Kiyohiko G Nishimura: Demographic transition, impact of ICT, and
globalization - a long view of the post-crisis world
Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Central
Bank of the Republic of Turkey, Istanbul, 27 August 2012.
* * *
Introduction: Turkey and Japan - friendship and cooperation on the rim of Asia
It is my great pleasure to visit the Central Bank of the Republic of Turkey, and I am especially
delighted to have the opportunity to speak before you on global economic issues that I think
are relevant both to Turkey and Japan.
Turkey and Japan are nations on the opposite sides of the rim of Asia, separated by a
distance of some 9,000 kilometers. However, the distance has not hindered friendship and
cooperation between the two nations in the past and the present. We must not forget that the
two nations faced the same challenges as they tried to modernize themselves in the second
half of the 19th century. It was in this context that the Turkish Emperor Abdul Hamid II sent
the frigate Ertuğrul to Japan with more than 600 men on board in 1889.
The voyage, as we
know, ended in a tragedy caused by a typhoon. Nonetheless, the rescue efforts of Japanese
locals and the subsequent exchanges of goodwill laid the firm foundations of the friendship
and cooperation between the two nations.
Today, the world, including Japan and Turkey, is facing many challenges, some of which
were caused by the recent financial crisis. On this occasion, I would like to share with you
some thoughts on issues that I have been thinking about for the last few years. These issues
per
are not directly related to current macroeconomic developments se, but relate to
medium- to long-term influences on the post-crisis global economic environment.
My presentation will consist of three parts. First, I will examine three emerging trends that
seem to define the post-crisis economy. These three trends are: mismatches in the labor
market, lower trend growth, and the end of wage disinflation. I will then turn to the possible
root causes of these symptoms. I will identify four: demographic trends, balance-sheet
adjustment, the influence of information and communication technology, and
globalization/polarization. Finally, I will conclude by discussing the policy implications of
these trends for the future.
1. Economy after the Crisis: labor market mismatch, low trend growth and
inflation - the United States and Japan
So, let me jump into the first part. What are the most important trends in the global economy?
Different people will surely have different views, but I believe the three most important
emerging trends in the post-crisis economy are: seemingly increasing mismatches in the
labor market, persistently lower trend growth, and the stalling momentum of services wage
disinflation. I will explain each in turn.
1.1. Increased mismatch in the labor market
An indicator of the increasing mismatch in the labor market - the first trend - is an outward
shift of the Beveridge Curve, which is a well-known way to illustrate the state of the labor
market. The Curve represents the relationship between the unemployment rate and the job
vacancy rate, or the ratio of the number of job vacancies to the sum of employment and job
vacancies. In its typical format, with vacancies on the vertical (y) axis and unemployment on
the horizontal (x) axis, the curve slopes downward, as a higher rate of unemployment
normally occurs with a lower rate of vacancies. Data points are expected to move up and
down the curve along with the business cycle.
The graph of the U.S. labor market on this slide shows that data points moved down on the
curve as the recession took hold in the early 2000s, climbed back up during the subsequent
expansion until they reached their high point in December 2006, then fell again after the
Great Financial Crisis struck, all the way down to June 2009. If we extend the data to June
2012, the data points climb back up again along with the recovery. Nevertheless, after about
three dozen data points, it seems sufficiently clear that we are not moving back up the old
curve, but along a new curve.
As I have said, the outward shift in the curve, which means higher unemployment for a given
level of vacancies, is usually interpreted as an indication of increasing mismatches in the
market. The implication is that, ceteris paribus, we would see a higher unemployment rate for
a particular stage in the business cycle. This development reminds me of what we
experienced in Japan ten years earlier, which you can see on the next slide. Data points after
the bursting of the bubble, shown in black, are clearly on a different curve.
1.2. Lower trend growth
As to the second trend, evidence for lower trend growth can be derived from Okun's Law,
which describes the empirical relationship between unemployment and the decline in a
country's output. In the next graph, annualized quarterly changes in the unemployment rate
and annualized quarterly changes in growth for the United States are plotted on the x and y
axes respectively. If we draw a regression line for the data points before Q4 2000, the
coefficient is -1.8573, which is broadly in line with the rule of thumb advocated by Okun: a
1 percentage point increase in the unemployment rate corresponds to a 2 percent decline in
output.1 The point where this line intersects the y axis, in other words the intercept of the
regression line, could be regarded as an estimate of the trend growth, given that such a rate
of growth would leave the unemployment rate unchanged.
