Japanese Malaise

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THE IMPACT OF SUPPLY-SIDE FACTORS ON JAPANESE ECONOMIC STAGNATION

Japan’s ongoing economic stagnation for decades has provoked wider debate in the US. Along with the raise in unemployment rate and weak industrial production relative to other major industrial countries, the economic malaise in Japan was described as a lost decade. Studies have shown that Japanese economy suffers of severe problems that are not only cyclical but also structural in nature. In this paper, I will shed light on the major cause of the prolonged slowdown of the Japanese economy by analyzing the impact of supply-side factors, including the decline in total factor productivity (TFP) and Japan’s aging population. The fall in TFP coupled with the effects of a shrinking labor force are attributed to the fall in potential output, leading to a contraction in investment demand, a saving-investment imbalance, a fall in nominal interest rates and the emergence of the liquidity trap. According to Hayashi & Prescott (2002), a major contribution to the productivity slowdown is that Japanese banks conceal their non-performing loans from inefficient firms by discounting lending rates regardless of the little likelihood of being recovered. As the result, banks restrain from providing the capital necessary for firms to adapt to changes through investment and the introduction of more productive technologies. Microeconomic theory suggests that in the market with low entry barriers, high-productivity firms will dominate and expand their production. However, this is not the case of the Japanese economy during the lost decade. The study conducted by Nishimura, Nakajima, & Kiyota (2005) find that the average TFP level of exiting firms was higher than that of staying firms in some industries. In addition, limited new entries and the small effect of reallocation of resources also account for the low level of TFP growth. Since 1998, the labor force size has...
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