2024-E-7

Bank of Japan Review

Effects of Demographic Changes on Medium- to Long-TermBusiness Fixed Investment
Research and Statistics Department
CHIKAMATSU Kyosuke*, IKEDA Shuichiro, YAGI Tomoyuki

July 2024
In Japan, labor input is unlikely to increase significantly, based on the outlook for demographic changes.
This paper analyzes effects of demographic changes on firms' fixed investment using microdata from theTankan. The analysis shows that firms facing labor shortages tend to be active in making business fixed
investment and replace labor with capital (machines). Given that labor market conditions are highly likely
to remain tight, potential demand for labor-saving investment to address labor shortages appears to belarge. For potential demand to materialize as actual investment, the following factors would be important:firms' medium- to long-term growth expectations being held up; training up highly skilled personnel with
sufficient skills to develop and use labor-saving software; and human capital being allocated appropriately
through increased mobility in the labor market.
Such decline in labor input would exert downward
pressure on Japan's economy. Assuming the standard
Cobb-Douglas production function, 𝑌𝑡 , which shows
output (real GDP), can be written as:

Introduction
In the 2010s, labor supply (the number of labor force
participants) increased in Japan even amid a decreasing
total population, as labor force participation of seniors
and women advanced, with growing labor demand due
to economic recovery (Chart 1). However, room for
additional labor supply of seniors and women appears
to be declining, and labor input is unlikely to increasesignificantly, based on the outlook for demographic
changes.1

𝑌𝑡 = 𝐴𝑡 𝐾𝑡𝛼 𝐿1−𝛼𝑡 .
𝐴𝑡 , 𝐾𝑡 , and 𝐿𝑡 denote productivity, capital input, andlabor input, respectively. 𝛼 represents the capitalshare and 1 − 𝛼 represents the labor share. The
subscript 𝑡 denotes time. Converting this equation
into a logarithm shows that the difference from theprior period is the rate of growth, and thereby the GDP
growth rate (∆𝑦𝑡 ) can be expressed as:[Chart 1] Labor Force Participants
200

y/y chg., 10 thous. persons

150

100

Men (aged 15-59)
Women (aged 15-59)
Seniors (aged 60-74)
Seniors (aged 75 and over)Labor force participants
Total population∆𝑦𝑡 = ∆𝑎𝑡 + 𝛼(∆𝑘𝑡 − ∆𝑙𝑡 ) + ∆𝑙𝑡 .
In the right-hand side of the equation, ∆𝑎𝑡 is
productivity growth, (∆𝑘𝑡 − ∆𝑙𝑡 ) is growth in thecapital equipment ratio (the rate of change in theamount of capital input per unit of labor input), and ∆𝑙𝑡
is growth in labor input.2
Therefore, for an economy to grow amid declining
labor input, it is important that productivity rise or thecapital equipment ratio increase, from a somewhat
long-term perspective. 3 The importance of
productivity for economic growth has been discussed
in many studies.4 This paper examines how tightening
labor market conditions will affect firms' medium- tolong-term fixed investment stance, in relation to thecapital equipment ratio, referring to an analysis using

50

0

-50

-100
FY 05

08

11

14

17

20

Source: Ministry of Internal Affairs and Communications.
Note: Figures for labor force participants are staff estimates adjusted forgaps due to revisions of the benchmark population.

1

Bank of Japan July 2024

microdata from the Bank of Japan's Tankan (ShortTerm Economic Survey of Enterprises in Japan). It thendiscusses issues involved in achieving economic
growth through increasing investment amid thedeclining population.

firms facing labor shortages have been taking a more
active stance toward investment in both tangible fixed
assets and software than those not facing labor
shortages (Chart 3).
[Chart 3] Investment Depending on Firms'
Assessment of Labor Shortages

Will Labor Shortages Promote LaborSaving Investment?

16

Firms reporting "insufficient" employment

14

We examine whether tightening labor market
conditions can promote labor-saving investment as a
substitute for labor force. Labor-saving investment
followed an uptrend in the economic recovery phase
before the pandemic. 5 Although demand forinvestment declined temporarily after the outbreak of
COVID-19, firms' efforts to address labor shortages
using digital technology have accelerated recently inlabor-intensive industries such as "accommodations,eating and drinking services" and "retailing," whichhave faced severe labor shortages (Chart 2).