Looking at the data after 2001, we can see that the relationship between unemployment and
growth has changed. The regression line is much flatter and has shifted lower after Q4 2000.
The change is more pronounced after the so-called Paribas shock of August 2007. This
implies that the trend growth is significantly lower than it used to be, at least for the time
being.
1.3. Stalling wage disinflation
Turning to the third trend, the next graph shows the changing relations between
unemployment and wage inflation in the United States. Wage inflation for a given
unemployment rate steadily declined in the service industries from the early 1980s into the
mid-2000s. In other words, there was a pronounced downward drift in the short-term Phillips
Curve. In the early 1980s, on the yellow line, wages increased by about 8 percent even when
unemployment stood at around 8 percent. Shortly before the Great Financial Crisis, wage
inflation did not even reach 4 percent as unemployment dipped below 5 percent. In other
words, we saw substantial wage disinflation relative to the 1980s or 1990s.
Having said this, the downward shift seems to have been more or less arrested in recent
years. The data points since Q1 2005, around the black line, seem to be resting comfortably
on this regression line. Statistically, the coefficient of determination (R squared) is 0.89.
Given that services account for more than 60 percent of household consumption
expenditure, it is not surprising to find inflation creeping up with the upturn in the business
cycle, even if unemployment remains stubbornly high. The recent movements in the trimmed
mean of U.S. PCE inflation on the next graph show this point. Here the trimmed mean PCE
inflation is usually regarded as representing the steady trend component of PCE inflation.
Turning to Japan, we can draw graphs that are quite similar to the U.S. ones that we have
just seen. In the next slide, while Okun's relationship is not very visible in Japan, regression
lines for periods corresponding to the U.S. example suggest that trend growth has indeed
declined in Japan as well. The short-term Phillips Curve after the bursting of the property
bubble in the late 1980s is also stable, as you can see in the next slide, and, as a result,
trend inflation as represented by year-on-year changes in the trimmed mean of CPI has been
edging up until recently, although the level of inflation is much lower in Japan.
1.4. Temporary or permanent?
Are these trends temporary or permanent?
Many in the United States certainly believe that they are temporary. One example is the table
on the next slide, which shows a projection made recently by the Congressional Budget
Office. Potential GDP growth may be lower in the period 2012-2013, but it is expected to
return to pre-crisis levels in 2014-2022.
Such a view rests on an assessment that the three trends result not from structural changes
but from the unusually large shock that was the Great Financial Crisis. More specifically,
these observers believe that the Beveridge Curve itself has not shifted: the data points are
just following a historical counterclockwise pattern during the upward leg of the business
cycle. They also believe that unusually large layoffs and subsequent rehiring in the face of
the shock could explain the deviation from Okun's rule of thumb. Accordingly, they tend to
recommend measures to jump-start aggregate demand, which would enable the economy to
return to its pre-Crisis trajectory in a relatively short time.
The problem with such a view is that reality is beginning to work against it. In particular, the
speed of the recovery has remained very slow, and is not expected to accelerate anytime
soon. The economy is not rebounding as rapidly as in previous business cycles. It is
becoming more difficult to refute the parallels with the Japanese experience since the
beginning of the 1990s, which I have just shown.
There are also differences with past cycles in the pattern of recovery. For example, the auto
sector enjoyed a relatively swift recovery, whereas the housing market shows little signs of
life even at the current extremely depressed levels. In addition, some historical research,
such as that presented by Reinhart and Rogoff, suggests that recovery from financial crises
tends to be slow and prolonged.2 The fact that not only the United States but also other
advanced economies are suffering from similar symptoms, and that emerging economies,
which initially weathered the storm fairly well back in 2008, are now visibly slowing down
makes us wonder if there are common threads that tie economies to a prolonged period of
sluggish growth.
I will explore these common factors in the next part of my presentation, but before moving
on, I would like to stress that I am not a fatalist. While structural factors play an important role
in the economy, and they may have a lasting influence, not all economic developments could
or should be attributed to them, and the economy can benefit from sensible aggregate
demand policies, including monetary policy. These policies can certainly prevent excessive
swings in aggregate demand, in both the upward and downward legs of the business cycle.
