In the first two parts this article, I have written as if Japan’s demographic decline is a given, which of course it is not. Essentially, Japan has 3 potential options to solve this issue. The first is to do nothing and try to mange the decline as best as possible. The second is to allow mass migration to Japan. This would the easiest and fastest option (and the one I would personally recommend) but I don’t think this is a likely option given the mood of the Japanese society. This leaves rapidly increasing the birthrate back to replacement level.

Since I think option 1 is the most likely outcome but option 3 is the most desirable (since I do not foresee mass immigration becoming a politically viable option anytime soon), I will give recommendations on what should be done now to deal with population decline and how to move towards increasing the birthrate.

The first thing that needs to be done in Japan is to increase the age at which retirement benefits start and move away from mandatory retirement. It makes absolutely no sense for workers in one of the longest lived and healthiest workforces in the world to be forced to retire at 60 or 65 whether they want to or not. This is not to say that people can’t or shouldn’t still retire, but just that there is no longer really a need to do so at 65.

The second thing to be addressed is defense policy. Japan should keep its pacifist constitution and refrain as much as possible from foreign entanglements. Japan’s low defense burden has been a blessing to its economy despite what some politicians would have people believe. It would be insane at this point for Japan to start playing a more active military role in the world when it can least afford to do so.

The third thing that needs to be done is quickly start balancing the budget. Japan’s debt burden is far too large already and if it is not fixed very soon it could spell economic disaster. Unfortunately, this will almost certainly mean higher taxes, but this could be offset somewhat if they increase the age at which people get retirement benefits and would allow workers to continue working longer. It will also require an end or at least a large reduction in subsides to agriculture and industry. The longer the Japanese government waits, the more painful these changes are going to be when they are made.

Finally, on the topic of increasing the birthrate back to replacement level. Even if this were to happen tomorrow it would still not fix the problem. It will take at least 20 years for those born today to start entering the workforce. But that doesn’t help us with getting back to replacement level. Japan is by no means the only country to be facing this problem; it is just the most extreme example.

The only way things are going to change is if Japanese society changes – taking care of kids has to become a more equal burden. Basically, men will have to do more to take care of kids or the government will have to provide options for taking care of kids. Essentially, Japanese women shouldn’t be punished for choosing to have children. More egalitarian Western societies tend to have higher birthrates compared to more male dominated ones.

A more egalitarian society would also have another hugely important benefit; it would allow more women to enter the workforce. Increasing female participation in the workforce is critically important if Japan wants to avoid the worst effects of a shrinking workforce. Essentially, more women working would offset some (but not all) of the decline in workers as well as increasing the tax base. This is true whether or not Japan is able to bring its fertility rate back up to replacement level.

So there we have it, the demographic issues facing Japan are its biggest problem by the simple fact that they touch on almost all other policy areas, from economic growth and public debt, to things such as defense policy and even gender politics. All of them have or will be impacted by Japan’s aging and shrinking population.

As I mentioned earlier the easiest, fastest and (in my opinion) best option to solve the crisis would be to allow large scale immigration to Japan, even if it were only a temporary measure until it could get its birthrate back to replacement level. However, since I don’t think this will happen, Japan is left with many difficult tasks ahead. It is going to have to become ever more automated, shifting resources away from labour and into machines and robots, while also providing retirement benefits to an ever increasing group of people, all while (hopefully) not adding too much to its debt.

Will Japan succeed? Only time will tell, but given what they have manged to overcome in the last 200 years, I would be somewhat reluctant to bet against them.

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.

If I were to ask you what is the single biggest problem facing Japan today, what would you say? If you answered the current economic meltdown, Japan’s ballooning public debt, the rise of China or the threat from North Korea, you are way off. While, these are certainly extremely important issues and concerns for Japan, they pale in comparison to the real crisis it is now facing: that of demography.

Now this may seem like an hyperbole to you at first, but I am going to show you why Japan’s demographic structure – and specifically its aging and shrinking population – is by far the most important issue it now faces. I will demonstrate this by looking at a number of different issues including public debt, economic growth and international reputation. Finally, I will examine what, if anything, can be done about the current situation.

However, before I continue I think it would be useful to look at a few numbers to get an idea of the magnitude of the problem. According to the Japanese government’s statistics bureau, Japan’s population peaked in 2006 with 127,771,000 people. Since that time it has shrunk, with the UN estimating that by the end of next year Japan’s population will have fallen to just under 127 million people. This represents a loss of over 700,000 people in just 4 years.

If the current trend continues, the UN’s median variant estimate is that Japan’s population will fall to just over 100 million people by 2050, a loss of about 27 million people from its peak in 2006. To put that in some perspective, this is 5 million more people than currently live in the whole Kansai region of Japan. Or, to put this in a historical perspective, it means that by mid-century Japan will have roughly the same population it did in 1970.

Even more startling than this decline, though, is the decline in the size of the working age population (15-64 years of age) due to Japan’s aging population. Between 1996 and 2006 (the latest figures I could find), the size of the traditional working age population declined 3.4% – foreshadowing the decline in overall population that is now occurring. Worse still, if labour force participation rates remain the same for men and women, the total labour force will shrink 20% by 2030. Thus, Japan’s workforce is shrinking at an even faster rate that its population as a whole.

As you can see the numbers are large, so how did this happen? The answer is actually quite simple and has been know for a long time. After 1975, the total fertility rate for Japanese women dropped below 2.1; the replacement level needed to keep the population stable. And despite small recent increases (to 1.37 in 2008) it has stayed well below that level for the past 35 years. With little net immigration, it was inevitable for the population to start shrinking at some point.

Alright, so we have established that Japan’s population is aging and shrinking, so what? In some ways, a shrinking population might be good for Japan. It could mean a smaller environmental impact or more space for individual Japanese citizens. While these benefits may indeed occur with a smaller population, I hope to show that the downsides will dwarf these potential benefits in part 2 of my article.

To read part 2 please click here.