12

-100

reversed, DI, % points

8
6
4
2
0
Tangible fixed
asset investment-80

Note: Based on the Tankan. All industries and enterprises. The chartshows tangible fixed asset investment (excluding land purchasing
expenses) and software investment aggregated based on firms'
assessment of their employment level at the beginning of the fiscal
year using microdata from the Tankan. The figures for fiscal 2023
are forecasts from the June 2023 survey.

350

Second, we measure the impact of labor shortages
on investment depending on their degree, bycontrolling business cycle components and otherfactors, including business sentiment and firms'
perception of excess production capacity. Specifically,
we count the number of times a firm reported"insufficient" employment in the Tankan during thepreceding eight quarters, and measure whether its
stance toward fixed investment differs according to thedegree of labor shortages. Smaller numbers indicatethat firms have been facing temporary labor shortages,
while larger numbers indicate chronic labor shortages.
We employ the degree of labor shortages and otherfactors as explanatory variables and the ratio of
business fixed investment to sales as the dependent
variable. The results show that firms do not become
active in making tangible fixed asset investment
immediately when labor shortages are only temporary;
however, when labor shortages become acute andprolonged, firms increase such investment in a nonlinear manner (Chart 4). Likewise, firms tend toincrease software investment when they face persistentlabor shortages.
Given these results, since labor market conditions
are highly likely to remain tight going forward, it canbe said that firms' potential demand for labor-saving

300

-60

250

-40
200
-20

150

0

100

20
40
CY05

10

Softwareinvestment

Source: Bank of Japan.

2. Software
Investment
FY 2005=100

Firms reporting "excessive" or "adequate"
employment

10[Chart 2] Industries with Labor Shortages andSoftware Investment
1. Employment
Conditions

FY 2020-2023 avg., y/y chg., %

50
10
15
20
15
20 FY05
All industries
Accommodations, eating & drinking services
Retailing
Construction

Source: Bank of Japan.
Note: Based on the Tankan. All enterprises. The figures for software
investment for fiscal 2023 are forecasts from the June 2023
survey.

We use microdata from the Tankan in analyzing therelationship between labor shortages and business fixed
investment to gain a detailed picture of firms' behavior.
First, based on firms' assessment of their employment
level in the Tankan, we simply categorize firms into
two groups: those facing labor shortages (reporting"insufficient" employment), and those not facing labor
shortages, and then aggregate the amount of businessfixed investment for each group. The results show that
2Bank of Japan July 2024

investment is large. However, the extent and pace atwhich such potential demand will materialize depend
on factors such as the following: whether labor can be
replaced with capital (machines) in the first place, andwhether firms' appetite for investment is maintained(whether their growth expectations are sustained andimproved). In the next sections, we examine the current
situation in Japan regarding these points.

somewhat considerable improvement. For example,
self-service cash registers have been introduced inretailing and an automated check-in system has been
introduced in accommodation services, as labor market
conditions have tightened and labor shortages havematerialized in recent years; such progress has likely
led to an increase in the elasticity of substitution innonmanufacturing.

[Chart 4] Labor Shortages and Business Fixed
Investment[Chart 5] Elasticity of Substitution between
Labor and Capital[Number of quarters firms reported labor
shortages during the preceding 8-quarter period]

1.0
0.8

1-2 quarters

3-4 quarters

5-8 quarters

Temporary

Somewhatprolonged

Prolonged

sensitivity

CY 2005-2014

***

0.3

0.03

***

Software investment*

0.6

elasticity of substitution

CY 2015-2019

sensitivity

Tangible fixed asset
investment

0.4

***

0.02

0.2

***

***
***

***
0.01

0.4
0.2

0.1

​

0.00

*
​

-0.01

0.0
Temporary Somewhat Prolonged
prolonged< Labor shortages >Source: Bank of Japan.

0.0

Temporary Somewhat Prolonged
prolonged

All industries

Manufacturing Nonmanufacturing

Source: Cabinet Office.

< Labor shortages >Note: Figures are estimated from the capital intensity and the relative priceof capital to labor using industry-level panel data (all industries:
16 industries; manufacturing: 7 industries; nonmanufacturing: 9
industries). The legend shows the estimation periods. *** denotes
statistical significance at the 1 percent level.

