Japan experienced economic maturity and slowing growth in the 1970s-1980s after a period of high growth and catching up to developed nations. This was due to several factors: 1) Japan reached a high level of income and economic maturity by this time. 2) The oil shocks of the 1970s caused global stagflation which slowed Japan's economy. 3) Major currencies floating in the 1970s replaced the previous Bretton Woods system of fixed exchange rates.

1. Economic Development of Japan
No.11 Economic Maturity & Slowdown
YEN
OIL
TRADE

2. TOPICS – 1970s & 80s
• End of catching up, economic maturity
• Global stagflation in the 1970s
• Growth vs. inequality (and other social evils)
• Interpretation of the Japan system
• Current account surplus & international
politics – trade friction, exchange rate
pressure, systemic demands
• The 1955 Regime (LDP dominance)

3. Growth Slowdown in the 1970s-80s
• Japan’s economic maturity—income reached
the world’s highest level
• Oil shock and global stagflation
• General floating of major currencies
Catching Up: Real Per Capita GNP
(1995 dollars, conversion at actual exchange rate)
0
10000
20000
30000
40000
50000
US 10582 12060 13046 15454 17310 18754 21392 23858 26744 28157
Japan 776 1336 2127 3984 6962 11676 16486 15658 28912 40421
1950 1955 1960 1965 1970 1975 1980 1985 1990 1994
US
Japan
Per Capita Income at PPP
(US=100, price-level
adjusted)
0
20
40
60
80
100
1955 1965 1975 1980
Italy
UK
Japan
France
W.Ger.
US

4. 0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Japan
Singapore
Hong Kong
Taiwan
S. Korea
Malaysia
Thailand
Indonesia
Philippines
Vietnam
China
Speed of Catching Up: East Asia
Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the
Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating).
Per capita real income relative to US
(Measured by the 1990 international Geary-Khamis dollars)

5. Real GDP Growth (Fiscal Year – April to March)
Source: The System of National Accounts site, Cabinet Office.
Average 1974-90 4.2%
Average 1991-2010 0.9%
Average 1956-73 9.1%

6. The Cause of 1970s Stagflation
Supply shock view
• OPEC’s oil price hike was the main cause.
Aggressive wage hikes also contributed.
• Expansionary fiscal & monetary policy
accommodated and softened the blow.
Global monetarist view
• As US lost monetary discipline, the fixed rate
regime collapsed in 1971-73 and USD fell.
• Major central banks expanded money to
counter appreciation pressure, causing global
liquidity glut in the early 1970s.
• Oil shock was the result, not the cause, of
global inflation.
PP.188-90
AS
AD
P
Y
0
2
4
6
8
10
12
14
1960
1962
1964
1966
1968
1970
1972
1974
%
World Money Growth
Source: McKinnon (1979), p.264

7. Bretton Woods World Dollar Standard
• USA as the center country providing price stability to the world (“benign
neglect”: US to mind domestic affairs only); all other countries set “parities”
against US$ (“adjustable peg”). Gold=US$=other currencies
• 1950s-early 60s: American prices were stable; BW system achieved high
growth & price stability globally.
• Mid 60s-early 70s: US began to inflate & US$ was under downward
pressure (war in Vietnam, social welfare, space race with USSR).
• Gold=US$ link broken (1968); US$=other currencies link broken (1971-73:
Nixon Shock). Floating exchange rates began.

8. Monetary Growth and Inflation (12-month change)
-20%
-10%
0%
10%
20%
30%
40%
1965Q1
1966Q1
1967Q1
1968Q1
1969Q1
1970Q1
1971Q1
1972Q1
1973Q1
1974Q1
1975Q1
1976Q1
1977Q1
1978Q1
1979Q1
1980Q1
1981Q1
1982Q1
1983Q1
1984Q1
1985Q1
1986Q1
1987Q1
1988Q1
1989Q1
1990Q1
1991Q1
1992Q1
1993Q1
1994Q1
1995Q1
1996Q1
1997Q1
1998Q1
1999Q1
M2+CD
WPI
CPI
Monetary Growth and Inflation (12-month change)
Bretton Woods
fixed dollar
system ends General float
begins
1st oil shock 2nd oil shock
Plaza Agreement
Bubble
Bubble collapses
P.187

