The Real Crisis Facing Japan: Part 2 The Implications

This is the second part of a three part series. Read part 1 here. or skip ahead to part 3 here.

The first problem with Japan's shrinking and aging population is the actual structure of the population. At the end of World War II, Japan (like the much of the rest of the world) experienced a baby boom. This meant that during the miracle years of the late 1950s and early 1960s many, many children were born. However, as I mentioned in the first part of this article, the fertility rate began to fall, permanently falling below replacement level in 1975.

In the short term, this posed no problem for Japan's economy. Those born during the miracle years entered the workforce during the 1970s and the bubble years of the 1980s. Thus, most of the Japanese baby boomers began working when things like lifetime employment actually meant something in Japan. Those who lost their jobs or failed to find jobs during the “lost decade” (really two now) were the younger workers born at the end of 1960s and into the 1970s.

At the time, this was viewed as a temporary measure; younger workers would enjoy lifetime employment once the economy picked back up again. But on the whole, this has not happened and during this time, the baby boomers have gotten older and older and closer and closer to retirement.

Now we are left with the situation as it exists today. Japan's workforce one of the most productive in the whole world, now faces a tidal wave of retirement among older workers – many of whom are able to keep working but will be forced out due to the mandatory retirement packages many companies have. These workers will no longer be contributing to the economy, unless they can find alternative employment options.

Worse still, is the fact that younger workers will have to pay for the increased costs for government programs such as health care and pensions due to the aging population. Moreover, both of these will be extremely costly due to the longevity of the average Japanese citizen. The problem is that these younger workers do not have the money to pay for these programs, since they have largely been denied the golden careers of their parents. Those careers assumed lifetime employment with pay increases based on seniority.

Making things even more difficult is the fact that the ratio of workers to retirees is going to decrease, due both to the retirement of the baby bloomers and the fact that not enough babies were born after 1975 to keep the size of the workforce stable. Some projections see the ratio falling to 1.4 workers for every retiree by as early as 2020. So what we are left with is a system where there are too few workers, making too little money to realistically be able support everyone.

Thus far, Japan has escaped dealing with this issue largely by borrowing money (admittedly mostly from its own people) to finance various attempts to revive the economy after the bubble burst in the early 1990s. But this option is quickly becoming less viable. Japan's debt to GDP ratio stands today at a staggering 170% and may rise to 200% by the end of next year due to fiscal stimulus packages. As Japan's population shrinks, the burden of the debt that falls on each person will increase. And since Japan's population is aging even faster than it is shrinking, the share on each worker is increasing at an even faster rate.

At some point, there will have to be a day of reckoning. Right now the debt servicing costs (interest paid on the debt) are manageable largely due to the fact that interest rates in Japan have been incredibly low for a long time. This makes it seem as though things are okay. But just like a low teaser rate for a credit card, the interest rate on Japan's debt has no where to go but up. And the fact that they keep pilling it on means debt servicing costs are going to eat up more and more of the government's revenue.

So we have now seen that Japan faces rising costs from an aging population due to things such as increases in the number of pensions and an increase in the cost of providing health care at exactly at the same time it can least afford it, due to its ever mounting debt burden. However, these are not the only problems an aging and shrinking workforce creates. The overall Japanese economy will find it increasingly difficult to even stay the same size, let alone grow.

The most important part of most economies is the value of the work performed in it. Often, countries are compared on the basis of GDP per capita, which just takes the size of an economy and divides it by its total population. A more accurate measure though it output per worker, since these are the people actually doing the work. So the most important part of any economy is the sum of all the output created by each worker.

Thus broadly speaking, if there are fewer workers then that means that means each one has to produce more value just to keep the total size of the economy the same. Now for a long time, Japan didn't have to worry too much about this – it had a growing workforce that was able to become more efficient and thus produce an ever greater amount per worker. This is why it went from total devastation at the end of World War II to the world's number 2 economy in less than 2 generations.

However, the Japanese economy can now no longer rely one of those two pillars. Economic growth going forward has to come from increasing productivity. Moreover, for the economy as a whole to grow, the increase in productivity has to be greater than the decrease in size of the working population. Whether or not Japan will be able to do this remains to be seen.

