How will population ageing affect Japan and the rest of South-East Asian countries that are following in Japan's footsteps? The populations of all industrial countries are aging; however, Japan's population will age faster than any country has ever done before. Population ageing is a normal part of the modernization process whereby increased opportunities for women lead to lower fertility and improved medical care extends the life spans of older adults. But population ageing also has three major impacts on Japan's economy, namely in the productive capacity: it will reduce rates of saving and capital accumulation; it will shrink the labor force; and finally, population ageing may slow the growth in total factor productivity. Japan, whose population enjoys the greatest longevity worldwide, will be particularly affected. There are few signs of self-correcting tendencies that would slow the population ageing process or even prevent its acceleration. This paper will examine the effects of population ageing on the future economy of Japan and provide possible prevention strategies for South-East Asian countries.
From here on, the paper will have six sections. The first section will take
a close look at Japan's population ageing. The second section will analyze
Japan's savings rate and capital accumulation. The third section will look
Japan's shrinking labor force. The fourth section will explore Japan's shrinking
output and current account balance. The fifth section will present some
policy options for Japan's future. And finally, the last section will conclude
this paper.
Japan as a Country of Ageing Population
Looking at the current trend, the population of Japan will continue to grow
older.
Declining fertility combined with increasing longevity will cause the Japanese
population to age rapidly. Since 1950 up to 2000, the median age of the
Japanese population has increased from 22 years to 41 years, and by 2050,
fully half the population of Japan will be over the age of 53. By 2025,
there will be roughly one elderly person for every two persons of working
age, which will leave Japan with a higher old-age dependency ratio than
any other major industrial country. At this rate, Japan will have more than
85 dependents for every 100 working age. This unusually high dependency-ratio
can unload a great deal of social and economic problems onto Japan.
The causes of the rapid aging population in Japan are a result of a steady
fall in the total fertility rate and rising longevity. Total fertility rate
has been on a plummet since World War Two, and the cause of it is delayed
age at marriage. Almost 50% of childbearing age women are not married women
are delaying marriage to take advantage of increased opportunity for higher
education and improved employment opportunities. In addition, the benefits
of children are not what they once were in Japan. Already, fewer than half
of elderly women live with their children. And with the rapid improvements
in technology and Japanese diet, Japanese are also living much longer. As
a matter of fact, they have the world's highest life expectancy rate.
Savings Rate and Capital Accumulation
Savings rate equals investment. One of the main reasons Japan's economy
ranks second in the world is because it has the highest savings rate among
the developed countries. But recently, Japan saves a little less than 1/3
of its GDP, and its gross national saving rate has generally declined since
1991. The future course of Japanese savings rates will depend on the strength
of the factors likely to reduce savings rate relative to factors likely
to increase them. Among the factors that are likely to reduce savings rates
are: the ageing of the population; the decline in economic growth rates,
and an increase in the retirement age. Among the factors that are likely
to increase savings rates are: the decline in the labor force participation
rates of the elderly; and the increases in life expectancy at retirement.
It is likely the factors exerting downward pressure on saving will predominate.
Many explanations revolve around the life cycle hypothesis of Modigliani
and Brumberg, which predicts that individuals will finance their consumption
during retirement by dissaving. Many of the challenges to the application
of the life cycle hypothesis to Japan center on whether the elderly really
do dissave. The articles found that the elderly, though some may continue
to work and save, generally dissave as a group. Population Ageing will mean
a large decrease in savings, leading to a big blow in the economy.
The ultimate effect of population ageing will depend on the size of the
decline in domestic investment relative to the decline in savings. Population
ageing will have opposing effects on domestic investment. On the one hand,
a declining labor force may stimulate the demand for labor saving investment.
On the other, the decline in profit rates due to the reduced labour supply
and the higher interest rates may discourage investment. If the decline
in savings is greater, Japan's external balance will fall, since the current
account balance relative to GDP is equal to the saving rate minus the domestic
investment rate. Many economists suspect the decline in saving will ultimately
outweigh the decline in investment, and Japan's current account surplus
will eventually become a current account deficit. Another prediction is
that an increasing old age dependency rate has a greater impact on domestic
investment than on saving. Hence, the current account surplus of Japan is
likely to grow. Therefore, there seems to be no consensus on the effect
that population ageing will have on Japan's future stock of foreign or domestic
capital.
Labor Force is shrinking
Since World War Two, population decline has since continued at a somewhat
slower pace, but the fertility rate has now dropped well below the replacement
rate. This decline is often attributed to three economic factors: a decrease
in the salary gap between men and women, difficulties reconciling work with
child rearing, and the generous social security system that has increased
the financial independence of the elderly and made them less reliant on
the support of their children. Japan's demographics imply not only an aging
population but also a declining population. With fewer young adults expected
in the future, the proportion of working-age people will diminish over time
and the labor supply will decrease.
It was the group of educated and low wage labor force that powered Japan's
economic growth during its reconstruction era. However, Japan's labor supply
is likely to fall rapidly in future decades. And since labor supply is likely
to fall, the rate of capital formation is also likely to stagnate, meaning
the chances of maintaining economic growth in the twenty-first century depend
crucially on accelerating the rate of growth of productivity. As a result,
we will probably see an enormous transition in Japan's economy as the country
move from a heavy physical capital country to a heavy human capital country.
One of the reforms the Japanese government implemented is the re-employment
of elderly after they reach the mandatory retirement age at a lower wage.
