Demography and the Japanese Economy

Date September 29, 2016
Speaker YOSHIKAWA Hiroshi (Senior Advisor and Faculty Fellow, RIETI / Professor, Faculty of Economics, Rissho University)
Moderator NOHARA Satoshi (Consulting Fellow, RIETI / Director, Economic and Industrial Policy Division, METI)
Language Japanese

Summary

Population problem of Japan

YOSHIKAWA Hiroshi's PhotoThe relationships between the population, economy, and society of a country or region are diverse. There have been many times in history when the size of population was said to be too large. Prewar Japan was considered to be overpopulated, which was one of the factors that drove the country to colonize a region then known as Manchuria. From a global perspective, we are now in a state of overpopulation, and the United Nations acknowledges it as a global challenge. Thus, we must first recognize that population decline is a problem unique to advanced countries.

On that basis, I would like to move on to discussing the situation in Japan. Population projections over the next 100 years through the early 22nd century have been made available. Under the medium fertility scenario, Japan's population is projected to decrease to about 40 million by the early 22nd century. However, as this scenario is quite optimistic and the low fertility scenario is more realistic, there is a good possibility that Japan's population will fall below 40 million. It is a tremendous challenge for any society to lose two-thirds of its population in the span of 100 years without massive deaths caused by war or other extraordinary events.

Population decline is the biggest problem facing the economy and society of Japan. So, I am in support of the government's efforts to implement proactive measures to address the problem of population decline and low fertility. In particular, it is an undeniable reality that many young couples want to have children but are unable to do so because the current social environment is far from supportive, and there is significant room to improve the situation.

Social security and public finance

Population decline and aging are closely related with the problem of growing disparities, which is profoundly global and becoming a major issue in the ongoing presidential campaign in the United States. However, circumstances vary significantly from one county to another. Japan is facing two types of disparities that are intertwined with each other, namely, growing disparities in the entire society driven by aging population and disparities within the working population as exemplified by income inequality between those in permanent full-time positions and those in precarious employment. However, given the fact that significant disparities are observed among people in their 70s while those in their 20s are fairly homogenous in economic and health status, we can say that the existing disparities are, to a substantial extent, attributable to population aging.

We must do something to address the problem of widening disparities, but many different factors are involved and it is impossible to solve all of the micro-level problems with measures taken at the macro level. Having said that, however, it is possible to alleviate the problem with macro level measures. This is exactly where government policy must come into play, and implementing social policy measures, mechanisms, and programs designed to prevent the widening of disparities is what social security is about.

If it is determined that there is nothing wrong with growing disparities, social security can be kept to the minimum. However, if we perceive them as a social problem and intend to put the brakes on the trend, social security is needed. Indeed, as Japan's population is aging rapidly, the role of social security is becoming increasingly important.

In reality, however, Japan's social security expenditures are rising with the aging of the population to a level far exceeding the amount of revenue received in premiums, and 40% of the expenditures are now covered by public funds. But Japan has been running massive fiscal deficits with revenues failing to catch up with expenditures. Against this backdrop, the government embarked on the integrated reform of the social security and tax systems. Yet, efforts to increase revenue have been insufficient. For instance, the bill to postpone the planned consumption take rate hike got passed with little ado. I find it quite problematic.

Problem of rural areas

As exemplified by the recent buzzword "chiho shometsu" or "extinction of rural municipalities," it has been warned that many rural municipalities might disappear in the coming years as more rural areas become depopulated along with their populations aging. Although the government has been promoting the urban-to-rural migration of retirees and other senior citizens, particularly those dwelling in the Tokyo metropolitan area, there is a limit to the effects of such policy.

