Japan's Golden Era

WINTER 2006 THE INTERNATIONAL ECONOMY 35
Japan’s
Golden Age
What to make of the age demographic.
Contrary to conventional wisdom, the effect of Japan’s aging
population on the economy and the asset market could be
positive in the short- to medium-term. In the short-term
(three to five years), Japan’s shrinking population (expected
to start falling by 2007) will shrink the labor force, tighten
labor market conditions, and lower the jobless rate. On the
back of a structural economic turnaround, a tighter labor
market will push up wages, boost inflation and, hence, nominal
GDP growth, which is essential for the asset market growth.
In the medium-term (ten to twenty years), the declining birth rate will lower
the dependency ratio (thus lessening the burden on the workforce), and the rising
female labor participation rate will offset some of the decline in the labor force.
These forces will boost household savings and consumption, giving Japan a new
window of growth opportunity. But Tokyo needs to embark on new and drastic policy
initiatives soon to tackle the aging population’s dire long-term effects.
SHORT-TERM BOOST TO NOMINAL GDP
Japan’s jobless rate has fallen to 4.2 percent now from a peak of 5.8 percent in
March 2003. The number of unemployed peaked in December 2001 at 3.67 mil-
Chi Lo is an economic strategist based in Hong Kong and author of Phantom of
the China Economic Threat, Palgrave Macmillan, upcoming 2006.
BY CHI LO
THE MAGAZINE OF
INTERNATIONAL ECONOMIC POLICY
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36 THE INTERNATIONAL ECONOMY WINTER 2006
LO
lion. It has since fallen steadily to 2.83 million in
the third quarter of 2005.
The improvement in the job market came first
from the decline in the labor force, which fell by
1.3 million persons between the end of 2001 and
the end of 2004. Employment fell by 40,000 in the
same period. Then job growth picked up, with the
number of employed rising by almost one million in
the first three quarters of 2005.
While job market improvement due to a shrinking
labor force may be cold comfort under normal
circumstances, it is different for Japan. Japan has to
live with a falling population, but the resultant natural
decline in the labor force will tighten the labor
market as the economy recovers under structural
improvement.
The upcoming retirement of the baby boomers
will create a bottle-neck condition in the labor market.
The jobless rate will thus continue to fall in the
next few years, unless there is a negative demand
shock. There are now 6.8 million people in the
56–58 age range, including five million workers
(7.5 percent of the labor force). These baby-boomers
will reach Japan’s typical retirement age of sixty
years old starting in two years. With employment
growth expected to remain steady under the secular
economic rebound, this will put downward pressure
on the jobless rate and upward pressure on wage
growth.
Indeed, after falling for more than six years,
wage growth has returned since this April. The
improved structural backdrop behind the job market
suggests that the wage recovery this time would not
be a false alarm as in 2000 and 2003.
Empirical research shows that the so-called
Phillips Curve phenomenon applies to Japan—as
the jobless rate falls, core CPI inflation rises. In particular,
the inflation rate will start rising as the jobless
rate falls below 4 percent for a sustained period
(over six months).
Wage hikes on the back of a tightening job market
should create inflationary pressures via increased
private spending. When wage growth rises faster
than inflation, real purchasing power rises. This will
boost demand-pull inflation. Current trends suggest
that Japan’s jobless rate could fall below 4 percent
by early 2006, so that inflation is expected to pick up
after mid-2006. This is consistent with the Bank of
Japan’s recent assessment that the core inflation rate
will start rising in late 2006 and early 2007. The
resultant rise in nominal GDP, which is on a multiyear
recovery path, is positive for asset price growth
in the next few years.
MEDIUM-TERM BOOST
TO SAVINGS AND SPENDING POWER
Japan’s shrinking and aging population does not
need to result in declining income and savings in
the medium-term. Interestingly, labor discretionary
earnings and savings could even rise because of the
fall in the dependency ratio, which is the nonworking
population (those under 14 and over 65
years old) divided by the working population (ages
15–64). Since the working population has to support
both the youngs and the olds, this ratio measures
the burden imposed by the dependent groups
on the workers.