What will have to happen for this to succeed in the long run is a massive shift in the labour-capital ratio. The labour-capital ratio is an economic term that simply refers to how much labour and capital (machinery, tools etc.) you need to produce something. For example, say you want to produce 100 t-shirts. If labour was really abundant and hence cheap, maybe you would hire 100 people with just a few sewing needles and thread to produce your shirts. However, if labour is scarce (read expensive) it may be cheaper just to hire 1 worker to use a t-shirt producing machine to do the same job.

So what Japan has to do is constantly shift production, by using less labour to using more capital. This is part of the reason why Japan has been a leader in automation and why Japan has by far the largest number of robots. Robots are a perfect example of shifting work from person to a machine. However, the problem is with today's technology is you can only do this up to a point. It is every easy to have an ATM give you money versus a bank teller, but it is a lot more difficult to create a robot doctor.

Thus, the industries in Japan that will be the hardest hit by the demographic shift are those that are the most dependent on cheap labour with no easy automated replacements.

Finally, I have so far only focused on the impact Japan's aging and shrinking population will have on economic matters, but I should also point out that this will in turn impact on other factors. As one example, Japan's political and military clout in the world will likely further diminish.

For the size of its economy Japan has played a disproportionately small role in world affairs in the post World War II era. Part of this is due to its pacifist constitution which forbids overseas military engagements. This has also meant a very low burden of military spending relative to GDP for Japan.

However, as the memories of World War II have begun to fade (at least in Japan), many would like to see it play a more active role in the world. This is somewhat ironic given that Japan is going to be less and less able to do so. First, of all a smaller population means there are fewer people who can potentially join the military. Second, China will soon overshadow Japan in the size of its economy just as it does now in the size of its population. This in turn limits Japan's ability to become even a regional player let alone a global one.

By 2050, Japan will only be the world's 17th most populous nation, down from 10th today and 5th in 1950. Moreover, its economy will most likely be smaller than China's, India's and remain behind that of the the United States. Therefore, its military will not be able to grow due to both population and economic constraints.

Japan's aging and shrinking population poses a huge risk to the economy and thus what priorities the Japanese government is able to pursue. However, you may still be thinking that the potentially positive environmental impact may outweigh the enormous costs imposed by the shifting demographic structure of Japan.

While I think it is pretty hard to dispute the fact that having 27 million fewer people will mean an overall smaller impact on the environment, I think the decrease will be somewhat less than one might originally think. Japan's population density in many ways helps it. All sorts of mass transit options are available at relatively affordable prices (certainly compared to driving). However, as the population decreases, density will also decrease and thus the price of mass transit will either have to increase, or, they will have to decrease service (or most likely a combination of both). This will most likely cause a shift away from mass transit towards more people driving cars.

Moreover, fewer people likely means that land prices will decrease. This in turn means people may opt for bigger apartments or houses. This means higher heating costs in winter and more air conditioning use in summer. Finally, the reduced environmental impact coming from Japan will pale in comparison to the vast increase in pollution that will come from India and China. In fact, the CO2 output per Japanese citizen is half that of an American, so we would be better off having fewer Americans than fewer Japanese from an environmental point of view.

In the final section I will address what could and should be done to solve some of these problems. Read part 3 here or read part 1 here.

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Comments (15)

DargJune 29th, 2009 at 1:38 am

I think you’re oversimplifying the problem a tad – not all young people see it as them having been “denied the golden careers of their parents” as you put it, as more and more people are staying as far away from a corporate path as they can. Fewer people want to give their lives to the company like their parents did, and more and more they are looking for alternatives.

With all the problems the Japanese economy has built up over the years, I’m not totally convinced that the aging society is the big problem there. I do, however, think that an aging working population and decreasing overall population will force Japan to reevaluate the way it does things. As conservative as Japanese society as a whole is, it’ll take a crisis of extreme magnitude to back them against a wall and actually change some things, so it might not be all bad.

JapanianJune 29th, 2009 at 12:20 pm

@Darg: While I agree with you that now all young people want to give their lives to a company like their parents did, I don’t think that is the main issue. The issue is that not everyone who wants these jobs can get them. Thus, some people have looked for alternatives because they don’t want corporate jobs but many other have looked for alternatives because there are no stable corporate jobs available.

