Don't Talk About Wages And Incomes

by: Scott Sumner

Here's a particularly maddening paragraph in a post by Edward Hugh:

And there are plenty of people in Japan who have been pointing this out all along. Seki Obata, a Keio University business school professor for example, who in 2013 published a book "Reflation is Dangerous," argues exactly this, that "Abenomics" is exposing Japan to considerable risk without any clear sense of what it can accomplish. Obata also makes the extremely valid point that there is simply no way incomes can rise across the entire economy because the baby boomers are now retiring to be replaced by fewer young workers with post labour reform entry-level wages. Japan's overall consumer spending power will therefore fall, rather than rise as Abe hopes. "Individual companies may offer wage increases, but because of demographics it is simply impossible to increase the total amount that is paid out in wages," says Obata. "On the contrary, that amount will shrink." Simple logic you would have thought, but logic in the face of irrational exuberance scarcely stops people in their tracks.

Not only is Obata's point not "extremely valid," it's pretty much meaningless. I really don't have any idea what Hugh is talking about in this paragraph, because he uses terms like "wages" and "incomes," which don't have any clear meaning. It might as well be written in Korean. Now the term "nominal wages" has a very clear meaning. And "real wages" has a very clear meaning, which is totally, completely, entirely different from the meaning of nominal wages. Nominal wages are as different from real wages as cucumbers are from nuclear power plants.

Now before you say "come on Sumner, the meaning is clear from the context," read the paragraph again. The paragraph makes no sense under either interpretation. Obviously he can't mean "nominal wages," because then Obata's comment would be "extremely invalid." But he can't mean real wages either, because he is talking about demand-side factors.

What makes this Hugh post so frustrating is that just a few days ago, I read an excellent post by the same blogger, discussing how a lack of NGDP growth in Italy was worsening the debt situation. Unfortunately, this very long post is riddled with confusion from beginning to end. After each paragraph, you scratch your head wondering whether he is talking about real or nominal problems, and when he does make it clear, you wonder whether he has confused the two problems.

Japan has a public debt problem comparable to Italy's, and an even worse NGDP performance over the last 20 years (essentially, no growth in NGDP.) And yet, he cites with apparent sympathy a Japanese commentator who fears Japanese monetary policy is too expansionary. Elsewhere, the opposite concern is expressed; Abenomics is failing to generate inflation:

The Bank has had more success with inflation since core inflation was up 3.3% over a year earlier in June. But that number soon shrinks in proportion when you strip out the estimated impact of the recent tax hike. According to the Bank of Japan the ex-tax number for June was 1.3%, down from 1.4% a month earlier. And even this inflation isn't demand driven: it is largely a carry over from the earlier yen devaluation. As such it is quite likely to disappear with time.

Then later, inflation is so high that it is depressing real wages:

Nominal wages have been rising again in Japan.

Average total wages, consisting of base pay, overtime and bonuses covering both regular and part-time workers, grew 0.4% on year in June, following increases of 0.6% for May and 0.7% for April and March. Four straight months of year-on-year rise is the longest stretch since total wages grew for six straight months between June and November 2010. But real wages - which take into account inflation and matter much more to consumers than nominal wages, declined 3.8% on year in June, the fourteenth consecutive month of decline, and the biggest drop since December 2009.

Reading this post, you have no sense of what Abenomics is trying to do, or what would constitute success. And yet, it's clear to me that the "three arrows" are aimed at boosting both AS (economic reforms) and AD (monetary stimulus). Here's another maddening comment:

Part of the reason they might not see it in the same light as the central bank dependent investment community is that there is a solid body of opinion in Japan that recognizes that a large part of the country's issue is demographic and that simply "jump starting" a bit of inflation won't make the problem go away...

The question I would ask is this: given all the doubt which exists about the real roots of Japan's problem, and the fact that it may well be a permanent structural problem and not a temporary liquidity trap one, is it really justified to run such a high risk, all-or-nothing experiment?

What does that even mean? Clearly, Japan has both AS and AD problems. There is no single "real problem;" there are multiple "real problems." One arrow of Abenomics is aimed at the nominal problem, and one is aimed at the real problem (not "real" as in "actual," but real as in not nominal). And somehow, the specific policy that is aimed at the nominal problem is misguided, because it doesn't address the real (i.e. supply-side) problem. So what?

Monetary policy has its limits. As Martin Wolf so aptly put it, "you can't print babies".

I guess in the blogosphere, that's what passes for a profound comment. Who would have ever guessed that monetary stimulus cannot solve all problems? (BTW, tight money in the US clearly did reduce the birth rate after 2008.)

Japan needs more NGDP growth to reduce the debt burden and create jobs. It's that simple. Japan just instituted a tax increase that, if tried in the US, would cause a violent revolution - 3% more on the national sales tax. The largest sales tax increase the US adopted in my entire life (that I can recall) was a 4 cent gas tax increase under Clinton, and that was highly controversial. The Japanese tax increase was probably 50 times worse. So the Japanese people are frustrated with taking a sudden 3% hit to their standard of living from an adverse supply shock? No kidding. And this tells us what about monetary stimulus?

BTW, I reluctantly supported the excise tax increase because... well, because Japan is going broke if they don't change their ways.