Is there reason to be pessimistic about Japan's declining population?

Yutaka HARADA (Executive research Fellow, Economic and Social Research Institute, Cabinet Office)

Introduction

The population of Japan is decreasing. A decreasing population means a decreasing workforce, and this is becoming a source of anxiety. But there is no reason to lament a decreasing population from an economic standpoint. If the workforce is declining, simply increase productivity; and there will be room for more people wanting to work, such as women, to get jobs. If the price to sustain the aged society gets too expensive, just decrease the cost. Japan's pension benefits, the most generous among industrialized countries, would remain one of the highest even if it were to be lowered considerably. Japan could continue to thrive if a new system could be devised to cope with the decreasing population. The following discussion is intended to show that there is no reason to be pessimistic about Japan's economy in the future because of the declining population.

Decreasing population not necessarily bad

A decreasing population means there will be less young people to support increasing numbers of elderly persons. This is often cited as a reason for such a society to become dreary. But consider if the population was to keep increasing. Japan's population was 43 million in 1900, which in one hundred years tripled to 127 million by 2000. If this increase were to continue at this rate there would be 375 million people in Japan by the year 2100. Would it at all possible for this number of people to be able to live on this small land in peace and prosperity?

There were times when a population remained stable with only a small number of old people. That was when the demographic chart resembled a pyramid. But sustaining such a pyramid by a society with a small population fluctuation means there are people dying at all ages. It occurs where not only the elderly but also babies, children, men and women of all ages die all the time by various causes.

On the other hand, a pillar shaped demographic chart means many people die a natural death at a ripe age. In a civilized society of less disease, less violence, and ample nourishment, people need not die prematurely as babies, children, or middle-aged men and women. Such a society where less people die prematurely is where people are cherished and well cared for.

Japan is not alone in experiencing a decreasing population. Most industrialized countries, except the US, are on a similar path. Italy is already seeing its population decrease, Germany will be next in 2005, and other countries such as the UK, France, and Sweden are expected to follow the trend by 2025. Even in Asia, populations are expected to eventually decrease in most countries except Indonesia, the Philippines, and Malaysia. China is predicted to see its peak at 1.5 billion people in 2030.

Policymakers and scholars are discussing ways to sustain affluence in a world of decreasing population. I would rather point to a possibility that decreasing population will bring the potential to boost per capita wealth. This is derived from studies on the era of the Industrial Revolution when the population did not increase as much as had been predicted. Nobel Prize winning Professor Robert Lucas at Chicago University notes that the bottom line of the Industrial Revolution was not the increase of production but the fact that the population did not increase proportionately. Before the Industrial Revolution, an increase of production would be diluted and absorbed by a growing population. Thus, per capita income would remain unchanged and there would be no improvement in the quality of life of people. What happened during the Industrial Revolution was an increase of production through technological innovation so the population did not increase in relative terms, resulting in per capita income growth.

The Industrial Revolution was also different from technical innovations preceding it in that it provided for various professionals to come into play. People realized that rather than simply increasing units of production, i.e. the number of children, providing each child with better education would bring themselves and the children larger wealth. Knowledge of machine operation and bookkeeping became more valuable than simple labor. And because education was expensive, people began to opt for fewer children.

Increasing Productivity

If population decreases, so does the overall economic growth rate. This is different from whether per capita growth would decrease or not. Shortage of labor could induce revolutionary methods that could boost productivity not practical before.

Indeed, analysis show that among industrialized countries, those experiencing a decreasing or relatively low increasing rate of labor force tend to have higher growth of labor productivity. As seen in Figure 1, a positive rate of productivity can be seen in all seven countries experiencing a decreasing labor force, and the average gain is 2% per annum. A decreasing labor force had acted as a trigger to undergo a phase of industrial reform and adopt labor saving technologies in these countries, making their industry efficient and resulting in increased productivity.

Figure 1: Relationship Between Growth Rate of Workforce and Labor Productivity

It is often argued that a catch-up process for Japan to the levels of other industrialized countries was accomplished in the 1980s, and thus the economic system tuned for catching-up would not provide further growth in Japan. But further analysis show that the catch-up was superficial, that it seemed so because it was calculated at prevailing foreign exchange rates. When a better indicator, such as Purchasing Power Parity (PPP) is used, it can be readily recognized that catch-up has not yet been accomplished. Japan's Gross Domestic Product Per Capita at Purchasing Power Parities is only 80% of that of the US. The existence of price differentials in areas such as food, clothing, sundry goods, housing, and communication indicates Japan's productivities are low in these industries. What the number indicates is that if Japan could catch-up with the US in every industry, it would boost Japan's productivity by 25% (100% divided by 80%).

