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Premature end to tightening could riskaccelerated inflationOf course, an end to tightening now might limit neartermEME economic deterioration, somethingpossibly responsible for the upbeat sentimenttemporarily evident in the financial markets. But thereis also a risk that supply constraints could becomegreater. This could cause inflation to rise even faster,making future tightening so drastic that the economicconsequences could be much more severe. Thesharp drop in commodity prices since the springcould be a trap for EME policymakers. Led by thesofter tone of prices for food and gasoline, pricessuperficially seem to be falling, and a subduedheadline inflation rate could increase the pressure onpolicymakers to switch from tightening to stimulus(this is especially true when share prices are alsoweak). But with wages on the rise in many EMEs,there is a risk that home-made inflationary pressurescould be aggravated. EME policymakers,consequently, could become unable to fine tunemacro-stabilisation policies.Japan’s misguided macro policies in the late1970sWhile all EMEs have seen inflation pick up alongsiderobust economic growth in the last three years, theChinese economy is particularly worrying. Conditionsin China today closely resemble Japan in the secondhalf of the 1970s when the era of robust growthended. At that time, Japan was undergoing a changein its trend growth rate (potential growth rate) but thegovernment and BOJ misunderstood this andadopted macro-economic stimulative policies thatresulted in rampant real estate speculation andsoaring inflation. In the hope that the Chineseauthorities do not make the mistakes Japan made,this report will be devoted to describing Japan’sexperience in the late 1970s.Japan’s ‘Lewis turning point’Japan’s era of robust economic growth lastedroughly 20 years, from the middle of the 1950s to themiddle of the 1970s. At this time, the economy onaverage spanned good times and bad and enjoyedgrowth well over 9% (average growth in 1957-1973was 9.4%). We thus came to expect double-digitgrowth during recovery phases. However, inhindsight, an analysis of economic indicators showsJapan’s trend growth rate started falling in the early1970s as internal migration, its primary growthengine, was tapering off. In a typical example of the‘Lewis turning point’, Japan’s period of rapideconomic growth ended when the supply of surplusrural labour for urban industries was fully absorbed.This model has been used to describe the age ofrobust growth in Europe after the industrialrevolution, but it applies surprisingly well to Japan.Chart 3: Japan: Rural to Urban Migration Trends(net immigration rate = net immigration total/totalpopulation of area)2.5%2.0%1.5%1.0%0.5%0.0%-0.5%-1.0%-1.5%55 60 65 70 75 80 85 90 95 00 05 10Source: MIC, BNP Paribas30252015105Tokyo areaOsaka areaNagoya areaothersNet in-migrationNet out-migrationChart 4: Japan and US Consumer Price in 1970s(% y/y)071 72 73 74 75 76 77 78 79 80 81 82 83 84 85Source: EcoWin, BNP ParibasJapanJapan’s era of robust growth was the heyday ofinternal migrationStatistics confirm that there was intense internalmigration in Japan between the mid 1950s and thefirst half of the 1970s, as the surplus offspring offarming families (second and third sons withsecondary education) left the countryside in favour ofjobs in the three big metropolitan areas of Tokyo,Osaka and Nagoya. With urban factories and serviceindustries absorbing this surplus labour from thecountryside, Japan’s era of robust growth wascertainly the heyday of internal migration.Demand-side aspect of Japan’s rapid growthWhile this describes the era of rapid growth from asupply-side perspective, there is also the demandsideas the population influx into cities swelled thenumber of urban households, making higherstandards of living possible. The expansion of urbanlifestyles fuelled demand in the 1950s for TVs,washing machines and refrigerators (the original socalled‘three holy durables’ or must-have products)and this was followed in the 1960s by demand forcolour TVs, cars and air conditioning units – the new‘three holy durables'. The speed at which theseUSRyutaro Kono 27 October 2011Market Mover22www.GlobalMarkets.bnpparibas.com