Japan's Shrinking Economy: Investigating the use of foreign workers to reverse the trend

OGURO Kazumasa Consulting Fellow, RIETI

Market contraction and sluggish reform

Japan's image as the "economic miracle," following its rapid development post World War II, is already part of its past. Today, the Japanese economy is on a path toward a balanced contraction as the population declines due to decreasing fertility and an aging population. It is perhaps for this reason, that the whole nation seems to be engulfed in a sense of pessimism, and people are so desperate to ensure their own survival and make short-term gains, that they are losing the ability to take a long-term view and think about the future of Japan. The living standards of a country are determined by the level of gross domestic product (GDP) per capita and, therefore, it is possible to maintain or even improve living standards even when the population declines. What is needed now, is a bold growth strategy that will guide Japan toward the future and enable its people to have hope and aspirations. Although the sustainability of public finance and social security is being undermined in Japan, it is not too late to restore these systems if drastic and thorough reforms are implemented now. Unfortunately, however, no concrete image of such reforms is on the horizon at this point of time. Primarily, political leaders should be developing bold growth strategies and striving to reform the fiscal and social security systems to ensure sustainability. However, facing fierce opposition from various vested interests and bound by political dynamics, the government is caught in a dilemma, making little headway in its reform efforts.

Against this backdrop, moves have emerged to advocate for allowing more foreign workers into Japan as a way to solve various problems in the country. In June 2008, a group of lawmakers in the ruling Liberal Democratic Party (LDP) proposed a plan to accept 10 million immigrants over the next 50 years. Then, in October in the same year, Nippon Keidanren (Japan Business Federation) called for more vigorous acceptance of foreign workers in its policy proposal "An Economy and Society That Responds to the Challenges of a Declining Population." However, both of these proposals are qualitative in nature and not based on quantitative analysis of the impact of immigrants. Thus, they have not examined how the acceptance of immigrants would affect the Japanese economy, how the impact would differ across different generations of Japanese people, and so forth. In this article, I would like to explore the possibilities presented by a "Japanese-style immigration policy," drawing on the findings from a joint study between Manabu Shimasawa, associate professor at Akita University, and myself on the impact of immigrants on the utility of each generation.

Will unskilled foreign workers have a negative impact on the economy?

It is often argued that the acceptance of skilled foreign workers would have some degree of positive impact on the national economy but the acceptance of unskilled foreign workers could negatively affect the economy by causing a downward spiral of wages for their native counterparts. While this is a widely accepted view, it is based on circumscribed observations and gains on the part of the corporate sector are not taken into consideration. As a general theory, an increase in the supply of labor - whether skilled or unskilled - reduces wages by stimulating competition among workers, but leads to an increase in corporate profits. If the amount of the increase in corporate profits exceeds the amount of the decrease in wages, the net impact of the increased labor supply on the economy is positive. Then, the question of whether or not to accept foreign workers boils down to whether or not the negatively affected native workers can be appropriately compensated.

In this regard, Hatton and Williamson (2005)( note1 ) offer many suggestions. One such suggestion is to impose additional levies on companies employing unskilled foreign workers within a limit not exceeding the amount of an increase in their profits, attributable the use of such workers, and redistribute the resulting revenue to the affected native workers. In fact, such an attempt has already been made in Singapore. Specifically, companies hiring foreign workers are subject to "foreign worker levies" imposed at the applicable rate depending on the type of business and the skill level of foreign workers. However, the question remains - and it has been controversial in Singapore - who is or should be ultimately paying the cost of such employment taxes. That is, the cost of employment taxes could be passed on to native workers in the form of further reductions in wages or to consumers in the form of higher product prices, and therefore it requires caution and careful consideration in introducing such taxes.

Another suggestion is to collect certain additional taxes from unskilled foreign workers. The prospect of higher wages is at least part of the reasons why unskilled workers seek jobs overseas. In other words, unskilled workers working in foreign countries are receiving greater benefits than they would have been in their home countries. Thus, it is suggested that a host country could impose taxes on unskilled foreign workers within a limit not exceeding their additional benefits gained by working in the country and redistribute the resulting revenue to the affected native workers. This scheme has an advantage in that the tax burden would not be transferred to others, unlike the case in which taxes are imposed on employers.

That being said, however, all these concerns may turn out to be largely unnecessary. Recently, a group of researchers led by Jiro Nakamura, professor at Nihon University, has conducted a detailed empirical analysis of the impact of allowing a large number of foreign workers into Japan, including the possibility of causing a downward spiral of wages (" Nihon no Gaikokujin Rodoryoku (Foreign Workforce in Japan)," Nikkei Publishing Inc.). Their findings suggest, though with certain reservations, that the acceptance of unskilled foreign workers could work to raise, rather than decrease, wages for low-educated Japanese workers, who are most likely to compete with unskilled foreign workers.

Presently, the Ministry of Education, Culture, Sports, Science and Technology and five other ministries are jointly promoting a program aimed at increasing the number of foreign students to 300,000 by around 2020. The program is being implemented as part of Japan's global strategy and from the viewpoint of enhancing the nation's international competitiveness in education and research and attracting exceptional foreign students to study in Japan. At the same time, the government has been seeking to expand employment opportunities in Japan, taking steps to create a more accommodative environment to help achieve that end. Efforts are being made to identify and explore the recruitment needs of companies having a positive attitude toward the employment of foreign graduates from Japanese universities. The government is also considering enhancing job-matching services for prospective foreign graduates and Japanese employers. Thus, if the entire flow from foreign students' education to their employment functions effectively, it would provide a golden opportunity for Japanese companies to recruit foreign workers of a certain quality.