9. High Growth & Inequality
 Japan, Korea and Taiwan narrowed internal income
gaps (personal, sectoral, regional); but in China,
Thailand, Philippines, Indonesia, Vietnam, etc. income
became polarized during high growth.
 To sustain growth and achieve high income, three
policies are needed. In principle, they can be executed
separately—cf. “pro-poor growth,” “inclusive growth”
(1) Industrial policy—creation of growth sources
(2) Social policy—coping with new problems caused by
high growth: income gaps, pollution, migration, traffic,
congestion, crime & corruption, cultural change…
(3) Macroeconomic management under globalization—
coping with global business cycles, price shocks, huge
and unstable capital flows

10. Separability of Growth & Social Policies in
E.Asia’s Successful Latecomers
Economic growth
New social problems
Macro instability under
integration
Political stability
Developmental policies
Exit to a richer & more democratic
society (examples: Korea, Taiwan)
START
END
Supplementing
policiesA few decades later
Generation of
growth sources
- Social policies
- New macro
management

11. 0
20
40
60
80
100
Lowest20%
Next20%
Next20%
Next20%
Top20%
Japan (1969)
US (1972)
W. Germany (1973)
France (1970)
UK (1973)
Italy (1969)
Productivity Change by Industry (%/year)
-4
-2
0
2
4
6
8
10
12
Food
Textiles
Woodproducts
Paperandpulp
Chemicals
Oilandgas
Ceramicsetc.
Ironandsteel
Nonferrousmetals
Metalproducts
Generalmachinery
Electricalmachinery
Transportmachinery
Precisionmachinery
1954-73
1974-90
McKinnon-Ohno (1997) chap.2
Productivity
Slowdown
(estimated by labor-material
Cobb-Douglas prod. func.)
Income Distribution
(Lorenz Curve)
OECD Economic Outlook, July 1976
--Postwar land reform
--Agricultural subsidies (1955 Regime)
--Labor migration to cities

12. Sharing of Fruits of Growth between Rich &
Poor, Urban & Rural, Industry & Agriculture
• Japan around 1960s—direct (income) tax for redistribution,
rural-urban labor migration, SME support, fiscal policy in favor
of rural areas (public investment, agro subsidy & protection,
regional development plans, etc.); household Gini coef.: 0.31
(1963), 0.25 (1970)
• Korea around 1970s—Saemaul (New Village) Movement for
invigorating and improving rural life and production; regional
income gaps were small and even narrowed; regional Gini coef:
0.16 (1971), 0.08 (1981), 0.06 (1991)
• Taiwan 1960s-80s—Strong export-led growth driven by
vigorous SMEs
• Indonesia—Gini coefficient 0.32 in 1990, 0.33 in 2002, 0.41 in
2012.

13. The Japan System: Delayed Reform?
• After catch-up industrialization, Japan should have
changed its system in the 1970s
• However, large macro shocks (oil shocks, floating,
stagflation, trade disputes) diverted policy makers’
attention from structural issues.
• As a result, the Japanese economy continues to be
over-regulated even today.
Opposing view:
• Don’t copy US financial capitalism—trust, stability,
equity, patience, teamwork should be maintained.
PP.190-91
Long-term relations
Official intervention
Open markets
Private initiative

14. The 1940 Regime: Farewell to the War
Economy by Yukio Noguchi (1995)
• I would like to advance the hypothesis that the key
components of the Japanese economy today were created
during the war.
• The 1940 Regime--(i) production-first; (ii) suppression
of competition, (iii) social policies to reduce friction
• These alien systems were implanted to execute total war
(enterprise system, finance, bureaucracy, land reform)
and they continued as systemic core even after the war.
• They worked well for high growth, but not for coping
with change. Deregulation and consumer-oriented
society cannot be realized unless this regime is removed.

15. Kaikaku Gyakuso (Reform in
Reverse) by Hiroko Ota, GRIPS (2010)
• Prof. Ota was the Minister of Economy and Fiscal Policy
during 2006-2008 (serving PM Abe and PM Fukuda),
promoting economic deregulation and fiscal discipline.
• The Democratic Party government (2009-2012） has
reversed the economic reform and reintroduced past
policies that do not work any more:
– Fiscal activism & random subsidies leading to fiscal
crisis
– Economic deregulation was slowed down or reversed.

