Can Japan lift its economic growth trajectory?

Author: Peter Drysdale, Editor, East Asia Forum

There is a glimmer of hope — with the advent of Abenomics — that Japan might be on the cusp of lifting its economic growth and cheating the demographic fate of its shrinking working population.

Abe has moved quickly to implement his popular new economic policy strategies and that has already given a substantial boost to confidence domestically and a welcome boost in perceptions of Japan’s growth prospects internationally. Is the spurt in economic growth in the first two quarters of this year (with growth at 4.1 per cent in the first quarter and 3.8 per cent in the second) a harbinger of getting Japan’s growth trajectory above the magical 2 per cent in the medium to long term or just a flash in the pan?

At the core of Japan’s economic bind is managing the dramatic impact of its shrinking population — a demographic transformation of a kind now common among mature industrial economies but nowhere else so intense. Japan’s population will decline sharply over the coming decades: from 127 million today it is projected to fall to 84 million in 50 years. The working-age population (aged 15–64) is projected to fall by nearly half from 80 million today to 42 million five decades hence. The number of people aged 65 and over will account for 40 per cent of the population, putting substantial strain on Japan’s workers to sustain the non-working population.

With a strongly negative effect on output per head of population from a shrinking workforce, the only way to lift the economic growth trajectory is to lift total factor productivity substantially. The boost that Abe’s monetary and fiscal stimulus policies have given to economic growth in the short term (the first two ‘arrows’ in his three-pronged economic strategy) certainly won’t hold it up in the medium to longer term.

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.

A big push for regulatory reform is needed now, allowing the swift release of Abe’s third arrow.

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.

Peter Drysdale is Editor of the East Asia Forum.
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Faizullah Khilji
16 October 2013 1:59 pm

1. Abenomics consisted of “three arrows”, to be shot in unison to ostensibly deliver growth. Of the three, only monetary expansion has been put into play thus far, and this, printing more money, is arguably the easy part.

2. The two other elements of Abenomics, fiscal consolidation via higher taxation, and structural reforms such as the “freeing” the labour market, largely remain in the category of policy that is yet to be implemented.

3. The benefits for Japan from a yet to be concluded TPP are seldom specified. The specific bits of TPP that would help Japan’s economy grow are not identified. One particular aspect that needs to be explored is that Japan’s main trading partner, that is China, is not a party to the TPP; hence a good part of Japan’s trade would remain outside TPP.

4. Immigration does not appear feasible for Japan. Even the Latin American Japanese who were encouraged to migrate to Japan could not settle happily, and had to be “repatriated” back to Latin America.

5. Even if Abenomics were implemented and TPP effected, steady growth does not necessarily follow. In Japan’s case, for example, innovation is fundamental; and innovation is the forte of young. The numbers of young are falling.

6. We badly need a realistic appraisal of Japan’s prospects.