Greater acceptance of foreign workers may alleviate fiscal and social security burdens

Either way, there is a possibility that the acceptance of unskilled foreign workers will positively contribute to the national economy. What should be of greater concern in association with the vigorous acceptance of foreign workers is the possibility that many of these foreign workers may choose to stay on a more permanent basis, bringing their families to Japan. This would give rise to the issue of social integration, i.e., to what extent the rights to education and social security benefits (pension, medical insurance, and nursing care insurance) should be granted to foreign workers and their families and how should Japan proceed with their integration and assimilation into Japanese society.

However, social integration may provide some benefits to Japan, for instance, alleviating the burden of financing public pension programs, contributing to tax revenue, and giving a boost to consumption. As Japan's aging population and decling fertility rates advance, the working-age population - or those contributing to the public pension and medical insurance programs - is decreasing. By accepting young foreign workers on a significant scale, we can expect them to play a supplementary role as contributors to the programs on the short-term horizon. Furthermore, foreign workers having a regular source of income can be counted on as contributors to tax revenue and consumption expansion, giving a much-needed boost to Japan, a country with soaring public debt and a shrinking market.

On the long-term horizon, however, these foreign workers would retire from the labor market and become pension benefit recipients, thereby becoming a source of financial burden on Japan's fiscal position and social security system in the future. These advantages and disadvantages need to be rigorously analyzed to determine which of them has a greater impact. Thus, drawing on Fehr et al. (2004),( note2 ) my fellow researcher and I estimated how Japanese people of different age groups would be affected by the presence of foreign workers under two different scenarios, one assuming the acceptance of 150,000 foreign workers starting from 2015, and the other assuming half that number. Specifically, we calculated utility values for each age category, using an overlapping generations (OLG) model in an open economy setting. The "utility" referred to here is based on individual lifetime earnings and corresponds to the level of satisfaction felt about the affordable level of lifetime consumption. (The amount of "individual lifetime earnings" is calculated as a sum of the net income while of working age - i.e., gross income earned, less income taxes, and paid pension premiums - and pension benefits received after retirement.) Our estimation results, obtained by running a model based on the above-explained OLG model and modified to incorporate factors unique to the Japanese economy, are as shown in chart 1 below.

Chart 1 Utility of accepting immigrants across different age groups Chart 1: Utility of accepting immigrants across different age groups

(Source)Oguro et al.

In the above chart, the horizontal axis indicates the birth year for each generation, while the vertical axis shows the level of expected lifetime utility for each age group, relative to the expected lifetime utility for those born in 1930, which is represented by the value of 1. From this chart, we can see that the acceptance of foreign workers would improve the expected lifetime utility for those born in and after 1980. This is because the presence of foreign workers would work to alleviate the burden of taxes and insurance premiums to be borne by these generations. It is therefore presumable that the greater acceptance of foreign workers will have some degree of positive impact on the Japanese economy which is on a path to a balanced contraction ( chart 2 ).

Chart 2: GDP projections for Japan (2005=100%) Chart 2: GDP projections for Japan (2005=100%)

(Source)Oguro et al.

It should be noted, however, that the above discussion is made solely from an economics viewpoint. Whether or not to allow a significant inflow of foreign workers into Japan is the question that ultimately defines the framework of Japan as a nation state, including its nature and characteristics on cultural, historical, and security fronts. It is thus needless to say that sober and cautious discussions must take place before drawing any conclusions.

However, at the moment, Japan's population is aging rapidly, and we are steadily moving in the direction of a balanced contraction. While little progress has been made in formulating a bold growth strategy or implementing fiscal and social security reforms, those from the postwar baby boomer generation are retiring and starting to collect pension benefits. If things remain unchanged, the Japanese economy will suffer various distortions caused by its declining population. We have no time to waste and must immediately start taking action.

In doing so, we should not be confined to conventional ideas. It is necessary to continue to accumulate relevant research results such as this. At the same time, the government and the public sector need to get together to have sober and vigorous discussions on a Japanese-style immigration policy, with an eye not only on the benefits to the current generation but also on the benefits to future generations. Lately, widening disparities between permanent and contract workers have emerged as a serious problem in Japan. Particularly, since last year, sudden layoffs of contract workers, including those dispatched from employment agencies, has become a major issue. Indeed, unskilled foreign workers are the most vulnerable - far more vulnerable than Japanese contract workers - when companies begin slashing payrolls. Thus, if Japan is to consider an immigration policy with an eye on the social integration of foreign workers, employment practices and conditions, including eligibility to unemployment insurance, should be among the key issues that must be addressed.

August 4, 2009
  1. Hatton, T. J., and Williamson, J. G. (2005) Global Migration and the World Economy, MIT Press.
  2. Fehr, Hans, Sabine Jokisch, and Laurence J. Kotlikoff (2004) "The Role of Immigration in Dealing with the Developed World's Demographic Transition." FinanzArchiv 60(3): pp. 296-324.

August 4, 2009

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