Will Japan ever escape deflation?
Friday, January 27, 2006 at 03:30PM 
Although it has not showed in my writings here I have actually pondered for some time whether we were finally witnessing the Japanese economy emerge from the claws of deflation. The signs have certainly been there but trends are also pulling in the wrong direction as also reported by The Financial Times which has an interesting article about how the "Yen slips despite signs of Japanese inflation."
"The core Japanese price index rose by 0.1 per cent in the year to December, the second month in succession inflation has been positive, the first time this has happened since April 1998. (...) However the yen still fell (...)."
Now it all comes back to the question of deflation or no deflation. The central bank of Japan has to be increasingly vigilant about tightening policy especially when politicians claim that the deflationary spiral has not ended ...
"The yen’s lack of traction was partly due to fresh comments from politicians that deflation still existed and the BoJ had to be cautious in tightening policy. Indeed the GDP deflator is still indicating annual deflation of 1.4 per cent, while corporate services price data released on Thursday was also negative."
So are we coming any closer to answer the question of Japan and deflation? Not really, the article cited above does not provide any decisive answer but it perhaps shows that Japan is slowly getting there in terms of allowing and approaching the strutural changes needed to move ahead. Another answer could be that Japan's problems will endure and that the recent turnaround is part of a larger cyclical trend in which Japan hovers between deflation, mild deflation and slight inflation; this view articulated by Yoshitomi Masaru in a paper from 2004 entitled "Japan emerges from the shadow of inflation."
"One special feature of the deflation that has plagued Japan since the 1990s is that it has been moderate and cyclical. (...) As for their cyclical nature, just as there have been three identifiable business cycles over the past 10-plus years, there have also been three similar price cycles."
Another place where we could look for reasons why Japan has been experiencing a long recession is in the realms of demographics. Edward Hugh from AFOE and Bonobo Land has long been advocating the agening and essentially shrinking of the Japanese population as an explanation of the economic recession in Japan. In a guest-post at NewEconomist he makes a compelling argument ...
"There are sound theoretical reasons for expecting that there will be no sustained improvement in internal demand in Japan. Why? Well look at their median age. At 42.64 it's the highest on the planet. And since Japan has virtually no immigrants (as I said above, last year there was a net outward migration as young people move elsewhere in search of better prospects, more negative feedback) this age is set to rise and rise. So, when you come down to it there is no big mystery behind Japan's decade long recession, it has a straightforward explanation: the ageing of the Japanese population."
The argument is really interesting as we try to link the ratio of thrift relative to the demographic transition as described by the Swedish demographics researcher Bo Malmberg.
"Finally old age arrives, and once more people begin to save appreciable portions of their income, and consumer demand is flat, or even falling slightly."
Deflation is a strong driver of thrift and if an ageing population is as well who knows where Japan is heading?
Reader Comments (4)
What I think is called for here is prudence. And prudence is just what we aren't seeing. Too many people are talking as if the end of deflation in Japan was already a 'done deal' It isn't, and people should be balancing their risk basket much more evenly.
If we imagine for a moment a scale of 1 to 100, I am saying I think with a rating of 75 that deflation isn't over (remember that the latest data show the most consistent price rises since 1998, but the long recession started in 1989, and during the 90s we were here before). Most of the 'deflation warning over' people seem to be giving the possibility of continuing deflation a rating of around 25, and I am saying that this is not rational, the best they should feel able to go for is a rating of 50.
Why? Well when you assess a situation you have a mixture of theory and data. You can have strong theory grounds and strong data grounds (or the contrary).
Now since the evidence from Japan continues to be mixed, it is far too early for anyone to have *strong* data arguments, my side or the other one. OTOH I have theoretical arguments which I consider solid, so that lets me up my rating. The majority of the other side don't have such strong theory arguments, because quite simply they don't have a theory as to why all this has happened, or at least they don't have any kind of clear, systematic theory. So they don't have grounds for a strong call, and should stick to the 50 rating and keep a more open mind. That, at least, is my view.
Japan's problem is simply that it's not truly a capitalist economy; it is, rather, just about the most successful socialist economy there ever was. In the good times, they managed to increase production of some things by a set amount every year. See the table in the back of the book Revolution in Time on watch production, for instance (I have a twenty year old edition, so I'm not sure if a new one would show the same thing); it shows that they outdid even the old USSR with their ability to increase production of watches every year like, well, clockwork.
It's also a single-party state, ruled by the LDP. Everywhere else in the free world, the dominant party post-WWII has declined to the point where it now is either in the minority or in a strong competition that would have been unthinkable in the first decades after the war; the LDP is the only one that still doesn't really have to worry about its opposition. This political situation feeds directly into the economic situation, since it means that the old oligarchy has a stranglehold on everything, and isn't going to let anyone else in.
So, you have a single-party sort-of socialist state. Stagnation is a given once the initial stimulus from playing catch-up with the rest of the world is done with, and from the looks of it that game ended in 1990. The ageing of the population from a lack of immigration and from young people leaving are both effects of the causes above. Given a sufficiently dynamic, as in truly capitalist, economy, the young people would stay and the pressure to allow increased immigration would be enormous. That neither of these is true is telling.
"Deflationary recession" is the effect, but what is the cause ?
You say that ...
"The ageing of the population from a lack of immigration and from young people leaving are both effects of the causes above."
I see your argument and you point to some important structural characteristics of Japan's society which may all have some bearing.
My argument is that: If the ageing of a population is given as a result of an "all things equal" transition the demograpic factor should be seen as one of the main drivers (cause) of Japan's recesseion (effect).
The pivotal question then becomes what can a country do avoid a decline in its population and the subsequent challenges?
- Increase fertility (pro-natal policies)
- Encourage immigration
Indirect solutions:
- Make the gap between youth and pension larger; i.e. make people work longer. I hardly think Japan has this particular opportunity.
I am sure there is more ...;)
Ending my comment, I think that the points to which you point in stead shouldbe used to explain why Japan is unlike to remedy the fact that its population inevitably will get older.
In my view, Japanese civilization has completely lost its bearings. Native Japanese aren't interested in reproducing to maintain their population, and they are unwilling to assimilate immigrants. Negative population change eventually leads to zero population...