Now, take a look at a population ranking by city in 1878, 10 years into the Meiji Period (1868-1912). Following Tokyo, Osaka, Kyoto, and Nagoya, some regional cities such as Kanazawa in Ishikawa prefecture, Matsue in Shimane prefecture, Toyama in Toyama prefecture, and Hirosaki in Aomori prefecture—each of which had been governed by powerful feudal lords during the preceding Edo Period (1603-1868)—were ranked among the top 20 most populated cities. As such, major cities used to be found in various locations of the Japanese archipelago because agriculture was the mainstay industry back then. Since agriculture is a land-based industry, farmers obtain no benefits by agglomerating. Rather, farmlands need to be spread over fairly wide geographic areas. Thus, while the central city of each feudal domain had an agglomeration of population, the overall trend was that the population was dispersed across the territory because of the agriculture-oriented industrial structure.

In contrast, Japan's economic development from the Meiji Period onward was led by manufacturing industries, in which agglomeration offers various advantages. It is a natural course of events that people move closer to where they work. Thus, over a period of 100 years, people continued to flow into major cities to form urban agglomerations. Based on this idea, even though I do not necessarily oppose the government's view of seeing unipolar centralization in Tokyo as undesirable, I think it is inevitable that the distribution of population in 21st century Japan will be based on a degree of rationality.

Here I am referring to rationality as seen from two perspectives. One perspective is to what extent the advantages of agglomeration will be needed at a time when Japanese industries are transforming from traditional manufacturing-based industries to knowledge-intensive industries. Today, working from home is no longer a rarity but an accessible option for many people, and all sorts of communication can be done via email, and, yet, it is said that face-to-face communication is indispensable. However, how big is the advantage of agglomeration in terms of people physically meeting face-to-face with one another when teleconferencing is becoming an increasingly widespread practice?

The other perspective is what degree of special dispersion or agglomeration people find comfortable in living as residents. Each and every person would have a different view about this. Some people may long for urban environments, while others prefer to live in the countryside. With the development of transportation networks, the time required to travel from one place to another is becoming shorter.

The dispersion or agglomeration of population should be determined by the combination of those two factors—i.e., the advantage of labor agglomeration and the comfort of people's lives—and not by the government forcibly shifting the flow of people.

Japan's population and economic growth

The biggest reason why I wrote my forthcoming book, Jinko to Nihon Keizai [Demography and the Japanese Economy], is to refute the argument that Japan can no longer hope for economic growth because its population is declining. Historical changes in the size of population and economic growth over the past 100 years show that these two factors are hardly related with each other.

Many people say that zero economic growth is the best that a country with a declining population can hope for and positive growth is beyond its reach because a shrinking population means a shrinking workforce.

If I may use a bold metaphor, the image they have in mind is road work in which each worker is digging with a pick. Suppose that initially 100 workers are repairing a road. Now, if the number of workers is reduced to 70, what will be the outcome? They would say: "Getting the same amount of work done by each worker accepting a little more workload will be just as much they can manage. But normally, it will result in negative growth."

However, this image is fundamentally wrong. Economic growth in advanced economies is achieved by introducing heavy equipment to carry out the road work that have been undertaken by 100 pick-equipped road workers. The result may be that the number of workers can be reduced from 100 to 10 to carry out the same amount of work.

Furthermore, if the size of an economy is to be determined by the number of workers or population, the amount of income per capita would have to be almost equal. Or if the size of an economy is proportionate to the size of population, advanced economies would not have emerged in the first place. In order for an advanced economy to be an advanced economy, income per capita must have risen significantly. When we look back on the long history of humankind, we can say that steady growth in income per capita has been a rarity. Indeed, it is only after the Industrial Revolution of the 18th century that an increase in per capita income came to be taken for granted. Advanced economies evolved into what they are today primarily as a result of the rise in per capita income.

Improved labor productivity and innovation

Japan's real gross domestic product (GDP) grew at a pace of about 10% per year during the high growth period from 1955 through 1970. However, during the same period, Japan's labor force increased at an average rate of only 1.3%, meaning that the remaining increase of nearly 9% was attributable to improved labor productivity.

