Shrinkanomics: Policy Lessons from Japan on Aging

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Shrinkanomics: Policy Lessons from Japan on Aging

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Bibliographic details

• Authors: GEE HEE HONG, TODD SCHNEIDER
• Published: March 1, 2020

Overview

• Japan is framed as "the world’s laboratory" for policy responses to an aging, shrinking population.
• Demographic change globally: world population expected to virtually stop growing by the end of this century, driven largely by falling global fertility rates.
• Japan’s demographic situation affects economic and financial performance, urban form, and public policy priorities (pension, health care, long-term care solvency).

What makes Japan different

• Postwar baby boom length:
  • Japan’s postwar baby boom was short—only about three years, compared to other G7 members where such periods stretched anywhere from nine to twenty years.
• Life expectancy:
  • Japan leads the world in terms of life expectancy—surpassing all Group of Twenty economies as early as 1978.
• Immigration:
  • Foreign workers accounted for only about 2.2 percent of Japan’s total labor force in 2018, compared with an estimated 17.4 percent in the United States and 17 percent in the United Kingdom.
• Demographic timing:
  • The entire baby-boom population is passing the 75-year milestone in just three years (starting in 2022 and ending in 2025).

Labor force and labor market implications

• Potential labor force (ages 15–64 as a share of total population):
  • Peaked in 1991–93 at just under 70 percent.
  • Fell to just above 59 percent, the lowest level among the Group of Seven and well below levels seen in the mid-1950s.
• Projected trends:
  • Given current low fertility and accelerating death rates, this ratio is expected to continue to decline well into the medium term.
• Labor supply responses and technology:
  • Continued demand has spurred more women and more elderly (those outside the traditional 15–64 working age) to join the labor force.
  • Automation, artificial intelligence, and robotics (including technology to increase productivity per worker) will be critical to Japan’s response.

Productivity, sectoral shifts, and growth

• Age–productivity relationship:
  • IMF research suggests an inverted U-shaped relationship between age and productivity (productivity lowest at beginning and ending phases of a career).
• Sectoral effects:
  • Aging likely increases relative demand for services (e.g., health care), causing a sectoral shift toward more labor-intensive—and less productive—services.
• Density and scale:
  • The size or density of the population may affect productivity (productivity rises with greater size and density of a working population).

Fiscal challenges and financing social security

• Fiscal pressures:
  • A more elderly and reduced population implies relatively more retirees, a smaller labor force, and a shrinking labor-based tax pool—creating challenges to finance rising public expenditure on health care, long-term care, and pensions.
• Policy timing:
  • Early adjustment—particularly for public pensions, health care, and long-term care—is critical.
• IMF comparative findings on financing options (McGrattan, Miyachi, and Peralta-Alva 2018):
  • A continuous and gradual adjustment of the consumption tax dominates other potential measures to finance the cost of aging.
  • Postponing adjustment through debt financing results in a large crowding-out of private sector investment—by up to 8 percent—with detrimental effects on long-term GDP and welfare.
  • A uniform increase in health copayment rates for the elderly would have regressive consequences.

Intergenerational inequality and redistribution

• Wealth and redistribution:
  • Older generations are significantly wealthier than younger generations; wealth poverty is significantly lower for older generations.
  • The wealth ratio of older to younger cohorts is relatively high in Japan compared with Germany and Italy, though lower than in the United States.
• Policy implication:
  • The relative wealth of older generations calls into question costly fiscal redistribution mechanisms that aim to reduce elderly income inequality mainly via pensions.

Monetary policy and the natural rate of interest

• Natural rate impact:
  • Demographic change in Japan has had a significantly negative impact on the natural rate of interest in recent years (e.g., Han 2019).
  • Studies suggest Japan’s natural rate has already fallen into negative territory.
• Future outlook:
  • With working-age population growth projected to decline further by 2040, the negative demographic impact on the natural rate is likely to increase, potentially limiting monetary policy’s role.
• Policy response:
  • Structural reforms to boost potential growth and lift the natural rate—including labor market reforms and more active immigration policies—are highlighted as important.

Financial sector implications

• Regional banks and demographics:
  • Japan’s regional financial firms, dependent on local deposit-taking and lending, are particularly sensitive to shrinking and aging populations at the prefectural level.
• Business model shifts:
  • Shrinking populations imply smaller balance sheets and declining loan-to-deposit ratios for regional banks unless alternative sources and uses of funds are found.
  • The shift to a more securities-oriented and fee-based banking model is likely to accelerate.
• Supervision:
  • The potential for pockets of financial sector instability needs to be incorporated into supervision and oversight.

Key policy recommendations (from IMF 2020a, 2020b)

• Adopt a long-term view on public finances that fully incorporates the impact and cost of an aging population and shrinking workforce; early adjustment for public pensions, health care, and long-term care is critical.
• Prioritize structural reform and innovation to offset shrinkonomics’ negative impact on productivity and growth; emphasize labor market flexibility, automation, robotics, artificial intelligence, and a more flexible view of aging and retirement.
• Focus on maintaining intergenerational equity when considering social security and public transfer programs.
• Recognize that demographic forces may blunt monetary policy, increasing the role of fiscal policy and structural reform.
• Incorporate demographic-driven changes into financial supervision to address risks from changing business environments for banks and financial institutions.

Source: Shrinkanomics: Policy Lessons from Japan on Aging — GEE HEE HONG and TODD SCHNEIDER, IMF F&D, March 2020.

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