May, 2010

NIRA Report

Is the Aging of Society a Threat to Japan?
-Increasing Productivity in the Next Decade is the Key-

[Executive Summary]The decline of Japan’s birthrate and the aging of its population have long been
considered to represent a threat to the Japanese economy. This perspective assumes that
not only will the increase in the nation’s elderly population dramatically increase thenational deficit through its negative impact on the social security budget, but it will also
cause a decline in productivity and act as a dampener on economic activity. The main
purpose of the present report is to respond to the question of precisely what effect theaging and decline of the nation’s population will have on productivity in the Japaneseeconomy.
The considerations of the study group working on this project clarified the following
points:1) There is a strong possibility that the aging and decline of Japan’s population will
result in a decline in the growth of productivity in the nation’s economy. Looking at
both total factor productivity (TFP) and labor productivity, it appears that the rate ofgrowth of productivity will become negative, on a continuing basis, in the early2020s.
2) However, the aging and decline of the population is unlikely to affect the nation’srate of economic growth by causing a decline in productivity in the next decade.
From this perspective, the threat represented by the aging of the population should
not be emphasized in the short term.
3) The study group predicts that the negative effects of the aging of the population will
become manifest from the mid-2020s, when the growth of productivity becomes
negative on an ongoing basis. Given this, it will be essential to make efforts toincrease the potential for technological innovation and boost labor productivity in1

the next ten-year period.
4) In concrete terms, on the micro-economic level it will be necessary for companies towork directly to increase their numbers of full-time workers and to enhance in-housetraining programs for elderly and non-full-time workers. It would also be desirable
for the government to make a more active contribution towards the implementationof vocational training programs. On the macro-economic level, it will be necessary
to further increase the openness of the economy and the labor market in order toincrease the potential for technological innovation. Further, it will be essential toreconsider immigration policy and implement measures designed to boost thebirthrate in order to increase the nation’s population.
Five empirical analyses, considering the following questions, formed the basis for these
conclusions.
Analysis 1: What effect will the decline of the nation’s population have on the rate oftechnological progress? (Chapter 2)
Analysis 2: What effect will the aging of workers have on the rate of technologicalprogress? (Part of Chapter 3)
Analysis 3: What are the differences in terms of productivity between workers ofdifferent ages? (Chapter 4)
Analysis 4: What effect will the aging of workers have on wages and company
revenues? (Part of Chapter 3)
Analysis 5: Will the aging of workers suppress employment opportunities for youngpeople? (Chapter 5)
Analysis 1: Effect of Population Decline on Rate of Technological Progress-There is a positive relationship between the size of the population and the rate oftechnological progress, while there is a negative relationship between the percentage ofthe population aged 65 and over and the rate of technological progress.A decline in population can be projected as having a variety of effects on the rate oftechnological progress, including a reduction of collective capacity and a decline in thenumber of potential innovators due to the aging of the population and a reduction in theworking population. In this analysis, the rates of growth of multi-factor productivity(MFP) and total factor productivity (TFP), as published by the OECD, were employed
as indicators of the rate of technological progress, and the effects of the size of the total
population, the percentage of the elderly in the population, the level of economic
2

openness, and the rate of increase of the population were determined. The main
conclusions were as follows:

1) An analysis using OECD data showed that there is a positive relationship between
the total population and the rate of increase in MFP, while there is a negative
relationship between the percentage of the population aged 65 and over and the rateof increase of MFP.
2) Despite a certain level of statistical unreliability, an analysis using Japanese timeseries data showed that a decline in the working population has a negative effect on
the rate of increase of TFP.
3) Simple extrapolation of Japan’s rate of technological progress into the future
produced a figure of 1% year-on-year growth. However, calculations based on(median) future projections of a decline in the working population showed that therate of growth of the rate of technological progress would become negative in thelatter half of the 2020s.
Analysis 2: Effect of Average Age of Workers on Rate of Technological Progress(TFP)-TFP and wages both increase when the percentage of workers in their 40s increasesThis analysis attempted to determine the effect of the average age of workers (or the agestructure of the working population) on the rate of technological progress. The analysis
was based on the hypothesis that an average worker age (or worker age structure) would
exist at which the potential for technological development and the level of technologicalprogress would reach their highest levels in specific industries or in the economy as awhole.
This analysis clarified the following points:
1) There is a strong possibility that the rate of technological progress increases to its
highest level when the percentage of workers in their 40s in the working population
increases.
2) Industry panel data showed that the level of technological capacity reaches its peakwhen the average age is just under 46.
3) As the aging of the population progresses, as viewed from the perspective ofaverage age, there is a strong possibility that the nation’s level of technological3

capacity will decline, but the pace of the decline will be comparatively mild (Figure1).
4) An estimate of Japan’s future rate of technological progress conducted on the basisof the above empirical analyses showed that the nation’s rate of technologicalprogress will increase at a gradual pace until 2022, and will reach its peak in 2023,
when the average age of the population is just under 46; following this, it willcommence to decline (Figure 2).
Figure 1

Figure 2

Inverse Weibull distribution of hypothetical Future estimates of TFP (year-on-year)
values for TFP (Fixed effects model)
0.30%
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
135

TFP Curve0.20%
0.10%
0.00%
-0.10%-0.20%(Average age）
40

4550

55

Estimated value of TFP-0.30%-0.40%
2007

60

2015

2023

2031

2039

2047

Note: Model values with value for 35 years of age as 1.