This along with a shrinking and aging population is (in my opinion) likely to cause a crisis of extreme magnitude and will force some extreme changes in the economy and very way of life in Japan. This is going to become more and more painful the longer tough decisions are put off until later,

JapunditJune 29th, 2009 at 12:25 pm

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Chris ( 30th, 2009 at 3:56 am

I’m greatly enjoying this series, but there’s a few points up for debate:

1. Productivity – GDP per capita would be a pretty unusual way to measure it. Generally, we look at GDP per hour worked, or labour value-add per hour worked. In both cases, Japan is significantly behind its developed OECD cousins ( and

2. Debt:GDP – Japan runs on a non-unified budget accounting scheme, which means that intra-governmental lending is not netted out, nor are assets such as forex reserves and collateral against public loans included. Netting these out to put Japanese government debt on a par with other OECD nations, the number is much lower (

3. Debt costs – you’re at risk of falling into the same trap that the LDP seems to perpetually fall into – the rate on already-issued Japanese debt does not change as the market rate changes. It’s only new issuance that gets priced at a higher coupon. Equally, it’s hard to square higher long-term rates with low economic growth and a disinflatory environment – which, if you look at the current inflation-to-breakeven yield spread between Japanese 10 yr JGBs and Japanese TIPS is forecast at -2% for the next 10 yrs. So you either have a steep yield curve, which augers for growth and inflation (which would be great for Japan), or a low, flat yield curve which means disinflation and borrowing costs for the government that stay low.

4. Labor-Capital ratio – automation is clearly one route. The other, though, is offshoring production – and Japan is doing that in spades. Which obviously causes problems for the younger members of the workforce in Japan, as it drives down their wages.

5. Population density. My bet is that it continues to rise in the cities, and falls in the countryside, rather than smoothly declining everywhere. Mass transit in and between cities will stay as cheap as it is now (it’s regulated – they can only raise rates when the operating companies fall into the red), and you’re right that in the inaka the services will dwindle to near nothing.

This is a good series – I’m very much looking forward to part III.

RyanJune 30th, 2009 at 9:23 am

I really liked reading both part to this article and I certainly think that you make some very valid points throughout. I am of the opinion that at some point, Japan will have to think hard about its future and what it wants to be within this world. Generations of being at the forefront of many fields of expertise, economy and technology is not going to be the best precursor to accepting a lesser role in the global world..

DargJune 30th, 2009 at 1:30 pm

@ Japanian:
You could argue that some who want the jobs can’t get them, but that’s always been true. What I would argue is more true today than it has been in the past is that not all those who could get the jobs want them.

We seem to agree that the aging population is going to make some waves, and the sooner the better- the only difference is that you see it as the main problem whereas I see it as a problem for sure, but more of a pending impetus that should (hopefully) spur them into acting on the bigger issues that are becoming harder and harder to avoid such as those CJW pointed out.

JapanianJune 30th, 2009 at 5:34 pm

@Chris: I am glad you are enjoying the series so far. I really appreciate your thoughtful and well researched comments. You really seem to know your stuff. Do you have a background in economics?

I will attempt to respond to your specific point below:

1. Productivity – I agree that GDP per capita is not the best way to measure productivity. I was trying to keep things simple but I agree either GDP per hour worked, or labour value-added per hour worked are better measurements of productivity.

When I first looked at the data you presented I assumed the low value added per hour worked was somewhat offset by the fact that many Japanese workers work long hours (many of those hours are really not that productive). However, I found data from the OECD that seems to contradict the idea that Japanese workers work especially long hours:

The strange thing about this, is that it totally contradicts my own anecdotal experience living in Japan. From my experience, Japanese workers work long hours with many of the hours worked not being particularly productive. The only explanation I can think of for the discrepancy is due to the increase in part-time jobs in Japan.

In any case, if labour productivity in Japan is low it means the problem is even greater than I originally stated. With a shrinking workforce the only way Japan can keep its economy growing is through increases in productivity. And it seems – at least from the data – that Japan has longer way to go than I originally thought.

2. Debt:GDP – I had a chance to read the article you cite after you posted a link to it in your comments to my first post. Assuming the net debt numbers are accurate, it would certainly seem to indicate that Japan’s debt situation looks much better than the more conventionally estimates I use.

