How can Japan get more output from its shrinking population? One way is to encourage or require that a larger proportion of the population actively engage in work. Another is to lift the average product of labour employed. There is also, of course, the option of lifting the population base over time through immigration.

The assumptions behind Abe’s growth strategy rely heavily on the first two contributions to lifting Japanese growth. Productivity is assumed to rise strongly, and likewise worker participation rates. If productivity is to go up significantly — and productivity performance has been so-so for most of the past two decades — there’ll have to be a dramatic turnaround in innovation and industrial creativity. If participation is to rise, the incentives for women to engage and be more productively deployed in the workplace and for older people to work longer — they do work longer, around a lower retirement age, than they do in most industrial societies already — will have to fundamentally change.

As Hugh Patrick points out in this week’s lead essay, ‘Japanese people are already being encouraged to work for longer. Japan’s retirement age by custom and law is 60 for large companies and government officials. At 60, Japanese men can expect to live another 23 years, women another 29. Most are energetic, have skills, and want to continue working. Even now, about 70 per cent of new retirees either have their employment extended, are rehired by the same firm, or are introduced to another firm, often a subsidiary. Some 20 per cent of Japan’s seniors work, the highest rate in any developed country. Companies are under pressure to extend the retirement age but are doing so slowly. In April 2013, the minimum age at which retirees can collect government pensions rose to 61; this is scheduled to incre ase by a year every three years to reach 65 by 2025. An increase in participation rates would mean that the total number of workers would not decline significantly. But if present participation rates continue, decreases in the population and in its working age component would reduce the workforce by about 1 per cent annually’. Making it attractive for women and seniors to join the labour force is a huge challenge. Success will depend on major regulatory reform — most of it strongly opposed by vested interests.

Regulatory and institutional reform is, in fact, critical to both lifting participation in the workforce as well as improving Japanese productivity performance. At least Prime Minister Abe has now bitten the bullet on fiscal consolidation by committing to raising the consumption tax.

As Patrick explains, Abe’s growth strategy incorporates a significant tension between two fundamentally different policy approaches. One relies on markets: deregulation, increased domestic competition, institutional and corporate reform. The other relies on government industrial policy: incentives for growth industries, funding new technologies and lagging-sector consolidation. While both approaches can help, reliance on markets, Patrick concludes, needs to be the key. Only deregulation and structural reforms will generate adequate incentives for firms to invest and people to work in the medium to longer term.

How Japan fares in lifting its growth trajectory will hold important lessons for many countries, faced as most are at different points down the track of economic and demographic maturation with managing the same kind of problem.