The AI Divide Between the U.S. and Japan

Robert Feldman and Michael Gapen discuss how AI could reshape growth, labor markets and productivity in the U.S. and Japan.

Read more insights from Morgan Stanley.

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Robert Feldman: Welcome to Thoughts on the Market. I'm Robert Feldman, Senior Advisor at Morgan Stanley MUFG Securities in Tokyo. 

Michael Gapen: And I'm Michael Gapen, Morgan Stanley's Chief U.S. Economist. 

Robert Feldman: Today, we'll discuss why the U.S. and Japanese economies may react differently to the AI productivity test. 

It's Thursday, July 9th at 8 pm in Tokyo. 

Michael Gapen: And 9 am in New York. 

Robert Feldman: AI is the biggest theme around the world right now, but AI will play out differently in different economies. Take the cases of the U.S. and Japan. In the U.S., it's already a catalyst in investment, imports, productivity, and the labor market outlook. 

But here in Japan, it's seen as a savior for an economy with an intense labor shortage, low unemployment, and very little room to raise labor force participation. 

Mike, in the U.S., AI's contribution to real GDP growth will rise from about 0.05 percentage points in 2024 to an estimated 0.43 percentage points in 2027. 

What does that mean for markets? 

Michael Gapen: Well, Robby, I think it, it means a number of things, but, you know, I'm an economist, so the answer is always, "It depends." I think the real crux of the issue over time in the U.S., and therefore what it means for financial markets, is ultimately whether AI is labor replacing – and pushes the unemployment rate higher. Or it acts like a more traditional general-purpose technology that's labor augmenting. 

So, if, that's the case, meaning it looks similar to the internet and digital era, then it would mean faster output growth, stronger productivity growth, but still an economy that's running at or near full employment. That would be very beneficial in our estimation for risk assets, equity markets, credit markets, and it would probably mean that we stay in an interest rate environment that's certainly higher than it was during the post GFC period. 

But if – AI is a very different technology than we've seen in the past, and it displaces labor, and we get increases in the unemployment rate as AI diffuses through the economy. Then it could be very different for markets. Maybe returns to capital and equity markets are supported, but that might be more narrowly for technology stocks and not broader, say, consumer discretionary stocks. 

So, the answer, of course, is it depends. We don't know. And I think, ultimately, we come down on the side of thinking that AI will not create dystopian outcomes in the labor markets, that employment will hold up. 

So, we have a fairly constructive view, perhaps an optimistic view. And we think, ultimately it'll benefit markets greatly, similar to what we saw from the mid-90s to the early 2000’s. 

Robert Feldman: Well, in your model, you have a particular variable that captures the speed of diffusion. But your baseline has AI spreading twice as fast as the internet did. But without that rise of employment. Is that really manageable? And if it's not, what economic indicators would warn us, if we're crossing into the danger zone? 

Michael Gapen: This is really the tricky part as, as you know. We have a new technology. We have to model how it diffuses through the economy. And I would say I think there's an argument here that penetration rates and usage rates are very different than what economists think about diffusion, which is how the production process is reshaped because of this new technology. 

And so most economists look at the internet and digital era and think it took 20-25 years to fully diffuse. Mass penetration in maybe 10 years, but full diffusion in more like 20-25 years. And so, each innovation cycle tends to happen more rapidly. 

So, I do think AI will spread more rapidly. And even by saying it spreads twice as fast as the internet did still means that it'll take roughly a decade, maybe 10-12 years for this to fully diffuse. So, our argument here would be that that is enough time for a flexible economy and a flexible labor market, like we have in the U.S., to rebalance labor. 

But if we're wrong, then Robby, what I think you will see is that as AI rolls through, it diffuses faster. And what we would see then is increases in rates of job separation and layoffs that would overwhelm the labor market's ability to reallocate workers. 

So, I think we would see two things – or three things: scale layoffs, a rise in the unemployment rate, and probably a significant amount of underemployment. Those who get rebalanced may be rebalanced into work that's not, say, consistent with the skill of that worker. So, I think we would see a very disrupted labor market in the process. 

But if it takes a decade, maybe 10-12 years, we think ultimately the U.S. economy is flexible enough to rebalance labor without large scale layoffs. 

Robert Feldman: Now, people are afraid of a lot of things, but one other thing is that AI might create new kinds of jobs, new kinds of tasks, have different impacts on people's wealth, and different responses from policymakers as well. 

How do these knock-on effects change the AI labor story? 

Michael Gapen: Yeah. That's right. I think you make a very good point there that I think it's easy to fall into what an economist would call a pa