Now I will just point out that most of the literature on this subject tends to use the gross debt figures (the ones I used) instead of the net debt ones. Thus, for simplicity sake I decided to stick with them but I urge anyone interested in this issue to look at the article Chris mentions and make up your own mind.

Finally, even if we use the net debt figures we still have the two following problems. The first is that Japan is still running a large deficit, which (I assume) is adding to both gross and net debt. The second is that Japan’s debt per worker is also increasing due to the declining workforce. So, even if the figures today aren’t as bad as the gross debt ones would have you believe, they are still not heading in the right direction.

3. Debt costs – You are right that interest rate on existing debt is already known and will not change. However, my concern is that to a large degree Japan’s debt has been financed largely through savings from Japanese citizens. As more of them age and start to retire they are going to start pulling out their savings and spending it on their retirements. This means less money available for future bond issues which could push yields up and mean higher borrowing costs in the future. Also, there is the potential risk people could at some point lose confidence in the Japanese governments ability to pay back the money it has borrowed. If this were to happen it would send yields much higher deflation or not.

4. Labor-Capital ratio – I agree Japan has been a leader in offshore production, which has probably been good for the overall economy – but not as you say for younger workers. The problem is certain types of jobs (such as doctors, construction workers, policemen, etc.) can’t be easily offshored. This means they will still have to do more with fewer people and automation will be the key.

5. Population density – I agree with you in the short to medium term. From what I have read there seems to be a strong indication that the move from the countryside to the cities will continue for the foreseeable future. However, if Japan does indeed have 27 million fewer people in 2050 some of this decline will likely come from cities as well (maybe 2nd-tier ones?). Keep in mind Tokyo’s fertility rate is the lowest of any prefecture at just 1.09 children per woman (, so growth has to come entirely from people moving there from elsewhere.

Thanks once again for your comments. I really enjoy discussing these issues.

Chris ( 1st, 2009 at 5:30 am

Japanian – one thing I forgot to add under #3 is the effect of higher rates on the 4 quadrillion (!!!) yen of savings in the system. Currently, that money earns about five eighths of bugger all under ZIRP, but with a decent nominal yield (say a couple of percent at the short-end, and 5-6% at the long-end) then that would soften the blow of the aging population considerably – retirees could live off the yield, rather than eat through the principal. Higher JGB yields could be just what Japan needs…

Alternatively, companies could start to divest themselves of their unnecessary cash piles, funnel excess cash flows into dividends, and give retirees a place to invest their money for yield. I can dream..

P.S. I run computational stat arb for a hedge fund – which arguably makes me the least qualified person to be discussing macro-economics 🙂

[…] Wright at Japanian analyzes the implications of the diminishing population in Japan from an economic, political, and military point of view. Cancel this […]

JapanianJuly 7th, 2009 at 12:55 am

@Chris: I agree that higher yields on savings would greatly improve the lives of savers (the majority of people) in Japan. Also, divesting cash though dividends would be another good way to entice investment rather than just getting people to save their money.

I hope the recent global downturn hasn’t hurt you or your hedge fund too much. From what I hear it is a tough business to be in these days.

Thanks again for your comments

DargJuly 7th, 2009 at 11:11 am

“The strange thing about this, is that it totally contradicts my own anecdotal experience living in Japan. From my experience, Japanese workers work long hours with many of the hours worked not being particularly productive. The only explanation I can think of for the discrepancy is due to the increase in part-time jobs in Japan.”

You missed a big reason – the only hours they count are the ones reported, meaning that any ?????? isn’t counted. Also, not everywhere even keeps track of the hours worked, so that and the overtime people don’t report probably account for a bunch I imagine.

DargJuly 7th, 2009 at 3:44 pm

Oop! the ????s were saabisu zangyo, overtime without getting paid.

JapanianJuly 7th, 2009 at 11:04 pm

@Darg: Thanks for the new term. It certainly seems like a very logical explanation for the discrepancy between what I have seen first hand, and what the numbers seem to show.

[…] a readable, succinct overview of Japan’s demographic crisis in three parts: The Numbers, The Implications, and The Solution. Interesting back and forth in the comments, too. Via […]

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