Although Japan is still in the catch-up phase, it does not mean that it could continue on with things the way they have been. It is only clearer now that true reform is necessary to abolish rules and regulations that inhibit competition. More than ever, productivity must be sought through true competition, as the labor force is about to shrink and more people must work more efficiently. And to that end, the productivity gap with the US is something Japan is entitled to recoup.

More people to work

Another approach to sustain wealth is to maintain the number of working people. This could be achieved by bringing into play women and aged people presently not working. Barriers limiting those wishing to work from acquiring jobs must be resolved.

A social environment for women to be able to work while taking care of household chores and child raising needs to be established. The labor participation ratio of Japanese women according to age shows a large dip in the age group of 25-39. As this is not seen in other countries, it could be assumed that Japanese women are driven away from work against their desires during this period of child raising. Thus creating a better environment for women to work is not only desirable to compensate for the decreasing workforce, but also to meet the needs of women.

Nevertheless, this must be done without placing too much burden on society, or it would not be increasing productivity as a whole. It must be noted that bringing in all women, assuming all of them as full time workers having high productivity, would raise the number of workers only by 5%. Great care is necessary, therefore, so as not to infuse too many funds in providing relative facilities.

For example, enhancement of the child-care system is certainly necessary, but there is a caveat. Child-care facilities should be established to cope mainly with full time workers and not with part-timers. This is because the cost of child-care facilities is significantly high in terms of wages of working women. While an average part-time female worker in the 25-29 and 30-34 age groups earn 2,246 thousand yen and 1,233 thousand yen respectively per year, public child-care facilities operated by Tokyo Metropolis costs 2,273 thousand yen per child per year of public money to run.

The working environment also needs to allow child-raising women to work comfortably. Relaxed work regulations so that mothers could leave from and return to jobs more easily, and adoption of flextime jobs would support the change.

It is important to realize that a large portion of US economic growth after 1970 is attributable to the increase of the labor participation ratio of woman. Per capita productivity during the period has increased only barely, and the growth was realized through enlargement of the workforce, which was realized by participation of women.

Japanese companies used to adhere to lifetime employment and the seniority system to fence in their workers. It did work well in a pyramid shaped demography and high economic growth. Now, companies must opt for more flexible and resilient styles of operation.

Decreasing cost of aged society

A decreasing population itself is not a problem. The system created under the assumption that the population would grow forever is causing the complication. In addition, for nearly 30 years until the early 1970s, the Japanese economy was growing at the pace of 10% per annum. The current system was established in the mid-1970s under the assumption that the trend would continue. As we know now that the current system is too expensive, we must lower the cost.

There are a number of major cost factors in an aged society, including medical and nursing care, and here we shall look at the pension system as an example. Pension is a system where the working generation supports the old and retired. Already the situation is where the retired receive more than they had chipped into the pot, and it is becoming doubtful whether the younger generation will get back the premium they will have contributed. The pension benefit levels must be lowered, but to what extent? A comparison with a number of industrialized countries reveals that Japan's pension benefit calculated at exchange rate is twice that of Sweden, which is the highest among other industrialized countries. Adjusting the cost with commodity prices would lower the difference, but Japan stands still 33% (20 years/15 years) above the runner-up, in this case the US.

In addition, consider the fact that Japan's pension payment begins at the age of 60, whereas other countries' payments begin at 65. Assuming everyone will live to the age of 80, this fact alone would make the Japanese pension system 33% more costly than other countries. Combining the effect of amount and term of pension benefits, other countries' cost of pension system is only about 60% {100÷(133×130)} that of Japan.

The living standard of the elderly depends on the wealth of the society maintained by its working members. When there are less working people, it is natural for the share of wealth for everyone, including the elderly, to shrink. Calculations indicate that if the current benefit levels were to be sustained, in 2030 pension premium would reach 25% of total earning of an average worker. Even Sweden, considered to be the most welfare oriented country, has set a cap to this ratio at 18.5%. In practical terms, by raising the starting age to receive benefits to 65 within ten years and decreasing the amount of each payment by 20% in ten years, hikes in pension premiums could be avoided.

Streamlining of pension system is in progress among industrialized countries. Various measures are being implemented in the US and major European countries to shave pension benefits, relieving the burden on working people.

Japan could continue to thrive

There will be more old people and fewer children in Japan. There will be fewer workers to support pension payments of the elderly. As it is obvious that the system is unworkable, it must be changed. Pension benefits must be decreased to sustainable levels before the whole system collapses. It would serve people better to provide a predictable future based on lower pensions than to recklessly pay out the money until the inevitable consequences occur at an unpredictable moment.

Smaller numbers of people in a society could provide better life for its members. Better living standards and less congestion are easily achieved. But it is necessary to adapt the present system, created to match an increasing population, to that of a decreasing population. By reforming the current structure and adopting policies to increase per capita productivity, and by increasing the number of people at work and lowering the cost of an aged society, a decreasing population should create a fun society.