On average, about 70 percent of companies follow this approach, and these
men receive wages 20 to 40 percent below their pre-retirement wages. This
move will ultimately lessen the burden on pensions and the decreasing labor
force in the future.
Shrinking Economic Output and Current Account
On the basis of long-term simulations produced by the IMF's world macroeconomic
model, Japan's demographics imply that the level of real GDP will fall by
a cumulative 20 percent over the next century compared with a baseline simulation
with a stationary population. The output costs of aging will reach almost
1/2 of 1 percentage point in lower annual GDP growth between 2025 and 2075.
In per capita terms, GDP is expected to drop by about 5 percent relative
to the baseline scenario, primarily because the percentage decline in effective
labor is larger than the fall in the number of workers, given the aging
of the workforce and the differences in labor productivity and labor supply
across age groups implicit in Japanese age-earnings profiles.
In theory, increasing the efficiency of the economic system might largely
offset the effects of population ageing and allow sustained economic growth
in spite of a declining population. When there's a decrease in labor supply,
firms would seek to employ their workers more efficiently. Thus a decline
in the labor supply should be accompanied by an increase in productivity.
But contrary to expectation, this does not seem to be the case in Japan
where the slowing of labor force growth has been accompanied by a steady
decline in the growth of productivity. Japan's growth rate of labor productivity
has slowed since 1991. Therefore, Japan's best real hope for avoiding economic
stagnation is to increase productivity.
The pension and health insurance schemes are vital to the elderly population
of Japan, but it will also be a major determinant of whether Japan's current
account balance is in surplus or deficit, and thus the national savings
rate. The Japanese social security system has three major components: Medicare,
pensions and welfare. Measured by expenditures, public pension schemes are
the most significant components of the system. The economic impact of the
social security system is enormous. Together, social security contributions
and income taxes removed about 38 percent of national income that might
otherwise have gone to private consumption spending or saving.
Japan's public pension system is essentially a pay as you go system in which
current benefits are financed by current contributions. Since running into
trouble in the major expansion of pension benefits in 1973, there has been
a further deterioration of system finances in the pensions system. In 1984,
a new round of reform measures was introduced. It was to ensure that there
would be adequate reserves even at the peak period of population ageing.
However, many researchers warned that the large stock of assets in the pension
system would be exhausted well before the peak in system dependency ratios.
In 2000, the Japanese government came to realize the correctness of the
warning and enacted additional reforms that would cut lifetime pensions
by about 20 percent. But even after the new reform, it may not be adequate
to meet the pension obligations to a rapidly growing population of retires,
and therefore, Japan must consider various options for reducing outflow
and increasing revenues for the pension system.
Policy Options
As of now, it would be possible in theory to prevent the ageing of the Japanese
population by allowing increased international migration. However, such
migration is unlikely to take place in the future. The UN has calculated
that Japan would have to admit an average of 10 million immigrants per year
over the next 50 years. But such a move will also result in the growth of
the total population to 818 million in 2050, and 87% of that population
would be comprised of immigrants or their descendants. An enclosed society
such as Japan will never allow large scale immigration to occur.
Another policy option is change in the social security. Macroeconomic simulations
suggest that reducing pension and health benefits, coupled with lowering
social security contributions, would be preferable to maintaining the present
generous benefit levels, in terms of both growth and economic welfare measures.
While benefit cuts would imply short-term output costs, the positive long-term
effects on output would be substantially larger, owing to a fall in interest
rates that would boost investment.
Japan must also take careful measures in its fiscal policy. In view of Japan's
long-term fiscal imbalance, any move to address the fiscal deficit will
not only have a direct impact on aggregate demand, but will also affect
individuals' future saving behavior. Given the slow revival of confidence
after a long period of stagnation, any recovery in Japan is likely to be
fragile and prone to reversals. The choice of policies for stabilizing the
fiscal situation is therefore important, especially if the government decides
to pursue a somewhat faster pace of consolidation to reduce its exposure
to fiscal risks.
Conclusion
In a couple of decades, Japan's population ageing will soon take full effect.
Based on studies, it seems that Japan's current account will fall into deficit
and savings rate will also likely fall due to the effects of population
ageing. As the labor force shrinks and the dependency ratio increases, it
will put tremendous pressure on society and the economy. Economic output
will most likely decrease, and although an increase in productivity will
offset most of the decrease in output, Japan's productivity level has been
on a decline. As a result, Japan's future economy will require vigilant
monitoring and careful policies to maintain its economic advantage.
From Japan's lesson, other countries in danger of population ageing should
take preventive steps before it becomes too late. Trends in fertility and
mortality combined with an age structure that call for fewer women to enter
the childbearing years and for more adults to enter old age, guarantees
that over the next 50 years rapid population ageing in South-East Asia is
inevitable. In the case of Japan, this process is leading to "economic
stagnation". South-East Asia can avoid the same fate; but only if it
acts wisely and soon. Some insights from Japan's experience may be applied
by the nations of South-East Asia as they age rapidly over the next 50 years.
For example, the country should provide incentives for saving, make more
efficient use of the labor force, promote education for younger people,
and limit commitments for public pensions and health care.
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Muhleisen, Martin; Faruqee, Hamid (2001), "Japan: Population Aging and the Fiscal Challenge", Finance and Development, v38, n1 (March 2001): 10-13.
Yashiro, Naohiro (1997), "Aging of the Population in Japan and Its Implications to the Other Asian Countries", Journal of Asian Economics, v8, n2 (Summer 1997): 245-261.