In the long run, it's all microeconomics

Macroeconomics failed Japan. It's microeconomics – the supply side – that can revive developed economies.

By , Guest blogger

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    A man walks in front of a retail shop displaying a sale advertisement in Tokyo Dec. 28, 2010. Japan's core consumer prices fell 0.5 percent in November from a year earlier, down for the 21st consecutive month, illustrating the country remains mired in deflation due to weak domestic demand.
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Most of us are familiar with JM Keynes quip that in the long run we are all dead. To change this slightly, I want to point out that in the long run, it's all microeconomics.

Macroeconomics, the study of, among other things, demand, investment, equilibrium at the level of the whole economy and so on is, if you believe most macroeconomists, the only important thing about the whiole science of economics. And I would argue that that's entirely the wrong way around. Macro might be important, useful, possibly even interesting if you like equations, in the short term but the only thing that matters in the long term is microeconomics.

Take as an example the economy of Japan. For 20 years and more they've been doing what macroeconomists would suggest should be done to raise aggregate demand and thus boost growth. To the point that:

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The budget's structural position is what is known technically to economists as "completely hosed";borrowing now exceeds tax revenue, and debt service costs now eat up almost half of the tax revenue the government collects.

They've been pulling all the macro strings, ringing all the bells they can, for decades and managed to get basically nowhere. For those who say we should build infrastructure to boost the economy, there is hardly a ditch left in the entirety of Japan that is not concreted and without its own bullet train station. But what they have not been doing is paying attention to the microeconomics, to the supply side reforms.

Don't forget that the great Japanese boom years were when they were playing economic catch up. This is indeed a time when feeding more resources (people, education, steel, coal) into the system will create economic growth. But once you've got to the production frontier this no longer works. You need to be working out new ways of doing new things, not just doing more or better of the old. The lessons on how to do this being what microeconomics is in large part about: it's nothing to do with aggregate demand or the other things that the macroeconomists worry about.

Which is why, in the long term it's all microeconomics. The plain old basics: incentives, prices, flexibility, rule of law and so on. Whatever macro tells us, the secrets of long term economic growth are still rooted in micro.

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