Optimism about Japan

01.11.05 Publication:

People often think economics is all about money and statistics and strange mathematical equations. But that is wrong: in my view, economics is really just a way of studying human behaviour, using money as its method of measurement. And one ingredient of that human behaviour that is often forgotten or left out is emotion. The reason is that it is hard to measure. Yet it is vitally important.

            Britain´s greatest ever economist, John Maynard Keynes, made his reputation during the Great Depression of the 1930s, when he explained how important it was for governments to use their public spending to rescue the economy in such circumstances. He also, though, highlighted another idea: the role of emotion, which he called “animal spirits”, in encouraging people to spend more of their money or (in the case of businessmen) to expand their companies. If everyone feels depressed, then they will not spend their money, and so the economy will stay depressed.

            This is important in Japan right now. Earlier this year, when I visited Tokyo, a book publisher told me a surprising thing. He said that it was currently better to write a pessimistic book about Japan than an optimistic one, because pessimism sells more copies. Of course, we both knew that the right thing to do is to write honestly, saying what you really think. But the observation was interesting: Japanese, he thought, were then in a pessimistic mindset, so they welcomed more pessimism.

            I recently visited Japan again, to make some lectures at the same time as I was publishing a new article about Japan in The Economist. My article was very optimistic: the title was “The sun also rises”. And my feeling, based on interviews and the audiences for my lecture, was that Japanese people had become more optimistic since my last visit. But they were still not as optimistic as I am, nor as optimistic as all the foreign investors who poured money into the Tokyo stockmarket following Prime Minister Koizumi´s election victory on September 11th.

            But why not? Why are Japanese “animal spirits” still depressed? The economic statistics have been getting better. Overall growth has been quite strong this year, wages have started to rise for the first time in about seven years, and more regular, full-time jobs are at last being created than the lower-paying part-time and temporary jobs that have been such a feature of the economy in recent years.

            Probably, the reason is that Japanese know that their economy has been in bad shape for 15 years, so that they shouldn´t get excited at the first signs of improvement in their lives. They also know that there have been periods of improvement in the past, such as in 1997-98, which proved to be short-lived. But there is also, I think, another reason: they have been told so often that an ageing society and shrinking population will bring heavy burdens to Japan that they fear that even an economic recovery will make no real difference.  Life is going to be tough, over the longer term.

            It is certainly true that a falling population and ageing society will bring burdens to Japan. But my feeling is that these burdens will not be so heavy as to make life hard and poor, and to justify pessimism. In fact, my view is that now that the economy is recovering from the sicknesses brought to it by the bursting of the bubble in 1990, it is likely to grow quite rapidly, easily overcoming the burdens of ageing. But if “animal spirits” stay depressed and emotions do not change, then that future success that I am expecting might not happen.

            The reason I am optimistic about Japan´s future success can be summed up in two words: technology and productivity. In the 21st century, with cheap-labour countries like China expanding rapidly, rich countries like Japan need advanced technology if they are to continue to get wealthier. And Japan is very good at that, especially in electronics and information technology, but also the future technologies such as biotechnology, robotics and nanotechnology.

            Over the past 15 years of post-bubble depression, that Japanese technology has continued to advance. No doubt the country needs to do better, especially if the universities could be improved to match the scientific standards of American universities. But it is still pretty good. This technological capability hasn´t been converted very effectively into greater wealth in the past 15 years because of my second word: productivity.

            Productivity means the amount of output, in other words money, produced by each worker. With better technology and more money invested in efficient machines, this should increase every year. But the post-bubble 1990s saw huge amounts of capital being spent unproductively, supporting bankrupt companies and in public schemes to build useless bridges and roads. At the same time, companies had too many workers and were reluctant to fire them, so productivity growth was low.

            The most important question in the economy now is whether that productivity growth can be increased. If so, wages and profits will rise, and the country can get wealthier. I think it can. Capital is no longer been wasted on supporting bankrupt companies or on useless roads. Unemployment is falling, which will soon mean that workers will be in short supply. This will give companies a big incentive to invest more of their capital in order to exploit technological advances and get more productivity from their workers.

            So I think there could be a helpful increase in productivity growth in the next few years. But will Japanese people believe in this optimistic view of the future enough to be willing to spend their money? Will businessmen be optimistic enough to invest their money in order to generate this productivity growth? That is where emotions, animal spirits, come in.

            It is very hard to know how to change people´s emotions. But I do think the speeches of politicians now need to change. Prime Minister Koizumi won his election by calling for reform, which implied that there are big problems that need to be solved. Now, he and his successors need to switch to optimistic language: that reforms are needed because Japan has big opportunities that can be grasped.