Author: Edward J. Lincoln, GWU

If there is one conclusion that economists can draw with any certainty about the future of the Japanese economy, it is that the overall growth of GDP will be very slow for several decades to come.

Even under the best circumstances, overall GDP growth is unlikely to exceed an annual average of about 1.5 per cent. Advanced industrial nations like Japan do not grow quickly because they are constrained by the gradual shift of the global technology frontier. In the Japanese case GDP growth is further constrained by a very low birth rate, which is responsible for negative population growth.

A more informative measure of the success and health of advanced economies is GDP per person — a crude but widely used measure of affluence. In the 20th century successful advanced economies have typically experienced growth in GDP per person in the range of 1.5 to 2.0 per cent annually, but there are reasons to fear that Japan may not be able to achieve this growth rate.

The low birth rate is first among these. The age structure of the population has been shifting as the ratio of people over the age of 65 to the total population rises rapidly. Though this shift is happening in many countries, Japan has the highest ratio among OECD countries (23 per cent in 2010), and the ratio will continue to climb.

This shift causes an obvious fiscal problem for both the social security and the national health insurance systems. The government is already running a large fiscal deficit and has accumulated a large government debt, raising the possibility of a Greek-like fiscal crisis at some point in the future. At the moment there is no danger of such a crisis because high levels of domestic savings continue to be more than sufficient to finance the government deficit, but this situation cannot continue indefinitely.

An ageing population could have a negative effect on productivity or output per worker, because it will likely cause economic resources to shift towards those industries that serve the elderly. Japan’s productivity per worker has traditionally been higher in manufacturing than in services. If the ageing population results in less manufacturing output (less domestic demand for automobiles, for example) and more demand for services (such as health care, travel or other leisure activities), Japan could experience a drop in output per worker. Even with a constant level of output per worker, output per person in the total population will fall because changes in the national age structure are reducing the proportion of the total population that is in the labour force.

The dearth of young adults entering the workforce could also have a negative impact on productivity. With a low birth rate for the past four decades, the absolute number of adults aged 20–24 has been falling rapidly. From 1995 to 2010 the number of people in this age cohort fell 32 per cent, and based on the number of people aged 0–4 years old in 2010, it is due to fall a further 20 per cent by 2030. If young employees are a source of innovative thinking in corporations, then Japanese corporations face a problem as managers become increasingly older, less innovative and more risk-averse.

Though these negative factors may seem to doom Japan to unimpressive levels of per capita GDP growth, there are multiple strategies to avoid long-term gloom. Here are the top six.

First, the social security system must be rescued by increasing payroll taxes, delaying the age at which individuals receive benefits, and perhaps lowering the level of future benefits. National health insurance will require higher premiums and higher co-payment levels. Though some steps have already been taken to fix the social security system, more will be needed.

Second, the economy needs further economic deregulation, especially in service industries where productivity has lagged behind manufacturing. The productivity boost from deregulation would lessen the drag caused by the shift in economic structure.

Third, building a more encouraging environment for entrepreneurs will stimulate young people to create innovative start-up firms rather than being stifled in large corporate structures. Japan continues to lag behind other advanced nations on indicators of entrepreneurial activity; encouraging innovation can help solve this problem.

Fourth, better job opportunities for women will help boost productivity. Though women have made many social and economic gains in Japan over the past several decades, corporate management remains a largely male bastion. Japanese women are well educated, but their skills are often wasted in the labour force. Moving them into jobs that take better advantage of their skills will raise overall labour productivity.

Fifth, the Japanese economy needs to be more open to imports and more welcoming for inward direct investment, especially in agriculture and services. Joining the Trans-Pacific Partnership negotiations would be a useful start. The increased competition from imports and from foreign firms investing in Japan will help drive productivity improvements in the economy.

Finally, the economy will benefit from increased immigration. Immigrants tend to be young adults, which is positive for two reasons: on the one hand, they will increase the ratio of workers to total population; on the other, immigrant workers who move into management roles can stimulate corporate innovation.

Since the mid-19th century Japan has had a very practical and flexible approach to economic issues — a flexibility that helped to lift it into the ranks of the advanced industrial nations by the 1970s. Although the past record augurs well for the future, addressing these six issues would be difficult for any society.

The fiscal fix may be the easiest, as the recent move to increase the national consumption tax suggests. On other issues the political system has moved slowly at best: deregulation has occurred in some industries but resistance in others remains formidable. Past efforts to encourage entrepreneurs have yielded only very modest results and women continue to face serious obstacles in the labour market. Politicians remain deeply divided on whether to open markets to foreign competition while immigration remains miniscule and barely registers as a topic for political debate. Solutions will require clarity of vision and political courage — two commodities in short supply in current Japanese politics. Without progress on these six issues, the growth of affluence measured by GDP per person will continue to lag behind its potential. The danger is not a collapse, but a disappointing performance that may cause Japan to slide further down from its third place in the ranking of world economies.

Ed Lincoln is Professorial Lecturer at George Washington University and former director of the Center for Japan–US Business and Economic Studies at the Stern School of Business, New York University.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Japan: leading from behind’.

1. Growth: getting Japan back on track
2. Rebalancing the Chinese economy to sustain long-term growth
3. China: what long-term policies and reforms are needed to sustain growth?

Go here to see the original:
Japan’s long-term growth: six ways of staying afloat