Note: Based on the Tankan. All industries and enterprises. The chartshows the sensitivity of the investment to each dummy variable.
The dependent variables are the ratios of tangible fixed asset
investment (excluding land purchasing expenses) and software
investment to sales. Explanatory variables are as follows: dummy
variables for the number of quarters firms reported that they had"insufficient" employment during the preceding two-year period aswell as firms' assessment of their business conditions, production
capacity, and financial positions. The estimation period is fromfiscal 2008 to 2022. *** and * indicate that the results are statisticallysignificant at the 1 and 10 percent levels, respectively, while thebroken line indicates that the result is not statistically significant.

However, the elasticity of substitution in Japanobtained in our estimation is only in the range of about
0.2 to 0.3, although it has been rising somewhat inrecent years. Previous studies that estimated theelasticity of substitution in Japan show similar results,
although their number is limited.8 On the other hand,the elasticity of substitution for the United Statesobtained in many previous studies is around 1 -although the results differ across studies -- indicatingthat the elasticity for Japan is lower compared with theUnited States.9
As explained, the elasticity of substitution has been
lower in Japan than in the United States, and firms'
efforts toward making labor-saving investment thatutilize digital technology have lagged behind, evenamid declining software prices due to progress in IT.
This may be attributable to firms' cautious investment
stance amid continued low growth on the demand side
and a lack of highly skilled personnel who can use
labor-saving software and machines on the supply side.
10
Paradoxically, highly skilled personnel with
sufficient skills to develop and use labor-saving

Can Labor be Replaced with Capital(Machines)?
The elasticity of substitution between labor and capitalshows the extent to which changes in the relative priceof labor and capital reflecting factors such as wage
increases could lead to substitution of capital for labor.6
An estimation using industry-level panel data showsthat the elasticity of substitution in Japan has increased
somewhat since the middle of the 2010s, as labormarket conditions have tightened, suggesting thatfirms' efforts to make up for labor shortages withcapital have been spreading (Chart 5). 7 While thistrend has been seen in both manufacturing andnonmanufacturing, the elasticity of substitution innonmanufacturing, which had been low, has shown a3Bank of Japan July 2024

software and machines is said to be necessary to replacelabor with machines. 11 In other words, while laborsaving investment replaces simple labor, it requires
highly skilled personnel; therefore, the keys toincreasing investment are whether such personnel canbe supplied and whether human capital will beallocated appropriately (e.g., reallocated to the sectorsthat are in need of highly skilled personnel). On thispoint, it appears that, although the number of job
openings for highly skilled personnel has been on an
uptrend, they are not being filled due to labor
shortages. 12 Given that firms' actual software
investment in the Tankan recently has been falling far
short of their plans as a trend, it is possible that firms
have been unable to make as much progress withdigitalization as they had planned mainly due to labor
shortages (Chart 6).

capital through this channel had therefore been
relatively difficult. In fact, first and foremost, the ICT
capital equipment ratio has been at a lower level inJapan compared to the United States and othercountries, and its recent growth has also been quitemodest; this suggests that the accumulation of capital,such as software, for labor saving has not progressedsufficiently (Chart 8).
[Chart 7] Relative Prices of Capital to Labor
140

United States

120

Japan

100
90
80

y/y, % chg.

15

130

110

[Chart 6] Planned and Actual Software
Investment
20

CY 2000=100

70

Actual – planned investment
Actual investment
Planned investment

60
50

10
40
CY 95

5

98

01

04

07

10

13

16

19

Sources: Cabinet Office; Ministry of Health, Labour and Welfare; Japan
Bond Trading Co., Ltd.; BEA; FRED.

0

Note: Relative prices are capital rental costs divided by hourly wages.

-5-10[Chart 8] ICT Capital Intensity

-15
-20
FY 01

12

$/person-hour

CY 2010

04

07

10

13

16

19

22

10

Source: Bank of Japan.
Note: Based on the Tankan. All industries and enterprises. Figures forplanned investment are those at the time of the December surveyof each year.