Innovation is what drives an increase in labor productivity. In considering Japan's economy today, everybody says that we need to enhance labor productivity because the labor force is shrinking. However, we must first make it clear that the morale and work ethic of individual workers have nothing to do with labor productivity.

Productivity is a tricky concept. For instance, suppose that a department store employee is working as a parking lot attendant, ushering incoming vehicles into available parking spaces. Being aware that low productivity is a major problem facing service industries, the department store decided to measure the productivity of the parking lot attendant in terms of the number of vehicles handled per hour. A graph made by plotting the measured data shows ups and downs depending on the day of the week, with a particularly big difference observed between the number of vehicles handled on Thursdays and that on Sundays. However, this is nothing but counting the number of vehicles coming into the parking lot. In other words, the productivity of the parking lot attendant is determined by the number of incoming cars, which is entirely dependent on the department store's ability to pull in customers. The same holds true for the productivity of convenience store managers. Even if an extremely capable person such as a Nobel laureate serves as a store manager, productivity would be extremely low during the wee hours such as 2:00 a.m. or 3:00 a.m.

What I am trying to say with those examples is that productivity is determined by the ability to offer attractive products and generate business. I think this is the responsibility of top management.

In a nutshell, I think it is wrong to say that zero growth is the best the Japanese economy can achieve because the population is shrinking. As I said earlier, the reason is that the economic growth of advanced economies is determined by the growth of per capita income, which is determined by innovation.

I also find some problems with arguments concerning innovation. For instance, some people say that it is difficult to bring about innovation in an aging society. Indeed, if we assume that the number of innovations achieved by a group of people is obtained by multiplying the number of people in the group by the probability of innovation success, the number of innovations will decrease in an aging society even when the probability of innovation success remains unchanged, because the number of people with potential to innovate is to decrease.

Turning to Japan, the working-age population is decreasing and expected to fall to 44 million in 2062. However, this number is comparable to the number of working-age population in today's Germany, France, or United Kingdom. In other words, if a working-age population of 44 million is too small to achieve any innovation, Germany, France, and the United Kingdom should have had declined by now as economic powers. However, the reality is that despite being plagued with various problems, all of those countries remain confident in their high potential for innovation as leading advanced economies. Again I must say that Japan is too pessimistic in this respect.

Some people are concerned that population aging may spell stagnation in demand. To counter this argument, we can cite the life-cycle hypothesis of saving and consumption, which assumes that people in their working age save and those in their old age dissave. It is a standard economic theory that elderly people have a greater propensity to spend.

Roles of companies

The question is what value can be derived from consumption. If elderly people are offered what they need, they will definitely buy them. Young people may have a tendency to go for cheaper options, and elderly people can potentially afford high-end goods and services. It is the responsibility of companies to offer what consumers need.

I believe that the Japanese economy will eventually overcome the ongoing adversity with the power of innovation. However, I have some concerns about the current situation. For one thing, Japanese companies are even more inclined to save than households. In a typical capitalist economy, the household sector is a net saver, while the business sector is a net borrower, spending on investment. I wonder what is wrong with Japan, as a society and an economy, where the business sector—rather than the household sector—is the largest net saver.

Also, many Japanese corporate managers say that the Japanese economy is now on a consistent downward trend, but that observation is wrong. When we look at Japan's postwar high growth period in two stages, before and after the 1964 Tokyo Summer Olympics, the latter half was a period in which people embraced high growth as something occurring contemporaneously. In the first half, however, pessimism prevailed on the course of the Japanese economy. It was only in retrospect that the high growth period was reckoned to have begun in or around 1955.

"We are no longer in the postwar period," an oft-quoted phrase from the 1956 White Paper on the Economy, may conjure up a positive image in the minds of many people. However, we read the content of the white paper, the message is opposite. The true meaning of the phrase is that the Japanese economy, which had been enjoying robust growth for the first 10 years after the end of the war thanks to the postwar reconstruction demand, was entering a period in which growth would be hard to come by. It was meant to be a call for innovation, which was deemed to be the only possible way to keep the steam of the economy. Thus, Yonosuke Goto, the chief author of the white paper, introduced the concept of innovation, coining the term "gijutsu kakushin" (technological innovation) as a Japanese translation of "innovation."

