Krugman Wrong on Japan's Demographics and Stagnation

Beat the Press: 

BTP doesn't ordinarily focus on blogs, but Paul Krugman's blog is widely read, and most of us expect him to be right, so it is a big deal when he gets an important point wrong. This morning hetold readers that part of the explanation for Japan's decline in per capita income relative to the U.S. is due to its aging population. He argues that his has led to a drop in the percentage of working age people in the population, which has led to a drop in per capita output.

A quick trip over to the OECD's data base tells a somewhat different story. While the ratio of working age people to population did fall in Japan over this period, we also see a rather dramatic decline in average hours worked per worker. Average annual hours per worker dropped by 7.0 percent from 1992 to 2008.

This indicates that there was no shortage of potential labor in Japan over this period. If Japan had pursued policies that generated demand, there is no reason to believe that its workforce would not have supplied the necessary labor, inspite of the decline in the percentage of working age people in the population. In other words, Japan's economy was demand constrained, not supply constrained.

This doesn't mean that there are not circumstance under which Japan's population could become supply constrained, it's just that these circumstances did not exist in the stagnation of the last 18 years. This is sort of like a baseball team that is reduced by injuries to 23 players on its roster (rather than the usual 25), which gets beat 24-2 as a result of an awful performance by its starting pitcher and the early relievers. It may matter at some point that the team only has 23 players to draw upon, but that would not have been the issue in this particular loss.

This point is important because there is a whole industry devoted to scaring the public about the demographic changes that the United States is now experiencing. While these changes will certainly affect the economy, they will not be the main determinants of living standards. The success or failure of economic policy will dwarf the impact that projected decline in the ratio of workers to retirees will have on well-being.