The article below is from our BRIEFINGS newsletter of 09 April 2021
Amid concerns that Europe and China are facing economic and demographic headwinds similar to those responsible for Japan’s decades-long period of anemic growth, we sat down with Naohiko Baba, Goldman Sachs Research’s chief economist for Japan, to discuss how Japan is coping with its challenges and takeaways for other countries that are at risk of ‘Japanification.’
Baba-san, to set the stage, can you explain the concept of ‘Japanification’ and why it is relevant now?
Naohiko Baba: Japanification refers to the combination of low growth, low inflation and low interest rates that has plagued Japan since the collapse of its real estate bubble in the early 1990s. Our analysis suggests that it was triggered by a structural stagnation in economic growth potential caused by an aging demographic. Concerns about Japanification have been rising recently in Europe and particularly in China, where the working-age population is projected to decline significantly. Interestingly, however, despite its demographic headwinds, Japan's economy has still managed to grow, albeit modestly.
But isn’t Japan’s population in terminal decline?
Naohiko Baba: Yes, it is true that Japan’s working-age population has been declining since the mid-1990s. And historically leading economic indicators—including GDP, number of workers, capital stock and bank lending—rise and fall in tandem with the growth in the working-age population. But in recent years, we have seen these economic indicators strengthen and effectively decouple from the impact of changes in the working-age population. Instead, we’re seeing economic indicators exhibit a stronger correlation with overall GDP.
So how has Japan been able to push back against these demographic headwinds?
Naohiko Baba: Despite its aging population, Japan has managed to increase the total number of workers. The participation rate among the working-age population rose to 80% in 2019 from 74% in 2010, driven by a prominent rise in the labor participation rate among women and the elderly. In addition, we have seen a secular pickup in capital expenditures as companies look to improve efficiencies. Rising capex has made the greatest contribution to GDP growth since 2010, with particularly strong growth in digital investment among non-manufacturers that are facing severe labor shortages. In addition, as interest in relocating production facilities overseas has tapered off, domestic capex has increased in recent years as manufacturers look to replace obsolete facilities with more efficient ones. Finally, a return of the positive correlation between bank lending and capital stock suggests that banks have likely played a pivotal role in driving capex, by lending proactively amid a low-interest rate environment.
What are some takeaways for other countries?
Naohiko Baba: Japan was the first developed economy to experience a deterioration in demographics, so it was slow to realize the implications and unable to learn from other countries’ experiences. However, the country has managed to avoid a structural contraction in economic activity by reversing the strong positive correlation once seen between the working-age population and economic activity. We believe that Japan’s experience could provide useful lessons for other countries such as raising the labor participation rates among the elderly and women and increasing the number of foreign workers. Businesses also need to find substitutes for human labor by aggressively leveraging automation and digital investment, especially in the labor-intensive service sector. Additionally, banks could provide full support for corporate capex and other relevant activities aimed at enhancing productivity in response to worsening demographics. While GDP is influenced by a variety of factors including external demand and fiscal spending, Japan’s example suggests that demographic headwinds can at least partially be offset through self-help efforts on the labor supply, capital stock and financial fronts.