Paul Krugman's elementary mistakes on economics

In my previous post, I showed that the story of export-led recovery of mid-00's Japan is a myth.

However, there are still many economists who believe that myth. Paul Krugman may be the most famous one among them.

For example, in his April 27 blog post, he showed the following graph.



And he writes,

Here’s Japanese investment and current account balance (trade balance broadly defined), both as a share of GDP, over the period 1992-2007:
Investment was actually lower, as a share of GDP, in 2007 than it had been in 2000. What had changed was the trade balance.

He made two mistakes here.

Mistake No.1

　　What he used as investment is actually Gross Fixed Capital Formation (GFCF).
　　And by definition, it contains Government Investment.

Mistake No.2

　　He failed to recognize that Current account balance and trade balance could be very different.


Let's start with investment. Below is the graph of GFCF and Private Investment (% of GDP).

(source: Cabinet Office HP; click to enlarge)

You can see that while GFCF stagnated after 2003 as Krugman said, Private Investment did increase.

Why this discrepancy occurred? As GFCF consists of Private Investment, Residential Investment, and Public Investment, let's see the movement of each of the component.

Private Investment increased, but the cutback of Public Investment more than offset that increase. The cutback was done because the economy recovered, and budget deficit cannot go on forever. So using GFCF as the sign of lack of investment is total nonsense.


And here is current account and trade balance graph (% of GDP).

(source: Ministry of Finance HP)

Both moved in parallel until 2000, but after that, the movement became very different. Trade balance actually shrank from 2004 till 2006.

The reason of this discrepancy can be also understood by seeing the movement of components.



Income from abroad increased, and that increase was main cause of the discrepancy between current account balance and trade balance.


As a matter of fact, this is not the first time Krugman made mistake on Japanese basic economic statistics. Below is the graph he used in his February 28 post and April 2 post.



And here is the corresponding graph drawn using Japanese SNA statistics. Nominal basis growth is also shown for comparison.


You can see that Krugman is using GFCF as "I" in the above graph, too. And you can see "NX" contribution is next to nothing on nominal basis.

I repeatedly pointed out these facts in his blog comment, but apparently it didn't get through to him.


　

Was recovery of Japanese economy in mid-00's led by export?

No, it wasn't. And here is the reason.


This graph shows that net export did contribute to nominal GDP growth in 2002-2003, but after that, the contribution was marginal. In 2004-2005, the contribution was even negative.

But what is important is real GDP, and net export contributed to that growth, right?

...Um, not necessarily.

Well, it's true that net export contribute to real GDP growth, as I showed in the last graph in my previous post. I'll show the graph again.


This is in stark contrast to the nominal-based graph.

Then, what caused this difference?

Two graphs below answer that question.

(quarterly basis, seasonally adjusted annual rate, billion yen)

On real basis, import did not increase much from 2003 onward, but export did.
On the other hand, both import and export increased on nominal basis, so net export did not change much.

This means that import price hike, caused by the price hike of oil and other natural resources, was what led to contribution of net export to GDP growth on real basis. Of course, it has nothing to do with the increase in export. Yes, export did increase, but that increase was consumed by the increase in import.

In other words, Japan increased export to pay for the hike in price what they import. Otherwise it would have run trade deficit. That situation could be hardly called export-led growth.

Put another way, real GDP growth was somewhat due to net export, but real GDI (Gross Domestic Income) growth wasn't. This is because real GDI is approximately calculated by replacing net export factor from real to nominal. From this point of view, Japan is in contrast to Canada as Prof. Stephen Gordon explained.