Policies can still be effective, but they must be formulated, adopted, and implemented with
the understanding that structural changes do occur, and when they do, this will change the
context and effectiveness of policies. It may be unfair therefore not to mention the potentially
profound changes related to energy costs resulting from the so-called shale gas revolution in
the United States, to which I will try to return in the final part of my presentation.
So, let me now move on to part two.
2. What lies behind mismatch and low trend growth: ageing, balance-sheet
adjustment and the impact of ICT on workplace, value chain, and globalization
In this part, I will try to explore the root causes of the trends that I have just observed. As I
laid them out at the beginning, these trends are: demographic trends, balance-sheet
adjustment, the influence of information and communication technologies, and finally,
globalization.
2.1. Demographic transition and reduced mobility and flexibility
The first force that I would like to identify is the effect of the transition from what we might call
demographic bonus to demographic onus. The two graphs on the next slide demonstrate this
for Japan and the United States. The black lines show the inverse dependency ratio. This is
the ratio of the working-age population between 15 and 64 of age to the rest of population,
who are dependent on the working-age population.
The inverse dependency ratio shows how many independent working-age persons have to
provide for one dependent person (in the form of pensions and expenditure on children). The
two humps in the graphs reflect the post-World War II baby boom: the first hump appeared
as the boomers reached working age, and the second as the children of boomers reached
working age while the boomers themselves had not yet retired. The pink and green lines
show real estate prices and the amount of bank loans outstanding respectively, both
adjusted for inflation and on a scale where the peak level equals 100. The striking feature of
these graphs is that in both Japan and the United States, the peaks in real estate prices and
loans have more or less coincided with the peaks in the inverse dependency ratio. The actual
peaks are about 15 years apart between Japan and the United States, but the pattern is
surprisingly synchronous. Similar experiences are observed in other countries as well.
There are several empirical studies, employing multi-country panel analyses, which conclude
that demographic changes have a significant effect on economic variables, such as property
prices and long-term interest rates.3 This comes as no surprise since, in the population
dividend phase, young baby boomers want to buy more land and save more real money for
their retirement. Since the supply of land is physically limited, the real price of land will go up.
Similarly, if nominal money supply is held constant, the "price" of real money holdings, which
is the inverse of the price level, should also go up, implying deflation. Being mandated to
maintain price stability, the central bank is then likely to increase nominal money to keep
prices stable. The result is an increase in property prices while general price levels remain
stable.4 At the same time, I should also stress that demography alone does not explain the
formation and bursting of asset bubbles. For example, excessive optimism, or the
"this-time-is-different" syndrome is also an important contributing factor.
Meanwhile, demography makes a lot of difference when a bubble bursts. Generally
speaking, the effects are expected to be much more pronounced under the demographic
onus of an ageing population rather than the demographic bonus of a young and growing
population. Let me offer two examples: reduced flexibility or mobility in the economy, and
more acute balance-sheet adjustments.
Older people tend to be less mobile or flexible than younger people. This is because older
people, with fewer productive years ahead, are more reluctant to incur various adjustment
costs, for example relocating to a different geographical area or obtaining new skill sets to
work in a different sector of the economy. This tendency appears not only in workers but also
in entrepreneurs. As a result, when the population ages and the proportion of older people
increases, the mobility or flexibility of the whole economy is likely to decline.
Reduced mobility or flexibility leads to prolonged mismatches in the economy: job seekers
may need more time to find a new job and entrepreneurs may be slow in exploiting new
business opportunities.5 Such a trend would depress productivity growth. I should add that
the effects of balance-sheet adjustment, which are aggravated by demographic onus, will
also magnify the loss of mobility or flexibility.
Such a trend was observable in Japan after its bubble burst in the 1990s. Even the United
States, which is one of the most mobile and flexible economies, has been suffering since its
housing market collapsed in 2006. There is a wealth of evidence of reduced mobility or
flexibility. For example, the slide (on page 20) shows that the mobility rate among house
owners declined substantially, by more than 30 percent on average, between 2005 and
2009. The fact that the mobility rate among renters did not change suggests that the change
was influenced by the decline in house prices during that period. The next graph shows the
rate of births of new business establishments. It can be said that the higher this rate is, the
more flexible the economy. Here again, there is a marked decline after 2005, which coincides
with the peak in the inverse dependency ratio.
