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.