Nikkei Veritas – Market Eye column, 20th December 2010
In modern times, Japan is the first major country to experience a falling population, though it is likely to be followed by others. For example, Germany’s population is expected to start falling in about ten years from now. This has important and interesting consequences. It also produces scare stories, even in usually responsible and serious journals, which are quite unjustified. A recent example was a major report on Japan which appeared in The Economist in its 20th November, 2010 edition. This forecast that the declining population would cause living standards to fall unless there was a cultural revolution to improve productivity. This claim is a long way from being sensible. Japan’s living standards have continued to rise in recent years, despite the decline in the population and, far from the problem getting more difficult, the rise in living standards is likely to accelerate rather than decline without any change in current trend for productivity being required.
Japan’s productivity grew more rapidly than that in other major economies from the end of World War II until its asset bubble burst in January 1990. There is a general tendency for countries with relatively low living standards and productivity to catch up with the richer countries and, although Japan was the outstanding example of the past 60 years, the same pattern was seen in other countries, such as France and Germany. The process of catching up is more or less complete among the advanced economies and we now see emerging economies such as Brazil, China and India being the countries which are growing most rapidly and where living standards are catching up.
By the end of the 1980s, Japan’s living standards were similar to those of other advanced countries and its period of rapid growth, which had already slowed sharply in the 1970s, would no doubt have come to an end anyway. The bursting of the bubble in 1990, however, caused the change to be an abrupt one and, as always seems to happen when asset prices fall sharply, the economy received a major setback. For the next decade the rate of improvement in Japanese productivity fell from well above US levels to well below. During the current decade, however, there has been a recovery and Japanese and US productivity have been growing at similar rates.
On current trends the rate of growth in GDP per person employed is not only sufficient to improve living standards, it will cause them to accelerate. The key here, which seems to have been completely overlooked by many, is that the growth of GDP is determined by the interaction between the growth in employment and productivity, while living standards depend on the growth of GDP per person. If the population of working age is growing at the same rate as the population as a whole and unemployment is reasonably stable, then living standards will rise at the same rate as productivity.
The key relationship is thus between the rate of growth of the population as a whole and those of working age. As the numbers of working age started to fall in 1995, but the population continued to grow until 2005, living standards have not been rising as fast as productivity. Japan has, however, now passed through its most difficult period. Although the number of people of working age is still declining faster than the population, the gap is narrowing, while it is starting to widen in other major economies. It is increasingly out of date to see Japan as having a unique problem because of its demography. It is rather that it has been the path finder, with other developed economies now able and needing to learn from Japan’s experience.
Although the scare stories about living standards are unjustified, there are real problems that must be faced which come from Japan’s demography and the fact that its GDP will only grow slowly. One of these is that it makes the national debt problem more difficult. The other, which I have discussed in the past, is that the economy needs to be rebalanced. The slower an economy grows, the less investment it needs and although much of this adjustment has been achieved, Japan is only about halfway through the change it needs.