The Answer to Japan's Economic Growth Mystery

 
 

With the third anniversary of Shinzo Abe’s second term as prime minister approaching in a little over a month, a lot of Japan observers are taking stock of Abenomics’ successes and failures. Recent data revealed that the country’s GDP contracted by 0.8 percent in Q3 2015, after also shrinking in Q2 2015. Back-to-back quarters of GDP contraction mean a recession is underway in Japan. Does this signal a major blow for “Abenomics,” Japanese Prime Minister Shinzo Abe’s eponymous set of fiscal, monetary, and structural policies since his ascent to the prime ministership in December 2012?

It depends. Matt Yglesias over at Vox has a helpful and, in my view, compelling macroeconomic rundown of what might be at play in Japan today. He argues that “[t]he Japanese economy is shrinking because Abe already succeeded in fixing Japan’s unemployment problem. Japan is simply in an odd situation where low and falling levels of unemployment aren’t good enough to ensure economic growth.”

Indeed, what explains a recession with low unemployment, high (and growing) labor force participation, and even nominal GDP growth, restoring Japanese prices to 2010 levels? On paper, Abe’s government seems to be hitting a lot of the right markets, but Japan simply isn’t experiencing sustainable real GDP growth. The current recession is the second in the 35 months Abe has been in office.

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Of course, part of the perceived problem with Abenomics is the government’s sluggishness in implementing the third of Abe’s “arrows” of reform, namely structural reform. In an editorial the Wall Street Journal notes that this third arrow offers Japan “the only hope of sustained economic growth.” Fair enough. There are a range of structural steps that the government can still pursue to defibrillate a flatlining economy, but this might not be the most serious issue to zero in on at this point.

Yglesias has another diagnosis of Japanese malaise that is commonly brought up in other contexts, but less so in discussions of Abenomics and the Japanese prime minister’s seemingly Sisyphean task of “bringing Japan back.” In short, Japan’s demography may have already put a “hard ceiling” on the size of its labor force. With the country at near-full employment and labor force participation poised to plateau after rising, the hard reality is that the aggregate size of the labor force may have maxed out. Basically, Japan has run out of productive workers. As long as this is a fact, Japan’s economy may experience sluggish growth at best and stay prone to repeated recessions. Is this fixable?

As I’ve written before, Japan’s population distribution resembles an upside-down pyramid (in animated GIF format here). It’s an “old” country. Over time, its demographic issues will worsen if current trends persist. One Japanese government estimate found that the population may stand at 87 million in 2060, down from 127 million in 2014. From 2013 to 2014, Japan’s population fell by nearly by 250,000 alone.

As I wrote last year, the one way “out” of this downward spiral for Japan seems to be a radical rethink of its immigration policies. Of course, this will be difficult politically in a country that has remained deeply homogenous despite a high level of political and economic integration with the broader world economy.

The Abe government has been considering immigration reform for some time now, but has been slow to act. Based on the severity of Japan’s demographic crisis, the country may need to invite low-skilled workers into its borders. Tokyo has received criticism for its muted response to the ongoing global migration crisis. In any case, when it comes to expanding the absolute size of Japan’s labor force, there are two options: increasing immigration to Japan or increasing birthrates within Japan.

I haven’t gotten into the latter here because its simply a far more daunting task for the Japanese government.–according to the World Bank, Japan’s fertility rate is one the lowest in the world at 1.39 births per woman. Curiously, Abe’s bid to increase women’s labor force participation rate in Japan–‘womenomics‘–may end up raising fertility. Japan’s Ministry of Health, Labor and Welfare has shown that women’s labor force participation and fertility rates are positively correlated in the country.

There is no panacea for this problem in the short-term, but there are moves that the Japanese government could take. Unfortunately, Abe doesn’t appear to be poised politically to make a bold move on immigration or influence fertility rates. Haruhiko Kuroda, Abe’s bold central bank governor, is close to irrelevant on these issues, despite his central role in navigating Abenomics’ early successes. Matters will worsen further as an aging population applies growing pressure on the country’s social services, contracting fiscal capacity elsewhere. The task for Abe now will be to defy its demographic destiny.

It won’t be easy and it may not be politically viable, but it is a must for a return to sustained economic growth.

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