Furthermore, the period before and after 1960 was an era of Marxian economists in Japan, and they would have been the last ones to say that the Japanese economy would continue to grow. In other words, Japan's high growth was achieved as a result of individual companies' efforts to innovate in the midst of the prevailing sense of wariness.

Therefore, it does not necessarily sound convincing when today's corporate managers say that things are much more difficult today as the time is tough and completely different from the high growth period. In particular, saying that the Japanese market is dead on the ground of the shrinking population is tantamount to losing by default. Companies should be making much more efforts as they are the ones counted on to serve as the driving force of the Japanese economy.

Commentary by NOHARA Satoshi

I believe that how we can encourage private-sector companies to raise salaries and make investment holds the key to vigorously driving the economic cycle. When we analyze private-sector companies' behavior in domestic capital investment, we can see a strong interrelation between domestic capital investment by companies and the expected growth rate of the domestic economy. This indicates that the challenge for Japan is how to raise the expected growth rate of the economy.

One of the findings from the analysis is that the expected growth of the Japanese economy, as perceived by Japanese companies, is closely interrelated with the growth rate of the Japanese population. Thus, in other words, we can say that the challenge is how to break Japanese companies' preconceived idea that the domestic economy will not grow because the population is shrinking. Another finding is that there is a strong interrelation between the latest GDP growth rate and the expected growth rate of the domestic economy as perceived by Japanese companies. We can see that when the actual growth rate of GDP increases, the expected growth rate will increase as well.

At the Ministry of Economy, Trade and Industry (METI), we are struggling to find ways to make Japanese companies more forthcoming in raising salaries and making capital investment in Japan, which is one of the policy challenges we face today. I would like to ask your opinion as to how we can effectively work on Japanese companies in forming expectations.

YOSHIKAWA Hiroshi

I am also wondering what is happening to Japan with respect to wages and salaries. In Germany, while the overall price level remained stable in the period from 2013 through 2015 with the inflation rate kept at 0%, the nominal level of wages and salaries increased by 4%. I cannot help but wonder where the difference between Japan and Germany comes from.

Regarding the expected growth rate of the Japanese economy, I find it quite strange that corporate managers refer to it as a factor for their decisions on innovation. According to Joseph Schumpeter, all of the keys to innovation are found at the micro level. In other words, innovation is spontaneously undertaken by individual entrepreneurs in their business activities.

For instance, while private railway services are said to be a declining industry, Odakyu Electric Railway Co., Ltd. is successfully operating reserved seat only commuter express trains, charging passengers extra fees. Here, the demographic trend is not a factor here. The company is implementing this innovative practice based on the belief that a business will prosper when it offers services that truly meet the needs of society.

The idea that the number of customers will increase when population increases is wrong as a starting point for innovation. I do not mean to say that demographics are meaningless as a factor. Demographic factors are important in decision making for advancing into global markets such as China and India. But I think now is a good time to introduce new services that can meet the new needs arising with the aging of population.

Q&A

Q1: Japanese companies' innovation ability is not necessarily poor in terms of generating new ideas. However, when it comes to turning the ideas into viable business, they lag behind their overseas rivals. It is often said that Japan lacks start-up dynamics, whereby the replacement of outdated industries with newly emerging ones is slow to occur. What is your view on this?

YOSHIKAWA Hiroshi
Although there are various types of innovation, my theory is that it is product innovation that holds the key. Currently, a U.S. company is the top brand in robot vacuum cleaners. However, technologies required for autonomous cleaning are not necessarily cutting edge. Indeed, long before robot vacuum cleaners became a popular household item, a Japanese consumer electronics company had developed a successful prototype. However, it did not reach commercialization because of concerns about the possibility of a robot cleaner hitting a family Buddhist altar and knocking over a candle and starting a fire. In a sense, this episode is quite typical of Japanese companies.

