Randall Jones, Head of Japan/Korea Desk at OECD (L); Richard Solomon, Editor-in-Chief, Beacon Reports (R)
As the OECD and the IMF call for an urgent collective response to sluggish worldwide demand, Beacon Reports asked OECD top Japan economist Randall Jones to put Japan’s economy into global perspective. The OECD (Organization for Economic Cooperation and Development) is a club of 34 mostly rich nations which provides member states with a forum for sharing policy experiences. They aim to improve global economic and social welfare.
Mr. Jones became interested in Asia, aged 19, when he worked in Korea as a missionary. Afterwards, he studied Chinese and later Japanese while earning a PhD in economics at the same university where economic scholar Gary R. Saxonhouse taught. On graduation, Jones worked briefly for The White House’s Council of Economic Advisors, and then a spell at The Japan Economic Institute, before working as an economist under George Schultz at the State Department. Jones joined the OECD in 1989 where his title is Head, OECD Japan/Korea Desk.
From OECD Paris headquarters, Jones drafts the ‘OECD Economic Survey of Japan’. The policy review, produced once every two years, gently pushes Japanese policymakers in the direction the OCED and its member countries think best. The result is a by-product of an exchange between member states, including 15 representatives from Japan’s ministries. The final text gets ‘negotiated’ and made more diplomatic than it would be in the original version. “Sometimes representatives of the 34 countries agree on issues but can’t publish them for political reasons and sometimes they don’t agree. Either way, it’s an interesting way to work,” he says.
What does Jones believe are Japan’s most important economic issues? These include weak private consumption and continuing concerns over the labor market. Wage growth is needed to lift private consumption. Increased labor productivity is needed to grow the economy back to fiscal sustainability. “The OECD is worried about the fiscal situation in Japan,” he admits.
We also posed some difficult questions: Would the minus interest rate policy work to end the deflationary mindset? Should Japan launch additional fiscal stimulus focused on public investment? Did he recommend a ‘haircut’ wealth tax on high net worth individuals? Would it take a crisis to kick-start meaningful reforms?
Jones says that global growth remains ‘elusive’. World trade, a key driver of the global economy, grew twice as fast as world output in the 1990s. It then collapsed during the 2008 financial crisis, only to bounce back to disappointing levels. As a result, global growth in 2016 would not exceed last year’s 3% sluggish rate.
China’s ‘rebalance’ only intensifies the impact of sluggish world trade growth on Japan’s economy. China is Japan’s largest trading partner. Exports of manufactured goods to China represent 3% of Japan’s GDP. China’s slowdown and shift away from manufacturing towards domestically produced (and consumed) services have therefore been a double punch to Japan.
Further, Japan’s aging and declining population is a factor slowing growth over the long run. “All OECD countries are aging to some extent, but here the headwinds are most severe because the aging is happening so fast,” notes Jones. Those headwinds will intensify as population decline speeds up in future years. Because of a shrinking labor force and slower productivity growth, Japan’s potential growth rate is only 0.4%. “This is not an economy that at present can grow 2% year in and year out,” says Jones, highlighting that Japan needs faster growth, preferably 2% in accordance with government targets.
The government’s medium-term fiscal target aims to put the public debt ratio on a downward trend after 2020. That might be possible if all three arrows of Abenomics were firing simultaneously. Wider and deeper ‘third arrow’ reforms are needed to double labor productivity growth from the present rate of 1% to 2%.
To achieve that, Jones argues the workforce must become more efficient. Low labor productivity holds back Japan’s per capita GDP, which ranks only average among OECD countries. One cause of lower productivity is that Japanese work long hours. Shorter work time could boost productivity while improving work-life balance. Another is that technological advances fail to filter into the general economy. Citing evidence of a dual techno-speed global economy, he says that technological advances driving big global firms are not being adequately diffused into other companies — a problem which exists throughout the OECD area. These ‘frontier companies’ enjoy strong productivity growth, while the rest languish.
Global productivity growth is trending downwards, in part because of a lack of creative destruction. The same problem exists in Japan, where only 29% of the nation’s 300 largest firms (by market capitalization) have been created since the 1960s, compared to 79% in the US. In fact, most big companies in the US were established in the 1980s, 1990s and 2000s. Japan, he says, lacks the economic dynamism of the US where small startups can more easily grow into big efficient companies. Such companies lower production costs and drive economic growth.
Labor market reforms he says are needed to speed up creative destruction. The increased economic metabolism would shift resources and workers away from declining firms into growing new and dynamic ones. It would also create much needed investment opportunities for corporations that today hoard cash.
A key objective is to end Japan’s dual labor market, now split between regular workers with permanent contracts and non-regular workers holding mostly temporary jobs. Firms hire non-regular workers in part to enhance employment flexibility, allowing them to adjust their labor forces to better compete in global markets. However this creates poverty in society as non-regular workers earn about 40% less per hour. With few chances to move into regular jobs, they also suffer from reduced social mobility.
