries France (62) and Italy (83).

Japan (24) shares the “median” position with the other large exporter in the group – Germany (19).

So while there certainly is scope for reforms in Japan it is hard to argue that Japan in general is a lot more interventionist than the other large economies of the world.

In fact it is also hard to argue that Japan has performed worse than the other G7 countries over the past decade. As the graph below shows Japanese GDP/capita has grown more or less in line with the other G7 countries since 2001-3. The real underperformer is Italy rather than Japan, which should not be surprising given Italy’s interventionist policies and excessive regulation.

A closer look at Japan’s structural weaknesses

But lets have a closer look at the data and see what Japan’s structural problems really are.

The graph below shows Japan’s relative ranking among the G7 economies in each of the subcategories of Index of Economic Freedom. I have indexed the average G7 ranking for each category at 100. The higher a score the more “free”.

Economic Freedom Japan 2Again the story is the same – Japan falls smack in the middle among the G7 countries when it comes to economic freedom – with an average for all the categories score of 101.

The breakdown of the numbers reveals both Japan’s relative strengths and weaknesses.

For example the Japanese public sector is relative small compared to the average of the other G7 countries and the Japan’s labour market is relatively free.

However, it is also clear that there are some clear regulatory weaknesses. This is particularly the case in the areas of trade, business, investment and financial freedom.

The three first of them all really is about an overly protectionist Japanese economy – both when it comes to foreign and domestic investors and I think it is pretty obvious that this is where the reform effort in Japan should be focused.

Mr. Abe please open up the Japanese economy

I really think it is straight forward. If Prime Minister Abe seriously wants to reform his country’s economy he needs to open it up to competition – both domestic and foreign.

In the domestic economy I would like other commentators highlight the lack of competition in the retail sector where for example the  “Large Scale Retail Location Law” tend to give artificial protection to small retail outlets (mom-and-pop shops) rather than bigger and more efficient retail shops such as hypermarkets.

Similarly zoning laws are hindering competition in the retail sector while at the same time is deepening the decade long Japanese property market crisis.

Finally I would note that interventionism in the agricultural sector in Japan is at least as bad as in the EU with price controls and very high levels of subsidies. Just see these scary facts from a recent WSJ article:

“In 2010, farmers added 4.6 trillion yen ($45 billion) in value and consumed 4.6 trillion yen in subsidies, meaning the industry netted out to zero. The average Japanese farmer is 66 years old and tills 1.9 hectares of land.”

This is hardly an efficient use of economic resources. The need for retail, housing and agricultural reforms therefor for seem to be very clear and this is where the focus should be for Mr. Abe when he fires off what he has called his “Third arrow” - structural reform.

Trade and investment liberalization will could enhance global support for Abenomics

Bank of Japan’s efforts to ease monetary policy has been criticized for being a beggar-they-neighbour policy. I think is a completely misplaced critique, however, it is indisputable that the outside world increasingly think of Japan as protectionist. I believe that a good way to calm these fears would be for the Japanese government to unilaterally remove all trade barriers and trade tariffs as well as opening up the Japanese economy to foreign investments. That would be in the best interest of the Japanese economy and would significantly boost Japanese productivity, while at the same making it very hard to the outside world to argue that Japan is protectionist.

The focus on monetary reform as been right and will support structural reforms

Even though there is an urgent need for economic reforms in Japan I fundamentally don’t think that the need for economic reforms is bigger than in France or Italy or even in Germany and I therefore think that the focus on monetary reform has been correct.

Furthermore, as the new monetary policy regime is likely to pull Japan out of deflation and boost economic growth (in the next 2-3 years) the Abe government is likely to get more support for implementing less popular reforms. Furthermore, as the new monetary policy regime is very likely to increase nominal GDP growth both public finance and banking problems are likely to be reduced, which in itself is likely to support real GDP growth over the longer run.

Concluding, the Abe government has gotten it more or less right on monetary regime (even though I would have preferred NGDP targeting to inflation targeting) and it is now time for Prime Minister Abe to prepare for his Third Arrow.

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3 Comments

  1. Benjamin Cole

     /  May 26, 2013

    Excellent blogging.

    I, too, find a great deal of difficulty in seriously comparing the structural rigidities of one country to another.

    Really, in the USA you have multiple layers of government—local, state, federal, special—each with varying degrees of interference in free markets. And, of course, some interference in free markets is necessary, as in, say, pollution.

    I am glad some outfits are trying to make comparisons among nations, and obviously some countries are better to do business in than others.

    But to assert that “Japan’s problems are structural” is stretching a point. Really, it is harder to do business in Japan than the USA? For what kind of business? Have you ever been sued in the USA?

    Besides, Japan had such structural problems in the 1980s, when they boomed (indeed, the USA was more regulated and had higher marginal tax rates in the 1960s than today, and the USA boomed in the 1960s). Monetary policy trumps.

    Japan’s problems are 90 percent monetary and 30 percent fiscal and 20 percent structural, to paraphrase Yogi Berra.

    Reply
  1. Let me say it again – it’s domestic demand (in Japan), stupid | The Market Monetarist

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