Latest year

8

In addition, a limited decline in the relative price ofcapital to labor compared with the United States seems
to have led to a delay in labor-saving investment inJapan (Chart 7).13 In the United States, prices of capitalsuch as software have been on a declining trend andwages have continued to rise, and thus the relative priceof capital have declined clearly. 14 In contrast, wages
had remained at around 0 percent in Japan since the2000s, in a situation where people's mindset andbehavior based on the assumption that wages and prices
would not increase easily had been entrenched insociety. Consequently, a decline in the relative price ofcapital to labor in Japan had been limited compared to
the United States, and the substitution of labor for

6

4

2

0
Japan

United States

Sources: EU KLEMS; OECD.
Note: ICT capital is the sum of ICT equipment and software. The latest
year is 2018 for Japan and 2020 for the United States.

Such situation in Japan may be interpreted ashaving large room for growth in labor-saving
investment. If the development of highly skilled
4Bank of Japan July 2024

personnel will progress through increased investment
in human capital and reskilling, areas that can be
replaced with capital are expected to grow. In addition,
the labor market for regular employees in search of newjobs has expanded in recent years, and it warrants
attention on whether the reallocation of human capitalwill progress through increased mobility in the labormarket.15 As a result, a decline in the relative price ofcapital to labor due to wage increases is expected tostimulate demand for investment, leading to economic
growth.

[Chart 9] Expected Growth Rate6y/y % chg.

y/y % chg.

18

Expected growth rate (left scale)515Growth rate of capital
investment (right scale)4

Are Firms' Medium- to Long-Term
Growth Expectations Maintained?
Even amid firms' active labor-saving investment, if
they think that demand will decline in the future due tothe decreasing population, firms' growth expectations
will also decline; this will push down capital stock
required in a country as a whole, and may lead to firms
holding back investment. 16 Therefore, firms' growth
expectations are the key in considering overall
developments in business fixed investment.
On this point, according to the Annual Survey of
Corporate Behavior released by the Cabinet Office -targeting large firms (listed firms) -- the growth rate ofindustry demand, which is considered to reflect firms'
growth expectations, has followed an improving trend(Chart 9). 17 The distribution of individual firms'
growth expectations obtained from compiling thequestionnaire information (microdata) of the survey
shows that a decreasing number of firms have had
pessimistic outlook such as continued negative growth,suggesting that growth expectations of many firms
have been rising (Chart 10).
It is not easy to identify reasons why growth
expectations have been improving amid the declining
population. That said, there is a channel through whichlabor-saving investment driven by intensifying labor
shortages has led to an improvement in corporate
profits and it is considered to have been mitigating theimpact of the declining population somewhat. In fact, acalculation using microdata from the Tankan showsthat firms actively investing in labor-saving software
have been using capital more efficiently (Chart 11). In
addition, firms have been active in making investment
in view of the next generation including investment indigital transformation and to address environmental
issues, and this has likely led to the improvement intheir growth expectations. 18 Through thesedevelopments, a virtuous cycle from income tospending is expected to intensify.

12

3

9

2

6

1

3

0

0

-1
FY85

-3
90

95

00

05

10

15

20

Source: Cabinet Office.
Note: Based on the "Annual Survey of Corporate Behavior." "Expected
growth rate" is the average of firms' forecasts of the real growthrate of industry demand over the next five years. "Growth rate ofcapital investment" is the average of the growth rate of firms'
planned fixed investment over the next three years. Shaded area
indicates the 20-80 percentile band of the expected growth rate.

[Chart 10] Expected Growth Rate Distribution
0.5

probability density
FY 2010
FY 2015

0.4

FY 2022
0.3

0.2

0.1

0.0
-10 -8

-6

-4

-2

0

2
4
6
8 10 12
expected growth rate, %Source: Cabinet Office.
Note: Figures were staff estimates obtained by compiling the questionnaire
information from the Cabinet Office's "Annual Survey of Corporate
Behavior." Figures show the distribution of firms' forecasts of thereal growth rate of industry demand over the next five years.

