Japanese officials are gripped by anxiety about the state of their country’s economy, considering it to be structurally uncompetitive and in terminal decline. Yet the reality is quite different. Japan may not be the economic juggernaut it once was, but reports of its demise have been greatly exaggerated.

Japan sees itself—and is commonly viewed by others—as the worst student in the class in terms of economic performance. The country that once inspired the best-selling book Japan as Number One: Lessons for America by Harvard’s Ezra Vogel now frets about a host of perceived economic shortcomings. Japanese complain of their country’s slow growth and big government debt, and they worry about deflation and Japan’s rapidly aging population. They point to labor-market inflexibility and claim unemployment is more widespread than official rates indicate. They also contend that Japan seems unable to attract foreign investment and suffers from sluggish exports and a deterioration in its balance of payments—all the familiar refrains of struggling business executives and beleaguered policymakers across Europe and the United States. A controversial hike in consumption taxes to deal with the country’s budget deficit has only increased concerns.

Uri Dadush
Dadush was a senior associate at the Carnegie Endowment for International Peace. He focuses on trends in the global economy and is currently tracking developments in the eurozone crisis.
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These economic worries are compounded by political and geopolitical ones. The debate about whether Japan should reopen its nuclear plants in the wake of the March 2011 accident at the Fukushima Daiichi Nuclear Power Station, the conflict with China over the Senkaku Islands, and tensions with China and South Korea over Japanese Prime Minister Shinzo Abe’s refusal to acknowledge Japanese war crimes all add to a profound national anxiety that is evident in every public discussion.

But the perception of economic decline does not match the on-the-ground realities. A visitor to Japan would see a country that has a very high standard of living, with sober and functional public buildings and magnificent transport infrastructure. It is a society in love with high-tech innovations, producing such marvels as the Honda motor company’s Asimo, a robot that walks, runs, and dances like a human being—and that I hope will never learn economic analysis. And statistics show a more equal income distribution and much lower unemployment than in the United States.

Even a cursory look at the data reveals that assertions of Japan’s decline are exaggerated. Japan’s per capita income, adjusted for purchasing power, is now almost exactly in line with that of France and the UK—hardly a disaster. The UN’s 2013 Human Development Report, which accounts for education achievement and longevity as well as income, places Japan at number ten in the world, just behind Switzerland and ahead of Canada.

At first sight, the country’s GDP growth record over the last twenty-five years looks pitiful. At 1.3 percent a year, it amounts to about half that of the United States. But that comparison is misleading because it does not account for the aging Japanese population and the attendant reduction in the Japanese workforce. When adjusted for the growth of the working-age population, Japan’s annual growth rate over the last twenty-five years is 1.6 percent, in line with that of Germany, actually higher than that of the United States, and twice that of Italy. So if there is a Japanese disease, it is one that also infects many of the other advanced countries.

It is true that Japan has intermittently seen gradual deflation since its financial bubble burst at the end of the 1980s, but this has not prevented consumers from spending—the household savings rate has declined sharply as the population has aged—nor has it prevented worker productivity and the standard of living from rising. Deflation has probably made it more difficult to service Japan’s large and rising government debt, now some 136 percent of GDP in net terms. However, nearly all the debt is held internally by the Japanese public, which affords the government a great deal more leeway than if the debt were held by foreigners, especially since the tax burden in Japan remains relatively light and the Japanese are still the world’s largest international creditor.

Moreover, the Japanese government pays only 0.6 percent interest on its ten-year bonds, the lowest rate in the world, even after accounting for low inflation expectations. And unlike the struggling countries of the eurozone, Japan retains its monetary and exchange rate tools, which under Abe’s aggressive monetary expansion policies have engineered a large yen devaluation in a quest to improve competitiveness.

Even though Japan’s growth is respectable for an advanced country, it is easy to become despondent when comparing the country’s current performance to its own phenomenal growth rates not long ago and to those of its Asian neighbors today. The perception among internal and external observers that Japan is in decline persists in part because the country is located in a region of the world where economic history unfolds at about three or four times the speed that it does in the West. Whereas the UK needed a couple of centuries to become very rich, Japan achieved this aim in about fifty years. Until its huge housing and financial bubble burst at the end of the 1980s, annual growth in the 5–10 percent range was the norm for Japan. Meanwhile, other Asian states, like South Korea and, more recently, China, are firmly on course to replicate Japan’s economic miracle. Countries such as Vietnam appear to be next in line.

Indeed, the increase in nearby competitive challenges reinforces Japan’s economic and geopolitical anxieties. Take car manufacturing, an industry in which Japan has been hugely successful—it produces over 8 million cars annually, twice as many as the United States. Japan now has to compete for investment and jobs in this industry with China, a country that mainly produced bicycles a generation ago. Today, China’s annual output exceeds 18 million cars, many produced by Japanese companies. Japan also has to compete with neighboring South Korea—a very poor economy in living memory but one that now produces 6 million cars annually.

To compete more successfully with these rising powers, Japan will need to address some of its self-inflicted handicaps, which have received too little attention until recently. The most economically damaging is the underutilization of its highly educated women, who are underrepresented in the labor force, dramatically so above entry level. The other big handicap is Japan’s extremely restrictive immigration policy, which deprives the country not only of skills and vitality but also of young unskilled workers willing to do the menial jobs that overqualified Japanese men and, above all, women take on. Correcting these shortcomings could easily add 1 percent a year to the growth of Japan’s labor force and—more than likely—between 1 and 2 percent a year to the country’s economic growth as far as the eye can see.

Japan will also need domestic structural reforms—an area in which Abe’s program is lagging—to help rectify other distortions in its economy, beginning with high agricultural protectionism, inflexible labor markets, inefficient services in some sectors, and practices that discourage foreign competition. But these are far from unique to Japan. To varying degrees, each of these impediments can be found in other advanced countries. Trade reforms—such as those envisaged under the Trans-Pacific Partnership, which aims to create a free trade area across the Pacific—can also help deal with some of these weaknesses.

It is easy for both Japanese and foreigners to draw the wrong lessons from Japan’s experience, assuming that the country’s economic heyday has past. But Japan is better-off than many think, which suggests that some of its beneficial policies are overlooked—such as its willingness to invest in infrastructure to boost the economy, for example. While entrenched, moderate deflation is not a good thing, it is far from clear whether it has been a big stumbling block in Japan or just a symptom of its growth slowdown.

Japan’s economy may no longer be “number one,” but neither is it as disastrous as many observers claim. And the path to improvement is clear—simple arithmetic shows that the economic emancipation of women as well as immigration and agricultural reforms would help increase the economy’s supply potential and expand demand. However, these policies would require dealing with some of Japan’s most entrenched hang-ups, which raises doubt as to whether it will regain its place at the top of the class any time soon.