Japan’s declining birth rate will lower her
dependency ratio. The current population dynamics
suggests that the drop in the number of children
will more than offset the rise in the number of
retirees. The birth rate’s decline will also exceed the
fall in the labor force in the next thirty-five years. All
this will result in a fall in the dependency ratio.
With a smaller burden to support the dependent
population, discretionary labor income and personal
savings will rise. Of course, the problem of supporting
an aging population still remains in the longterm,
when the smaller pool of children reaches
working age.
The drop in the number
of children will more than offset
the rise in the number of retirees.
Tokyo should relax
its immigration laws
to take in more foreign labor.
WINTER 2006 THE INTERNATIONAL ECONOMY 37
LO
Further, although Japan’s labor force will shrink
over the long-term, the rise in female participation
in the labor force is a bright spot for income and
demand growth in the medium-term. The rise in the
female labor force has been evident since the 1970s,
coinciding with a drop in the marriage rate.
The increase in the female labor participation
rate (the ratio of female labor force to total population)
is most notable in the 25–34 year old groups,
which has risen by 16 percentage points to 56 percent
of the labor force since 1975. This compares
with the overall female participation rate, which has
risen by less than 5 percentage points in the same
period. This rise in the female labor participation
rate helps explain both the fall in the marriage and
birth rates.
Higher female participation in the labor force
will increase the labor pool (by mobilizing the unutilized
female labor), and offset some of the decline
in the labor force. This should boost income and
demand growth. Meanwhile, with an increasing
number of females working in the coming years,
their spending power will rise, adding to the consumption
recovery.
RISKS
A big assumption behind the benign scenario of a
tightening labor market boosting nominal GDP in
the short-term is that there is no negative demand
shock to upset Japan’s labor market. But there are
potential risks. Asharp fall in exports, due to weaker
external demand, is one. Domestic fiscal consolidation—
involving public spending cuts, tax hikes,
and restructuring of public corporations—to pare
the fiscal deficit along with premature monetary
tightening are others.
Further, the baby boomers may want to remain
in the job market longer, due to concerns about their
public pensions. In this case, the expected decline in
the labor force will be smaller and, hence, the
upward pressure on wage growth, demand and nominal
GDP will also be smaller.
POLICY IMPLICATIONS
Japan still has to face a declining population, which
adds to the burden of the working population and
aggravates the government’s fiscal deficit, cutting
into the country’s growth and living standards over
time. To address these problems, Tokyo should relax
its immigration laws to take in more foreign labor.
It has always resisted such an idea due to a strong
preference for homogeneity to build an integrated
society. But as the negative impact of an aging population
bites, it will not have many effective choices.
Immigration can expand Japan’s labor force quickly,
boosting GDP growth, raising the ability of the
workforce to sustain the aging population, and
increasing tax intake, thus helping to cut the budget
deficit.
The government should also break the cultural
logjam of discriminating against female labor.
Japan’s support for working mothers has been
extremely unfavorable. Childcare facilities are in
extreme shortage. Less than 15 percent of Japanese
children under the age of three go to daycare centers,
compared with 54 percent in the United States.
Meanwhile, households are taxed without sufficient
child benefits. Legal support for pregnant and
working mothers is inadequate. The corporate culture
of long working hours and discouragement of
long holidays, including maternity leave, are deterrents
to working mothers. All this will need to
change in order to boost the birth rate and female
labor participation.
The authorities must enact laws to help working
mothers, build more childcare centers, raise tax
incentives for having babies, and provide friendlier
working practices for working mothers. The recent
measures to raise taxes and pension contributions
to address the fiscal deficit and pension liability
problems, ironically, act to discourage people from
having babies. The long time lag for changing the
legal and institutional frameworks to raise the birth
rate suggests that Tokyo will have to resort to immigration
as a stop-gap measure to halt the deteriorating
population trend. ◆
The rise in the female
labor force has been evident
since the 1970s, coinciding
with a drop in
the marriage rate.