Consider two graduates of the same year with the same qualifications: One becomes a regular worker and the other a non-regular worker. Twenty years later their wages have diverged. The regular worker’s pay rises with seniority and job training, while the non-regular worker’s career stagnates. “It is creating an inequality problem. It’s a big worry,” thinks Jones.
The best solution, rebuffed by those with acquired rights (notably high employment protection), is to abandon labor dualism in favor of a system which treats all workers the same. As a second-best approach, Jones points to a few European countries which are moving to ‘grandfather’ worker rights. Under this system, workers who already enjoy lifetime employment get to keep it, while new workers have to accept a more flexible labor contract.
Ending dualism is important for securing Japan’s future, he says. It would help reduce the current labor shortage by increasing the number of women willing to rejoin the labor force after an absence. “If you’re a woman with a degree from Tokyo University, why work (i.e. rejoin the labor force) at 60% of the wage of a regular job if your husband has a good salary,” he asks? Dualism helps to explain why the number of women in Japan’s workforce is not as high as in many northern European countries.
Jones supports the government’s initiative to create 500,000 new childcare places by 2018. In Korea, he notes, the government requires that big companies provide on-site childcare facilities. As Japan’s population declines, he reckons the private sector will find alternative solutions. “They’ll have to make that possible by changing pay strategies and by providing childcare. It will happen even if the government doesn’t help,” he says advising, “The Japanese government should start moving now in that direction.”
He thinks that labor market dualism may be one reason labor shortages have yet to increase wages. “US and European companies would be poaching workers from another company, driving up wages,” he says. That’s not happening in Japan, suggesting that firms are replacing regular workers with non-regular ones at lower wages. “We would like to see non-regular workers become regular workers at higher wages. That would create more private consumption and more growth,” he argues.
Yet private consumption, which currently accounts for 60% of Japan’s economy, remains weak. ‘Rush demand’ increased consumption in the run up to the 2014 VAT tax hike, before it returned to 2012 levels. Are Japanese consumers satiated? Do they have everything they need? Jones rejects such notions. Nevertheless, he worries there will be another case of ‘rush demand’ in the run up to the next tax hike in 2017, followed by a similar retreat, if there are not enough wage gains before then. Without increased private consumption, he predicts that “growth is going to continue to be weak”.
Higher wages must be paid to definitively end Japan’s deflationary mindset. But if people think prices will fall, they accept lower wages. Companies then charge less and the deflationary cycle continues. Therefore, Jones believes the Bank of Japan (BOJ) must do ‘whatever it takes’ to reach their 2% inflation target. Core inflation, which excludes food and energy prices, has been rising. But the decline in oil prices (which is good for consumers and also is causing havoc in financial markets) has dragged the headline inflation rate down to near nil.
Growth alone will not produce enough tax revenues to reduce Japan’s debt, currently the highest among advanced nations, down to sustainable levels. Measures are necessary to create higher tax revenues. In addition, it is necessary to contain the growth of public spending — notably on pensions, health and long-term care. Still, the government does not have to pay off its debt all at once. “They just have to get it on a downward trend to show that it’s not going to rise forever,” he says adding, “then people will have confidence the problem is under control.”
To ensure Japan’s fiscal sustainability, Jones urges the Abe administration to speed up the reforms. Japan still has time because its people own most of the nation’s debt, removing an external trigger which might cause capital flight. The yen, after all, remains a safe-haven currency.
Would minus interest rates help to end deflationary expectations? Jones believes that minus interest rates, already in use in Europe, may help to end deflation by encouraging firms to invest more. It is just another arrow in the central bank’s artillery that achieves some of the same objectives as quantitative easing. As a bonus, the policy reduces the number of JGBs the BOJ needs to buy.
He is less enthusiastic about public investment. Japan has launched at least a dozen public investment-centered spending packages since the bubble collapsed in the early 90s. None have worked to produce more private demand. “If you can convince me that that would generate more private investment and more consumption, I would say ‘go ahead’,” he says.
Nor was he keen for the government to levy a ‘haircut’ wealth tax on the assets of high net worth individuals. The OECD usually recommends property tax as a better alternative. Not only is it an efficient way to pay for social services, but it is less distorting than other taxes. Increased property taxes have a reduced negative impact on investment and the labor supply, because people typically don’t give up home ownership as a result.
Jones has hesitated to recommend increasing property taxes in the past as nationwide land prices have fallen for 23 years. Given the changing upward trend in property prices in some parts of Japan, “I think it’s something that now should be put on the table,” he says.
The top OECD economist is optimistic about the nation’s future. Japan successfully adapted when faced with challenges during the Meiji Restoration and after WWII. It would continue to adapt. While it is best for countries to avoid such crises, should one occur in the future, he hopes it would be used to good advantage: “Don’t let a good crisis go to waste,” he says, pointing to the Korean financial crisis of 1997 as an example of one which “got many things changed in a good direction.”
On a final and personal note he adds, “I believe Japan is a model to the world in many ways. Its influence is positive. The world needs a strong, open and outgoing Japan. I say this not only as an economist but as an admirer of Japan.”
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