Land of the setting sun – some stark choices ahead

Last week, we wrote about “Japan – Demographics and inflation, or is it nappies and haircuts?”. In our note we discussed some of the remarkable challenges Japan’s policy makers currently face. This week we look at policy choices, past and present.

Previous investment in high quality health care has increasing longevity in Japan with an average life expectancy of 87 years. At the same time, falling birth rates have left Japan with an ageing, shrinking, population. By 2050, 36% of the population is expected to be 65 and older, up from 28% today.

One of the critical issues behind this oddity is that older people save more. Furthermore, the resultant smaller population reduces the overall demand for goods and services across the economy. The fear is that despite deploying extensive pro-growth policies and higher wages from a tightening labour market (job places outnumber applicants two to one), the population demographic will continue to hamper economic growth. For Prime Minister Shinzo Abe, a mounting government debt pile, lacklustre economic growth and an electoral vote weighted towards the elderly makes it difficult to do what is inevitable, and necessary – he needs to trim pension benefits, yet again.

Extending the longevity of the people of Japan has come at a cost. As illustrated in the chart below Japan has outstanding debt that is more than double its Gross Domestic Product. In any other country this situation would be untenable but Japan’s debt pile is almost entirely funded and sustained by domestic savings. This means the risk of capital flight and early repayment demands from fearful investors is negligible.

With unemployment at very low levels and a dwindling population, policies that boost fertility, support working mothers, enhance automation and encourage immigration are all necessary.

Unemployment, Debt as a % of GDP and natural population change

Source: Worldpopdata.org and Trading Economics, September 2018

This week, Abe made a plea to overhaul further the nation’s social security system. If enacted this will extend the retirement age past the age of 65 and, if workers opt for retirement at 70, pension benefits received will be higher – an interesting dilemma for retirees to consider! In an interview with Asia’s popular press Abe said, “more labour participation would boost economic growth, raise tax revenues and generate more social security premium receipts”.

Abe is also pushing for other reforms including a] less stringent requirements for foreign workers to help alleviate the labour shortage and b] acknowledging the need for a “system that would bring in a broad range of foreign workers with a certain level of skills and expertise”.

Shinzo Abe is up for re-election this month. If elected it will be for a third term as Prime Minister, making him the longest serving Japanese PM. Despite low popularity poll ratings, his sustained tenure has paved the way for continuity in both domestic and foreign policy. Laying out his unpopular policies, which tackle the demographics and population structural issues, may ironically turn out to be what secures him a third term. The stark demographic reality Abe confronts is also faced by his rivals. With unpalatable choices ahead, the electorate may decide that it is better to be safe than sorry and stick with the man they know.