Japan's economy, after a brief spate of growth, seems to have faltered again. The investment and journalistic communities, as well as official Japan, have tried to uncover proximate causes for this latest loss of momentum. But after more than 20 years of such disappointments, it should be clear to all now, as it has been to many for some time, that there are more fundamental issues at work here.
Primary among these are the country's aging demographics and Japan's failure to take reasonable counter measures to offset its negative economic effects. If it were to take such measures now, even after all this time, the economy could pick up and its markets surely would fly from their present depressed valuations. But since Tokyo shows few signs of taking the necessary steps, the primary opportunities currently lie in stock picking.
The population's aging trend has two roots. First, improved health has so extended lifetimes in Japan that an ever increasing proportion of the population lives in retirement. According to the United Nations, those over 65 have risen from 9.1% of Japan's population in 1980 to 12% in 1990, to an unprecedented 22.2% presently. The trend will likely persist. By 2030, the U.N. projects, those of retirement age will constitute almost 30% of Japan's population. Second, decades of low birth rates have stemmed the flow of young workers into the labor force, compounding the economy's difficulties supporting this overhang of retirees. From almost 7.5 of working age people available to support each retiree in 1980, Japan today has less than 3.0, and the U.N. projects that by 2030 the number will fall below 2.0.
Though all the rest of the developed world is aging, Japan's situation is extreme and weighs especially heavily on the economy's present and its prospects. The problem has many aspects, but most obvious is the implied relative shortage of working hands and minds. Between 1980 and 2010, for instance, the labor available to support each dependent retiree shrank more than 60%. If this entire shortfall were transmitted directly to productive power, it would have removed three percentage points a year from Japan's real growth potential. Of course, such calculations fail to include productivity advances and shifts in the economy's industrial mix, among other considerations.
But if such simple calculations fail as a full explanation for economic stagnation, they nonetheless point out the impediment to growth implicit in these demographic trends. The demographics hurt still more by denying businesses financial resources for expansion and modernization. Profitability suffers because shortages of qualified workers raise wages, for critical groups, if not generally. While business loses some of its ability to self-finance in this way, the tendency for older people to draw down on their savings nest eggs reduces the pool of financial resources available for lending and investment.
The evidence of such a squeeze in Japan is clear, as savings rates there have fallen from more than 20% of after-tax income in the 1980s to less than 3% recently. Given demographic projections, they could even turn negative. Still more, the demographic pattern, by making demands on public and private pensions and health care plans, takes still more financial resources that could otherwise have gone for business expansion and modernization. According to Tokyo's finance ministry, the demands of public pensions and healthcare alone, already at 28% of gross domestic product, could rise above 40% by 2030.
Faced with such impediments, it is little wonder that Japan's once fast-growing economy has stalled. But besides the demographic dilemmas, Tokyo has compounded the matter by refusing to adjust. Instead of trying to mitigate the relative shortage of available labor by delaying retirement, for instance, it has held to its earlier practices, clinging for years to a retirement age of 60, only recently raising it, and then only to 65. And, instead of trying to enhance the pool of qualified workers by raising the rate at which women participate in the workforce, Japan has stuck stubbornly to its strong cultural bias against careers for women.
Tokyo has failed on the financial side as well. During its stock market and real estate crashes of the 1990s, it pretended for years that its banks had no bad loans. That posture may have made people feel better, but it was one that bottled up financial capital for almost a decade during a time that the aging trend was already limiting it. The failure to develop active commercial paper and corporate bond markets, much less asset-backed bonds, has further limited the financial resources available to Japanese business, as has the country's less than hospitable treatment of foreign capital.
Worst of all, Japan has refused to adjust its economic orientation to accommodate the unavoidable demographic reality. With its aging population, Japan has persisted, preposterously, in promoting its earlier broad-based, export-oriented growth engine. With its huge population of retirees, what Japan should have done and needs to do is rely more on consumption as an economic growth engine. It could import more, especially labor intensive products, and turn its relatively scarce but well educated workforce toward high value and innovative products and production techniques. While some of this shift has occurred in individual firms and industries, the country is generally still under the sway of its top-down approach to economic organization-the "iron triangle," as the Japanese say, of politicians, bureaucrats, and big business-that has persisted with policies to promote broad-based exports and its efforts to discourage consumption. Perhaps even worse, the iron triangle continues to subtly stifle any innovations that challenge established practice and industrial leadership.
Recent plans to double sales tax to 10% from 5% fit this pattern of failure. True, Japan has a huge budget gap, but the decision to solve it by burdening the consumer flies in the face of needed structural adjustments. Japan needs to encourage, not discourage, the consumer. The tax hike also raises near-term recession risks. The last time Japan tried to solve its budget problems this way, when it raised sales taxes to 5% from 3% in the late 1990s, it sank into a two-year recession that, incidentally, widened the budget gap. True, other things were happening at that time, not the least of which was the Asian Contagion financial crisis, but this is hardly a favorable precedent. Better for Japan's immediate prospects and its need to deal with its demographic pressure that it attack its budget problems by, for instance, excluding the many breaks that its tax code offers to exporters. It should also reform entitlements spending, and promote growth with a more flexible financial sector that depends less on banks alone and opens itself to innovations long present in the West, as well as to foreign capital and foreign financial interests.
Were Japan at long last to make such changes-to encourage the adjustments demanded by its aging demographics-it might at last break out of the economic doldrums in which it has drifted for decades now. The economy could grow, if not at the break-neck pace that typified the period from 1950 to 1980, then at least at a sustained and less halting manner than it has during the last 20 years. No doubt, equity markets would rise on such a policy shift, anticipating the likely economic improvement. But, as the sales tax plans show, Tokyo is still far from taking the necessary steps.
It is hard to see broad-based economic or market gains in Japan, at least on a sustained basis. Investors in Japanese securities will have to wait for that. In the meantime, they need to proceed selectively.
Even in this, however, there is opportunity. Because past failures have so depressed Japanese equity prices, it is possible to get a very good price on world class companies that just happen to have a Japanese headquarters. Many of them have begun adjustments ahead of their nation. They have started to fill consumer niches, for instance, or have a global presence for sales and financing. Many have given up on simpler, labor intensive products and have re-oriented their home-based efforts toward higher value products and productive techniques. These sorts of companies offer great potential at great value, even in an environment that is failing generally.
Milton Ezrati is the senior economic strategist at Lord Abbett
and affiliate of the Center on Economic Growth in the Department
of Economics at The State University of New York at Buffalo.