The situation is more serious in the area of nursing care robots. Japanese companies have highly advanced technologies applicable to nursing care robots, but such technologies have not been utilized in practice because of the Long-Term Nursing Care Insurance System. It is virtually impossible to introduce nursing care robots, unless they are incorporated into the government-prescribed fee system for nursing care services. In other words, without market making by the government, the situation will not change whatever efforts made by private-sector companies.

Innovation is not just about developing new engineering technologies but also about introducing new ideas and ways of doing things such as coordination. Brilliant innovation should also involve decision making because it is meaningless unless realized. It is in this aspect that the government should find its role.

Q2: As reasons behind the high savings rates among Japanese companies, we can cite the need to keep ample internal reserves to protect against currency risks under the floating exchange rate system as well as against litigation risks. Are there any other factors?

YOSHIKAWA Hiroshi
It is only after 2000 that Japanese companies' savings rate began to rise conspicuously. So, the floating exchange rate system is not the reason. Meanwhile, Keidanren (Japan Business Federation) explains that Japanese companies may appear to hold large amounts of internal reserves, but these include cash equivalents held by globally operating companies to be used in payment for cross-border mergers and acquisitions (M&As). But that is not the true reason either.

I think that Japanese companies are increasingly inclined to keep more cash at hand. This is an extremely defensive attitude. Schumpeter would give them a whipping if he were alive today.

Q3: In the coming years, we will see more innovation occurring in the area of information and communications technology (ICT). As the center of gravity of innovation shifts toward ICT, we may no longer be able to apply the same way of thinking as in the era of industrialization in discussing labor productivity and per capita GDP. What is your view in this regard?

YOSHIKAWA Hiroshi
A very important theme of product innovation, which I believe is the most important area of innovation, is population aging. This is because the advent of an aging society may change everything, ranging from goods and services to the modalities of distribution, buildings, healthcare, nursing care, and so forth. For instance, there is no doubt that automobiles per se will continue to evolve. However, in order to change the way in which people use them, virtually all aspects of society—cities, distribution systems, buildings, transportation means, etc.—must evolve gradually. Currently, each company has its specialized area of business, whether goods or services. In the future, systems or things that link them across organizational boundaries will become important.

Conjuring up abstract ideas of what will be needed in an aging society brings us nowhere. Naturally, the advantage is with the society that is confronted with specific needs of an aging population. That society may not necessarily be Japan. But in the 21st century world, Japan is one of the frontrunners, and this represents an unprecedented opportunity for Japanese companies. Whether to grab or miss this golden opportunity is up to these companies. However, creating a cross-cutting system or mechanism is beyond the capacity of individual companies or industries. In this sense, the government has its role.

Q4: What I feel recently is that young people are not taking initiative. It seems to me that pessimistic sentiment tends to prevail in Japan because everything is decided by elderly people, not by young people.

YOSHIKAWA Hiroshi
I perfectly agree with your view that Japan should become a society where young people can feel brave and relaxed to play more active roles. In this regard, I feel truly sorry for today's young generation. Actually, there are a significant number of college graduates who wanted but were unable to find permanent full-time employment, settling for unstable jobs against their will. This is something the Japanese society as a whole should reflect on itself.

After all, the young generation are the ones who should be playing the leading role in bringing about innovation. In order to create a society where they can feel freer to innovate, there must be a relaxing and tolerating environment in the society. A situation in which the whole society is strained is no good. When we continue to explore solutions to this situation, the endeavor will eventually turn into a driving force for innovation. If we manage to sow seeds for changes with innovation, problems such as those I have just mentioned will solve themselves just like plants growing themselves.

*This summary was compiled by RIETI Editorial staff.