Friday, July 14, 2017

East Asia and Economic Convergence

Japan's impressive post-WWII economic growth is a prime example of economic convergence -- Japan's GDP per capita went from a little under 40% of the US in 1960 to over 90% in the early 1990s. This is a classic prediction of the Solow growth model; poorer countries will have quick economic growth as they invest in capital and will slowly catch up to rich countries like the United States.
Then, all of a sudden, a recession in 1996 and the Asian Financial Crisis in 1997 hit, and Japan has been stuck at roughly 73% of US GDP per capita since then (the data from Fred end in 2010, but World Bank has data from 1990 to 2015 that show the same thing). A lot of ink has been spilled in pursuit of an answer to the question of why Japan has settled into a permanently poorer equilibrium, and I'm not sure if I have much to add. I am highly skeptical that demand side factors can depress an economy for more than two decades, especially when better cyclical indicators like unemployment and employment rates tell the opposite story. Japan's demographic transition is also pretty important -- the working age population has been shrinking since the mid '90s meaning that the amount of workers per person (and consequently GDP per person) has had downward pressure for quite a long time.

Regardless, a 20% reduction in GDP per capita relative to the US is pretty huge, and makes me question my expectation that technologically advanced countries with institutions that don't prevent growth from taking place (think North Korea or Zimbabwe) will unconditionally converge the wealthiest countries. Thinking about this led me to the other major wealth East Asian countries: Taiwan, Hong Kong, and South Korea (Hong Kong is technically a special administrative region in China, but some combination of capitalism and former British rule make it both rich and free enough to count as a separate country in this case).
As you can see these three countries look a lot like Japan did at various points in the past. If you compare at which year each country was in about the same position as Japan in 1960 (that is about 40% of US GDP per capita), you can see how far behind Japan they are in terms of convergence. Hong Kong is the furthest along, although it's about 15 years behind in its process of convergence while Taiwan and Korea come in about 16 and 20 years behind Hong Kong, respectively.

Hong Kong and Japan are the two more interesting cases here: both experienced large slumps in the late '90s that lasted well int the 2000s, but then things start to diverge. In the mid 2000s Hong Kong starts to take off while Japan remains plugging along at around three quarters of US GDP per capita. The real question is which is the exception and which is the rule. As a resident of Japan, a small selfish part of me hopes that Taiwan and Korea will eventually get stuck at around the same level as Japan, but it's really more likely that Japan is mired in its own problems and will continue to stagnate while the other countries grow.

This is easier to see when you look at labor productivity -- GDP per hour worked -- instead of GDP per capita, because things that affect hours worked per employee or the overall employment rate can actually misrepresent the state of convergence.
Labor productivity tells a slightly different story than GDP per capita; while Japan still shows stagnation at around 70% of US productivity after 1996, Hong Kong's recent impressive growth in GDP per capita seems to have been caused by a large increase in either employment rates or hours and Koreans have made up for slower productivity growth relative to Taiwan by working long hours.

Japan's collapse in GDP per capita in the late '90s seems to reflect labor market problems unique to Japan as opposed to evidence against convergence. Average hours worked in Japan has been declining for decades as people unable to find full time employment switch to low paying part time jobs ("バイト").
This is probably a symptom of an economy that has been weak for more than 20 years -- the unemployment rate only recently fell back to the level of the late 1990s -- and has little to do with Hong Kong, Korea, or Taiwan. All four regions do face low fertility rates and will likely start being affected by the same demographic transition as Japan over the next few decades, but as long as they avoid a mass transition to part time employment they should look forward to some combination of fewer hours and higher GDP.

The reason for Japan's slowdown in productivity growth still evades me. I find it hard to believe that it's normal for a country to just stop converging with productivity 30% lower than the US, but I guess Hong Kong, Korea, and Taiwan will be a test of this as they either continue to grow or stagnate relative to America over the next few years.

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