16. Mercantilist Pressure on Surplus Countries
Komiya (1994), McKinnon-Ohno (1997), McKinnon (2005)
When a country emerges as a new industrial power, it is often
criticized for unfair trader and an undervalued currency. Trade
and exchange pressures mount. But the trade gap cannot be
eliminated by currency appreciation or trade liberalization.
Ronald McKinnon

17. Elasticities Approach vs. Absorption Approach
in Financially Open Economies
Conventional view (elasticities approach)
• Exchange rate adjustment can reduce Japan’s trade surplus and
US trade deficit.
Fred Bergsten, W. Cline (IIE, Washington)
Krugman—the Mass. Ave. Model: Imports = f (yt, rert-2)
Friedman, Krugman— “daylight saving time” argument for currency float
PP.191-94

18. Our unconventional view (syndrome of the ever-higher yen)
• Thanks to wrong economics and Washington lobbying, the yen-
dollar rate was manipulated for mercantile purposes.
• But yen appreciation could not reduce Japan’s surplus and US
deficit, because it was structural (US savings < US investment).
The real solution was increasing US savings.
Current account = Y – A = S – I
• Intermittent yen appreciation only destabilized the Japanese
economy through recession, deflation and depressed interest rates.
Japan’s surplus
with US
1971-73, 1977-78,
1985-87, 1993-95 Pressure to
appreciate yen
Bilateral trade
negotiations
Persistent
trade gap
American responses
Reinforcement through failure

19. Exchange Rate Impacts Are Complex...
E Trade
balance
Competi-
tiveness
Inflation
Absorption
Monetary
expansion
(-)
offset
(-)
(+/?)
Pass-
through
Reverse
absorption effect
Yen
appreciation
Relative
price effect
LM curve shifts
Subject to M-L condition & J-curve
Price
channel
Quantity
channel
Engi-
neered
“Endaka fukyo” or
high-yen induced recession

20. --Countries with large foreign
exchange inflows often buy up USD
to resist currency appreciation
--However, having too much foreign
reserves may cause:
--Excess liquidity and bubbles
--Unbalanced asset position
--Exchange risk
International ReservesTrade surplus against US ($billion)

21. “Original sin” (inability to borrow in home currency)
• Developing countries that borrow in USD face
exchange risks in trade and debt payments. This may
lead to higher risk premium, higher interest rates,
balance-sheet mismatches, and the possibility of
currency crisis.
“Conflicted virtue” (inability to lend in home currency)
• Any high-saving country that lends in USD faces (i)
exchange risk on accumulated foreign assets, both
private and public; and (ii) accusation of unfair trade
and pressure to appreciate the currency by deficit
countries (esp. US)
• If the leading economy (US) is the largest lender, this
problem does not arise. In fact, it is now the largest
borrower.

22. Estimates of
Japan’s Net Liquid International Asset Holdings
(% of GDP)
-10%
0%
10%
20%
30%
40%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Private
Official
USD 1.17 trillion
Source: R. McKinnon, “Japan’s Deflationary Hangover: The Syndrome of the Ever-Weaker Yen,”
April 2007.

23. The 1955 Regime (LDP political dominance)
• The Liberal Democratic Party (LDP) formed in 1955,
held power until now (except 1993-96, 2009-12)
• Securing rural votes by subsidizing agriculture and
building rural infrastructure (firmly established by
PM Kakuei Tanaka 1972-74).
• LDP had many factions and zoku-giin groups
(politicians promoting subsidies in particular sectors)
• Opposition parties were too weak
to challenge LDP’s rule.
• Reform movement inside LDP
Koizumi reform—how successful?
Was it desirable?
Abe, Fukuda, Aso: weak PMs
Now second Abe?
P.178
LDP
Factions & zoku-giin
Other parties

24. Pure
dictatorship
Full
democracy
Democratic
institution
(Form)
Political
competition
Constitution
Laws
Parliament
Election
Court
Reform vs conservatism, big vs small
government, other policy debates
Edo
Meiji
Taisho
Fascism
Constitution
Parliament
Democracy
movement,
Party cabinet
Democratization
New constitution
Showa2
War
1937
1945-51 LDP dominance
Lack of policy debate
Male suffrage
1960US rule
Defeat
Showa1
1889
1925
1931
Military rises
1937-45
(Content)Political fights
Now?