Friday, March 05, 2010

Does a similar fate await you and me?

Ken Rogoff on Japan:

Unfortunately, as well as Japan has held up until now, it still faces profound challenges. First and foremost, there is its ever-falling labor supply, owing to extraordinarily low birth rates and deep-seated resistance to foreign immigration. The country also needs to find ways to enhance the productivity of those workers it does have.

Inefficiency in agriculture, retail, and government are legendary. Even at Japan’s world-beating export firms, reluctance to confront the ingrained interests of the old-boy network has made it difficult to prune less profitable product lines – and the workers who make them.

As the population ages and shrinks, more people will retire and start selling those government bonds that they are now lapping up. At some point, Japan will face its own Greek tragedy as the market charges sharply higher interest rates.

The government will be forced to consider raising revenues sharply. The best guess is that Japan will raise its value-added tax, now only 5%, far below European levels. But is it plausible to raise taxes in the face of such sustained low growth?

Investors who have bet against Japan in the past have been badly burned, grossly underestimating the Japanese people’s remarkable flexibility and resilience. But the fiscal road ahead looks increasingly perilous, with political consensus fraying badly in recent years.

In the end, are foreign leaders right to scare their people with tales of Japan? Certainly, the hyperbole is overblown; the Chinese, especially, should be so lucky. But nor should apologists for deficits point to Japan as reason to be calm about outsized stimulus packages. Japan’s ability to trudge on in the face of huge adversity is admirable, but the risks of crisis ahead are surely greater than bond markets seem to recognize.

Via Greg Mankiw.

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