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Op-Ed

Japan Can Rebuild on New Economic Foundations

Robert C. Pozen

The tsunami in Japan and its impact on nuclear plants are truly tragic for the Japanese people. But are there any silver linings in this dark
cloud for the depressed Japanese economy? There are three main possibilities.

First, Japan has been in the throes of a debilitating deflation for more than a decade. Consumer prices have been flat to down, and so have
effective interest rates on Japanese savings accounts. To combat deflation, the Japanese central bank has engaged in several rounds of
quantitative easing – buying large amounts of Japanese Treasury bonds. But these purchases have not turned around the deflationary mind
set.

Thus, a modest amount of inflation would be very useful for Japan’s economy. Higher prices in the near term are likely to result from the
tremendous demands of rebuilding whole towns wiped out by the tsunami. Such near-term price rises could lead to long-term changes in
inflation expectations, thereby helping Japan escape from its deflationary doldrums.

Second, Japan faces one of the worst demographic situations in the world. Its existing population is already old, and its life expectancy is quite
high. Yet its birth rate is very low: 1.2 children per couple; this is much lower than needed for population replacement. These demographic
trends in Japan will impose tremendous burdens on financing its Social Security and other retirement plans.

A logical response would be for Japan to allow the immigration of significant numbers of young families from other parts of Asia. But Japanese
officials have historically resisted immigration in order to maintain a homogeneous culture. On the other hand, the implementation of a massive
rebuilding effort will require the influx of many young construction workers. Perhaps these workers will become the initial wave of permanent
immigrants, who would mitigate Japan’s severe demographic problems.

Finally, Japan’s political establishment is still dominated by rural constituencies, despite electoral reforms a few years ago. This political
domination has led to excessive government spending in rural areas on bridges and other construction projects, which have done little to boost
Japan’s economic growth. In essence, Japan is now where the US would have been without the Supreme Court decisions in the 1960s, which
required legislatures roughly to reflect the current distribution of population among and within the states.

Before Japan decides to rebuild the whole area affected by the recent tsunami, perhaps it will look at alternative approaches, such as
relocating families to cities and retraining agricultural workers for other jobs. This could be part of a new focus of Japanese public spending on
programmes with more potential for stimulating economic growth than building bridges in rural areas. Such new programmes could, for
example, support advances in computer technology, drug discovery and financial innovation.

In short, our hearts go out to the Japanese people who are enduring a terrible disaster. In addressing this emergency, however, the Japanese
government could establish the foundations for stronger economic growth in the future.

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