5

Bank of Japan July 2024

investment in tangible fixed assets and software. Given
that labor market conditions are highly likely to remaintight going forward, potential demand for labor-saving
investment to address labor shortages appears to belarge.
To make this potential demand materialize, what isrequired is to train up highly skilled personnel who candevelop and use labor-saving machines and software,through increased investment in human capital andreskilling. In other words, it is necessary to makeinvestment in machines and software and investment inpeople simultaneously, and expand areas that can be
replaced with machines. In addition to an accumulationof human capital, increased mobility in the labormarket, which has started to be seen in recent years, is
expected to promote effective reallocation of labor
resources and to reduce friction that may occur whenreplacing labor with capital. In promoting labor-saving
investment, it is also important for firms to review theirbusiness models and build a framework that enables aneffective use of machines. Moreover, maintaining
firms' medium- to long-term growth expectations isnecessary to increase firms' positive investment. In thisregard, institutional support, such as deregulation,
would also be beneficial, in addition to firms' own
efforts, including creating new demand. Labor-saving
investment triggered by labor shortages andaccompanying measures is expected to promote firms'
labor-saving technological progress, and thereby raise
Japan's economic growth rate.

[Chart 11] Labor-Saving Investment andCapital Efficiency
0.5changes in ROA, % points

0.4

0.3

0.2

0.1

0.0
ActiveReluctant
Software investment

Sources: Bank of Japan; Ministry of Economy, Trade and Industry.
Note: Figures are calculated by matching microdata from the Tankan
and the Ministry of Economy, Trade and Industry's "Basic Surveyof Japanese Business Structure and Activities." Firms with theratio of software investment (to total asset ratios) surpassing themedian are defined as "active," and those with the ratio below themedian as "reluctant." Changes in ROA (cumulative changes fromFY 2015 to FY 2021) shows the average.

Concluding Remarks
This paper examines the effects of Japan's declining
population on business fixed investment. The results of
our analysis using microdata from the Tankan show thatfirms facing labor shortages tend to make active

decrease in the relative price of capital to labor, and willencourage firms to become more active in making investment.
7 We estimate the elasticity of substitution between labor andcapital ( 𝜎 ) using a constant elasticity of substitution (CES)
production function.

* Currently at the Personnel and Corporate Affairs Department.

For the current situation and outlook for labor market
conditions, see Box 2 of the January 2023 Outlook for Economic
Activity and Prices (Outlook Report).
2 In this paper, the framework of growth accounting is used. For
details on the derivation of equations, see the following paper.
Yagi, Tomoyuki, Kakuho Furukawa, and Jouchi Nakajima(2022), "Productivity Trends in Japan -- Reviewing Recent Factsand the Prospects for the Post-COVID-19 Era --," Bank of Japan
Working Paper Series, No. 22-E-10.
3 While prior studies have argued that a decline in labor force
would slow economic growth, more recent studies have argued
that labor shortages would not necessarily exert negative impact
on an economy because technological innovation that replaces
labor force becomes active amid a declining population (see, forexample, the following paper). This paper explains this point
empirically.
Acemoglu, Daron and Pascual Restrepo (2021), "Demographics
and Automation," Review of Economic Studies, Vol.89 (1), pp.144.
4 Yagi et al. (2022) summarize the recent discussion regarding
labor productivity in Japan.
5
For details on the increase in labor-saving investment before
the pandemic, see Box 4 of the July 2018 Outlook Report.
6 For example, a decline in software prices due to progress in IT
and an increase in wages owing to labor shortages will lead to a
1

𝜎−1

𝜎
𝜎−1 𝜎−1

𝑌𝑡 = 𝐴𝑡 [𝛼𝐾𝑡 𝜎 + (1 − 𝛼)𝐿𝑡 𝜎 ].

Specifically, we obtain 𝜎 from the following equation derived
from the profit maximization condition under budget constraints.
𝐾𝑡𝑟𝑡
ln = −𝜎 ln + 𝐶𝑜𝑛𝑠𝑡. +𝜀𝑡 .
𝐿𝑡𝑤𝑡𝑟 denotes rental prices of capital and 𝑤 denotes wages. See
text for the definitions of other notations.
8 For example, the following paper estimates the elasticity of
substitution in Japan and the United States, and shows that theelasticity for the United States was 1.47 (estimation period:
1985-2017) while that for Japan was only 0.20 (estimation
period: 1988-2017).
Hirakata, Naohisa and Yasutaka Koike (2018), "The Labor Share,
Capital-labor
Substitution,
andFactor Augmenting
Technologies," Bank of Japan Working Paper Series, No.18-E20.
9 The following paper examines the estimates of the elasticity
of substitution between labor and capital in the United Statesobtained in preceding studies. The median of the estimates isaround 0.7, but it should be noted that, since estimates differ