Another example on the next slide shows immigration into and emigration out of the United
States. Immigrants are the most mobile members of the population and are generally
regarded as contributing substantially to the flexibility of the U.S. economy. The concurrent
decline in arrivals (inflows to the U.S.) and increase in departures (outflows from the U.S.)
once more suggests less flexibility in the United States. To underscore this relationship
between demographics and mobility or flexibility, I would like to show you the next slide on
Japan. After the bubble burst, there was a sharp brake on the creation of enterprises
whereas destruction increased only modestly.
2.2. Severe balance-sheet adjustment
Let me now turn to the second force, the severity of balance-sheet adjustments.
The next slide (on page 22) shows the changes in inflation-adjusted house prices. The graph
on the left compares Japan, the United Kingdom and the United States. It shows monthly
changes in real house prices relative to the peak price. The shape of the graphs is strikingly
similar. It took more than ten years for the Japanese real house price to hit the bottom at
almost one third of the peak price, when her population was ageing. While recent data for the
United States is often regarded as showing signs of stabilization in the housing market, it is
far from certain that downward trending is finally over, if one takes into account the possible
effects of an ageing population that the Japanese experience suggests.
Even without any further fall, a 40 percent decline in U.S. real house prices is a deep
adjustment. This has led to a significant divergence among industries in the pace of
recovery. Some industries are recovering much quicker than others. The proportion of
households that have negative equity has jumped since 2010 and continues to increase,
which leaves the U.S. housing market still in the doldrums. In contrast, the debt service ratio
is now markedly lower, reflecting the decline in interest payments as central banks eased
monetary policy. Consequently, U.S. auto sales have now recovered to a level closer to what
can be considered normal.
Another problem related to severe balance-sheet adjustments is the breakdown of the
market economy's natural selection mechanism. The role of financial institutions to channel
funds to productive enterprises can be obstructed when those institutions have significant
amounts of impaired assets. Suffering from severe balance-sheet problems, institutions may
find themselves with no other choice but to keep borrowers on life support, which prevents
them from extending new loans to more promising businesses. Such patterns were observed
in Japan during the financial crisis of the late 1990s. The market selection mechanism broke
down, and the survival of the fittest no longer applied to the world of business. So-called
zombie firms were supported by zombie banks.
Strong evidence of this phenomenon is found in a study I conducted with Nakajima and
Kiyota, the main conclusion of which I have included in the next slide. By conducting a
large-scale panel analysis at the firm level, this research was able to show that during the
period of the financial crisis of 1997, the total factor productivity of surviving firms was
actually lower than that of exiting firms.6
2.3. Impact of information and communication technology
The third force that is shaping the global economy is the impact of information and
communication technology (ICT). I argue that ICT has in fact been a polarizing force both in
the labor and product markets. Furthermore, the effects are not confined to specific
industries, but are more or less ubiquitous and far reaching.
Labor markets
The reason ICT impacts the labor market is that it can be applied to a variety of moderately
skilled tasks, and consequently displaces workers from those tasks. For example, banks
used to be inundated with paper. Payments were made in checks, slips of paper were made
to record transactions, which were in turn tracked on paper ledgers, and ticker tapes
provided up to the minute market information. Banks employed hundreds or even thousands
of clerks to literally push the paper around their offices, just to keep track of their operations.
Clerks were skilled in the sense that they had to know what was the important information on
those pieces of paper, and in which books such information was to be written down. ICT
changed all this. Now, virtually all bank transactions are processed electronically with
minimal intervention from human workers. As a result, the bank clerk has become extinct, or
at least an endangered species. Such changes occurred not only in banking but in all
industries. Any task that could be programmed was moved onto electronic platforms,
displacing workers in the process.
This could be the force behind the graph on U.S. employment according to worker skills,
which shows the greatest job losses after the Great Financial Crisis were those for
medium-skilled workers.
The next two slides (on pages 25 and 26) are schematic illustrations of this development.