Source: JIP Database, Research Institute of Economy,
Source: JIP Database, Research Institute of Economy, Trade and Industry (RIETI)
Trade and Industry (RIETI)National Institute of Population and Social Security
Calculations: Credit Suisse
Research
Ministry of Internal Affairs and Communications
Calculations: Credit Suisse

Analysis 3: Calculation of Labor Productivity for Different Age Groups-The relationship between age group and labor productivity describes an inverted U shape, withthe 45-49 age group at its peakAnalysis 2 demonstrated that a fixed relationship exists between the average age of workers andthe rate of technological progress. Analysis 3 was conducted to determine whether, against thebackground of this macro-economic relationship, any relationship exists between laborproductivity per employee1 and the age of workers.
1

The relationship between TFP and labor productivity per person is defined as4

The results were as follows:1) The level of labor productivity of workers was highest in the 45-49 age range. The
relationship between age ranges and labor productivity described an inverted U shape withthis age range at the peak.
2) The decline in labor productivity following the peak in the 45-49 age range is comparatively
mild, with labor productivity in the 55-59 age range almost identical to that in the 40-44 agerange. This indicates that it is possible that labor productivity will not decline drasticallywith the aging of the population (Figure 3).
3) A projection of the future trend of labor productivity in Japan at the macro-economic levelbased on the estimated values for the labor productivity of different age groups showed that
positive growth in labor productivity can be maintained until around 2020, because the“second-generation” baby-boomers will reach their 40s, the peak age range for laborproductivity, between 2015 and 2025.

Analysis 4: Effect of Increase in Average Age of Workers on Wages and Company
Revenues-Real wages reach their peak when the average worker age is just under 44, following which
they declineWhat effect does an increase in the average age of workers have on average real wages? The
following conclusions were reached when the relationship between workers’ average real wages,
the worker age structure, and the average age of workers was considered:
1) When the ratio of older workers in the 50+ age group increases, the downward pressure on
real wages becomes greater than the downward pressure on the rate of technologicalprogress2) Analysis of the relationship between the average age of the working population and real
wages using industry panel data shows that the level of real wages reaches its maximum
value when the average employee age is just under 44. As the average age increases
following this point, the decline in the level of real wages becomes greater than the decline
in the rate of technological progress

follows: The rate of growth in labor productivity per person = The rate of growth in
TFP (technological progress) + The rate of increase in labor productivity due toincrease in the rate of capital intensity per person
5The average level of real wages reaches its peak at an average worker age approximately twoyears younger than that at which the rate of technological progress reaches its peak, but the rateof decline with increasing worker age, following the peak, is higher than that for the rate oftechnological progress. This suggests the possibility that many companies may receive a“bonus” with the aging of the workforce (it should be noted, however, that this is exclusively adiscussion of the allocation of income, and it is not clear whether or not company revenues will
increase in absolute terms). From this perspective, there is a strong possibility that there is asufficient margin for Japanese companies to invest in research and development and increase
their rate of employment of younger workers in order to avoid a future decline in productivity.
Figure 3
Labor productivity indices for five-year age groups, with productivity for the 18-24 age group as 12.5
21.5
10.5
0
18‐24 25‐29 30‐34 35‐39 40‐44 45‐49 50‐54 55‐59 60‐64

65‐

Labor productivity index
Labor productivity index (quadratic approximation)

Analysis 5: Effect of Aging of Workers on Employment of Younger Workers-Employment of younger workers tends to increase as the percentage of older workers
increasesIt has been pointed out that employment opportunities for young people will be lost if the jobsof middle-aged and older workers are retained. The concept that workers in the middle and older
age brackets in companies are suppressing employment of younger workers is termed the“replacement effect” theory. The study group investigated whether this was a real world
phenomenon, with the following results:
1) Analysis of the hiring rate shows that there is no clear evidence that job opportunities for6

younger workers are being sacrificed in order to protect the jobs of middle-aged and olderworkers.
2) Analysis of industry panel data shows that in industries in which the ratio of middle-aged
and older workers is high, the rate of increase in employment of younger workers is also
high, and at the same time employment of middle-aged and older workers tends to berestricted.
This indicates a strong possibility that Japanese companies are aware of the optimum employee
age ratio necessary to achieve the highest level of productivity, and have adjusted the age ratioof their workers towards that optimum range.

NNIR Research Report ““Is the Aging of Society a Threat to Japan?
-Increasing Productivity in the Next Decade is the Key-“The full report: http://www.nira.or.jp/pdf/0905english_report.pdf
Copyright Ⓒ 2010 by
National Institute for Research Advancement (NIRA)

7