6Bank of Japan July 2024

Jorgenson, Dale W. (1963), "Capital Theory and Investment
Behavior," American Economic Review, Vol.53 (2), pp.247-259.
14
The following paper points out that the relative price ofcapital have declined in the United States due to a progress in IT
and that such decline has led to the substitution of labor forcapital. See the following for more details.
Karabarbounis, Loukas and Brent Neiman (2014), "The Global
Decline of the Labor Share," The Quarterly Journal of
Economics, Vol.129 (1), pp.61–103.
15 For the expansion in the labor market for job changers inrecent years, see Box 1 of the October 2023 Outlook Report.
16 In the discussion of secular stagnation, which attracted
worldwide attention before the pandemic, a decline in demandfor investment due to demographic changes is considered as animportant channel through which the natural rate of interest ispushed down.
17 However, it is worth noting that the survey is conducted forlisted firms and thus the results are mainly for large firms. It is
likely that growth expectations for SMEs have not been as highas those for large firms, as it is not easy for SMEs to respond to
global demand.
18 Firms' fixed investment stance has been active in recent years
regardless of firm size. In the December 2023 Tankan, firms'
fixed investment plans for 2023 were at high levels. In addition,
the Annual Survey of Corporate Behavior mentioned aboveshows that the outlook for fixed investment by large firms
marked the highest level since fiscal 1990 (Chart 9).

across studies, such comparisons need to be interpreted withconsiderable latitude.
Knoblach, Michael, Martin Roessler, and Patrick Zwerschke(2020), "The Elasticity of Substitution between Capital andLabour in the US Economy: A Meta-regression Analysis,"
Oxford Bulletin of Economics and Statistics, Vol.82 (1), pp.6282.
10 The following paper clarifies that firms' demand for highly
skilled personnel rises in the process of increasing investment inintangible fixed assets by compiling the questionnaire
information of surveys, including the Basic Survey of JapaneseBusiness Structure and Activities released by the Ministry of
Economy, Trade and Industry.
Furukawa, Kakuho, Yoshihiko Hogen, Yosuke Kido (2023),"Labor Market of Regular Workers in Japan: A Perspective from
Job Advertisement Data," Bank of Japan Working Paper Series,
No. 23-E-7.
11 Looking at prior studies that focus on the elasticity of
substitution, Katz and Margo (2014) state that capital and labor
are complementary to each other and thus capital deepening
leads to an increase in demand for highly skilled personnel. In
addition, Acemoglu and Restrepo (2018) analyze the impact ofautomation on labor and argue that, while machines replace
simple labor, new complex and high-skilled jobs for using
machines are created simultaneously. See the following papers
for details.
Katz, Lawrence F. and Robert A. Margo (2014), "Technical
Change and the Relative Demand for Skilled Labor: The UnitedStates in Historical Perspective," NBER Chapters, in Human
Capital in History: The American Record, pp.15-57, National
Bureau of Economic Research.
Acemoglu, Daron and Pascual Restrepo (2018), "The Racebetween Man and Machine: Implications of Technology for
Growth, Factor Shares, and Employment," American Economic
Review, Vol.108 (6), pp.1488-1542.
12 Furukawa et al. (2023) show that the demand for highly
skilled personnel has been increasing in Japan using online job
advertisement.
13 We refer to the following paper for the calculation of rental
prices of capital in Chart 7.

The Bank of Japan Review Series is published by the Bank to
explain recent economic and financial topics for a wide rangeof readers. This report, 2024-E-7, is a translation of theJapanese original, 2023-J-13, published in December 2023.
Views expressed are those of the author(s) and do notnecessarily reflect those of the Bank. If you have any
comments or questions, please contact Research and Statistics
Department (E-mail:post.rsd18@boj.or.jp). The Bank of Japan
Review Series and the Bank of Japan Working Paper Series areavailable at https://www.boj.or.jp/en/index.htm.

7Bank of Japan July 2024