Let us suppose that there were three broad types of worker defined by their skill sets and a
labor market for each type before the prevalence of ICT. We could label them: top
management or highly-skilled professional workers, middle management and
moderately-skilled workers, and manual laborers or low-skilled workers. Looking at the
supply curve for the three categories of workers, we would expect a steeper curve for more
skilled workers, since it is likely that there would be a smaller number of these skilled
workers. On the other hand, the demand curve would be determined by the marginal
productivity of workers, which in turn is equivalent to what employers are willing to pay
workers as wages. In this regard, employers should be willing to pay higher wages for more
skilled workers, because their marginal productivity is higher. The resulting equilibria for the
three types of workers could then be illustrated as in this slide (page 25).
The effects of the widespread application of ICT are shown on the next slide. The resulting
increase in productivity is reflected in the upward shift of the labor demand curve. Meanwhile,
the market for middle management and moderately-skilled workers is now gone because
tasks performed by those employees are easily replaced by ICT. Since the displaced
workers are not likely to have the skill sets required for the top group of workers, they will
probably have to compete for jobs with the manual labor or low-skilled workers. This will
have the effect of shifting down the labor supply curve for manual laborers or low-skilled
workers. The resulting equilibria would offer higher wages for top management or
highly-skilled professional workers, reflecting the shift in the demand curve, and only
moderately higher wages for manual laborers or low-skilled workers, reflecting the shifts in
both the demand and supply curves. In addition, the influx of over-skilled workers into the
market for manual laborers or low-skilled workers implies increasing mismatches.
What would happen if this mechanism were not allowed to play itself out for historical,
cultural or political reasons? Employers may be compelled to (or even be willing to) preserve
the status quo. In order to maintain the middle market for labor, employers cannot take
advantage of ICT, which becomes a drag on productivity growth. This may explain the
slowing of Japanese productivity growth since the 1990s. Historically, up until the 1980s,
Japanese firms benefited from the accumulation of firm-specific skills or knowledge in their
workforce, particularly among middle management or medium-skilled workers. Nevertheless,
the reluctance of firms to replace those workers with ICT since the 1990s, because of the
high cost of shedding workers, began to weigh on productivity. I have shown the
consequences of this empirically in a panel study of sixteen industries from 1981 to 1998.7
Product markets
Turning to the product market, ICT is influencing business organization and business
models.
As mass-production developed and economies of scale advanced from the latter half of the
19th century, the cost of getting the right inputs at the right time became more of a concern
to firms than the cost of the inputs themselves. Thus, the skills required to organize and
optimize the production process and product development became the source of profits. An
early solution to this problem was the vertically integrated firm based on the
"ore-to-assembly" operation exemplified by the Ford Motor Company's sprawling River
Rouge complex in Detroit. A later solution in the latter half of the 20th century was Toyota's
Kanban operation, which improved the interaction between the car assembly plant and its
various suppliers. In both cases, the knowledge and skills of coordinating a complex
production system and product development were the major source of profits, and thus
assemblers became profit centers. Though not as pronounced as in the automobile industry,
the same was true in other areas, including consumer electronics.
Considering that such skills boil down to communication and information processing, we can
understand why the impact of ICT has been so enormous, especially since around the turn of
this century. As ICT dramatically reduced the cost of interfacing between functions, it soon
became more efficient to procure products and services from specialized outside suppliers,
who could offer better products much cheaper by virtue of specialization and economies of
scale. If everyone is buying the same inputs from the same supplier, and the cost for
sourcing is leveled due to ICT, there will be less opportunity to differentiate any finished
product assembled from those inputs. Consequently, the assembly business became a
business of attrition. This is clearly manifested in the next slide (page 26). The operating
profit margin is depressed in the downstream: particularly for LCD TV set makers. The same
is true for solar cells, where assemblers (system venders) are suffering from dwindling profit
margins.
ICT also forced changes in business models in many sectors. For example, if you wanted to
distribute music in the mid-20th century, you had to cut a master disk from a recording, plate
it to make a die, stamp a piece of vinyl with the die to make a record, put the record in a
paper jacket and send the final package off to stores around the country. Each record sale
had to cover the costs involved in this process. This model did not change much even after
the compact disc was introduced in the early 1980s. Now, however, music is distributed
digitally: a recording, once converted to an appropriate format, can be copied an infinite
number of times at virtually no cost. ICT is making this transition to electronic delivery more
practical in many industries. Economics tells us the price of a product will be driven down to
the marginal cost of production. Thus, it is not surprising to see the price of electronically
delivered products falling ever closer to zero, which is the cost of reproducing such products.
