Has Foreign Growth Contributed to Stagnation and Inequality in Japan?

This paper examines the contributions of foreign growth (particularly in China), on Japan’s domestic economic performance and inequality. While the standard approach to external sources of inequality has emphasized transmission through trade and labor markets, here the emphasis is on financial flows. We begin by exploring this link using a three factor, three sector, two-region dynamic computable general equilibrium model (CGE), in which the regions are interlinked by both trade and financial flows. To provide an empirical perspective, a lag-augmented vector autoregression (LA-VAR) and a sign restricted vector autoregression (Sign restricted VAR) are estimated. We find convincing evidence through numerical simulations that strong growth in a near neighbor not only retards domestic performance but also raises home inequality. Empirical results suggest that growth in China has a significant delayed effect in aggravating Japanese inequality and its importance in explaining Japanese inequality increases in magnitude over time.