These changes introduced by ICT have not only sealed the fate of traditional distribution
channels, but have also forced businesses to re-consider how they charge for their products.
The rise of platform businesses is perhaps one answer.
These developments in the product market interact with the labor market. When huge
integrated manufacturing firms are replaced by decentralized networks of smaller firms,
some of which are abroad, workers who were responsible for internal coordination are
released and replaced by ICT. At the same time, these smaller firms become more efficient
than before thanks to ICT, and tend to employ fewer workers to complete a certain task. As a
result employment creation in manufacturing is likely to stagnate. Furthermore, jobs are also
lost when existing distribution channels, which were a significant source of employment, are
replaced by electronic distribution. In contrast, now-flourishing platform businesses, by virtue
of being easily scalable, will not be hiring too many workers even if they grow rapidly in terms
of sales. Thus, the end result is a headwind in the labor market.
2.4. Globalization
ICT also influences globalization, which in turn affects developments in the labor and product
markets.
As is widely recognized, ICT has been one of the driving forces behind globalization. It has
greatly reduced the cost of communicating and coordinating across borders. Coupled with
the integration of former communist bloc countries into the global trading system, the horizon
has broadened considerably for locating business operations. Not only can firms now create
networks across borders in order to attain maximum aggregate output at minimum cost, but
they can also change them easily as conditions change in various corners of the world. If you
have chance to look closely at the content of your wardrobe, you will be surprised by the
wide variety of the countries of origin, even for seemingly similar items from the same brand.
A fashion brand may design a T-shirt, but it contracts out the production to specialized
factories around the world. The multitude of countries of origin on the labels shows that
brands are certainly not shy of taking advantage of an offer from a factory in Dhaka to make
a T-shirt more cheaply than a factory in Shenzhen.
Such practices put competitive pressure on wages across borders, and contribute to the
polarization of wages, because the benefit of increased profitability would accrue mostly to
top management or highly-skilled professional workers. Meanwhile, some multinational firms
might go one step further and directly play one country's workers against another's. These
firms might threaten to leave a country and reestablish themselves in another with cheaper
wages, thereby extracting concessions from existing workers. This would exacerbate
polarization by lowering the wages paid to manual labor or low-skilled workers.
Now, I am about to conclude my discussion of demographic trends, balance-sheet
adjustment, and the influence of information and communication technology, so before I
move on to the next part, I would like to summarize where I think we are. First of all, a period
of low trend growth is probably here to stay for some time, together with rigidities that may
become more entrenched. It is a problematic combination of factors that could reinforce each
other. Secondly, in such a state, economies would be more vulnerable to occasional
downward shocks. That could exacerbate inefficiencies. Finally, polarization may become
more pronounced, again aggravating general efficiencies.
This certainly is a challenging situation, but there are opportunities ahead as well. Let me
explain by moving on to the final part.
3. What lies ahead of us?
As I have just explained, in my view, the global economy, and the advanced economies in
particular, is affected by four strong undercurrents: demographics, balance-sheet adjustment,
the impact of ICT, and globalization/polarization. In this final part, since balance-sheet
adjustment is essentially a transitional (though prolonged) phenomenon and
globalization/polarization has been discussed extensively elsewhere, I will concentrate on the
other two, which have been changing the global economy permanently, but the significance
of which is grossly underestimated and largely overlooked by many observers. I would like to
think about where demographic factors and ICT will take us in the years ahead.
3.1. From demographic bonus to demographic onus
Firstly, the global population is now in the midst of a significant transition. One by one,
economies are watching their demographic bonus give way to demographic onus. Many
countries in East Asia will reach the turning point in around 2015, as you can see from the
graph on the next slide (page 27). Meanwhile, Latin American countries like Brazil and Chile
have a little more time, but are expected to face the transition in the years between 2015 and
2020, as you can see in the next slide (page 27). In short, many emerging economies are
going to lose an important engine of growth in t