Masaaki Shirakawa: Globalization and population aging - challenges
facing Japan
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, to the Board of
Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 22 December 2011.
* * *
Introduction
I am honored to have this opportunity to address the representatives of Japan's economy
gathered here today.
We have just over a week left in a year in which the most notable event for our nation was
definitely the Great East Japan Earthquake of March 11. Speaking only about the economic
impact of this terrible event, Japan's economy suddenly faced enormous downward
pressures arising from damage to production facilities, disruptions in supply chains, and
shortages in electricity supply. Thanks to tremendous efforts by company managers and by
employees in the field, these supply-side problems were resolved by the summer, which was
faster than expected. However, just as the prospects gradually began to look good for
Japan's economy to overcome the problems caused by the disaster, the sovereign debt
crisis in Europe triggered new problems - a slowdown in overseas economies and the
appreciation of the yen. As a result, after a sharp rebound, the pick-up in Japan's economic
activity has gradually slowed and is currently at a pause.
According to the Tankan (Short-Term Economic Survey of Enterprises in Japan) released
last week, business conditions deteriorated for large manufacturing enterprises, as has been
extensively reported in the newspapers, but improved for large nonmanufacturing enterprises
(Chart 1). As for SMEs, business conditions improved both for manufacturing and
nonmanufacturing enterprises. As such, although overall business conditions have improved,
the pace of improvement has slowed. As can be seen from the results of the Tankan, there
are currently two opposing forces in operation: on one hand, exports and production remain
more or less flat due to a slowdown in overseas economies and the appreciation of the yen;
on the other, in terms of domestic demand, private consumption remains firm and
postearthquake rebuilding and reconstruction demand is expected to materialize. The Bank of
Japan judges that Japan's economy will be more or less flat for the time being as the former
force prevails. Beyond that phase, it is our judgment that the economy will gradually return to
a moderate recovery path, reflecting a pick-up in growth of overseas economies, especially
emerging economies. Having said that, we are fully aware that this outlook is attended by
various uncertainties. The most significant risk is, of course, the impact of the European
sovereign debt crisis on our economy through its effects on international financial markets
and the global economy.
Although the economic outlook is important, I have already discussed it on various
occasions. Today, instead, I would like to give my thoughts on the challenges facing Japan's
economy and its central bank from a medium- to long-term perspective, as I believe the end
of the year is good timing for doing so.
I. Japan's economy during the past 15 years
Progress in globalization
In order to understand the medium- to long-term challenges that lie ahead for Japan's
economy, I will first compare how it is today to how it was back in 1995. I have chosen that
particular year as a comparison point because of its similarities with this year, as in 1995
Japan experienced the Great Hanshin-Awaji Earthquake (or Kobe Earthquake as it is also
known) and an appreciation of the yen, which peaked that year at under 80 yen against the
U.S. dollar.
There have been many changes over the past 15 years. First, we saw further globalization of
goods, capital, and people (Chart 2). For goods, global trade volume in real terms after
excluding the effects of price fluctuations is expected to rise from an index level of 100 in
1995 to 253 by 2011. This implies that global trade volume continued to expand at an
annualized rate of 6.0 percent, a pace much faster than the real GDP growth rate of
3.7 percent during the period. This increase was essentially caused by the end of the Cold
War and subsequent transition of regions worldwide to market economies. This increased
opportunities for an international division of labor, which led to more optimal production by
combining the technology and capital of advanced economies with the ample labor forces of
emerging economies. Emerging economies, particularly China, India, and Brazil, grew rapidly
in this process (Chart 3).
For capital, the average amount of daily transactions in foreign exchange markets worldwide
was 1.5 trillion dollars as of 1998 - which is as far back as we can go in making such a
comparison - and grew to 4 trillion dollars, corresponding to almost 20 times world GDP per
day, in 2010 (Chart 2).
For people, tourists traveling abroad have increased substantially from 530 million in 1995 to
940 million in 2011. The number of first-generation immigrants has also increased from
170 million in 1995 to 210 million in 2010 (Chart 2).
Rapid population aging
Second, Japan's population has continued to age rapidly (Chart 4). The working-age
population, or in other words the population aged from 15 to 64, has been declining after
peaking in 1995. The working-age population in 2010 declined by 7 percent compared to
15 years previously in 1995, or by 0.5 percent on a yearly basis. Meanwhile, the percentage
of people 65 or older accounted for about 15 percent of the total population in 1995, but rose
to about 25 percent in 2010.
This globally unprecedented rapid population aging has had far-reaching and various effects
on Japan's economy. The first of these effects is on the economy's potential growth rate. The
working-age population plays a central role in economic activity. Its decline has reduced
labor supply and thus has pushed down economic growth. The second effect is on the fiscal
balance. At a time when it has become difficult to increase tax revenues through labor
income, pressure has been increasing to expand the fiscal deficit, given that social security
expenses - including pension costs and medical and nursing care expenses - increase as
the population ages as long as the current level of benefits are maintained. The third effect is
the diversification of consumer needs and services. Given the diverse lives and lifestyles of
the elderly population, individuals have a wide range of unique needs, not only in terms of
medical and nursing care but also in wider contexts such as living fulfilling lives after
retirement, which encompasses hobbies and continued learning. To put it another way, the
continued population aging is, in a sense, a market expansion that cannot be considered in
mass terms.
Japan's delayed response to change
We can see that the environment has changed significantly over the past 15 years, with
globalization and rapid population aging. Change at any point in time always provides a
country with both difficulties and opportunities, and the capability of a society as a whole to
adapt to this change largely affects its economic performance. On this point, both Japan's
government and its firms have responded in various ways. Unfortunately, however, the
economic growth rate has continued to decline and prices have continued to fall moderately
as a result. Furthermore, government debt has increased substantially during this period.
Faced with these facts, we cannot deny that Japan's economic system has not managed to
respond swiftly and sufficiently to the big changes in the environment.
One reason for the decline in the growth rate is the aftereffects of the unprecedented
economic bubble in the late 1980s. The effects of that bubble were considerable. Prior to the
Lehman shock, an optimistic view prevailed among economists and policy authorities in the
United States - that a significant economic downturn following a bubble period could be
avoided through implementation of powerful monetary and fiscal policies once the bubble
burst. That optimistic view is no longer prevalent today. Economic activity remains stagnant
until excesses in production capacity and debt that have been built up during a bubble period
are resolved (Chart 5). Such balance-sheet adjustments, however, no longer acted as
constraints on Japan's economy at least by sometime between 2003 and 2004. The more
essential reason for the subsequent downturn in Japan's economy was Japan's delayed
response to the significant changes in the environment, namely, globalization and population
aging. Going back to my earlier reference to 1995, Japan around that time was desperately
looking for ways to recover from the collapse of the bubble economy. At that stage, I recall
that not many of us understood the significance of globalization and population aging for
Japan's economy as well as we later came to realize. In other words, it is better to attribute
the delay in responding to an inability to fully recognize the seriousness of the problem itself
than to difficulties implementing solutions despite knowing what they were. I believe the
same could happen in the next 15 years (Chart 6). For instance, how will Japan's rapid
population aging alter the course of Japan's future economic growth and fiscal conditions?
Will Japan's economy be able to maintain its longstanding current account surplus?
II. Setting the agenda for Japan's economy
Serious consequences of leaving situation unchanged
Regarding the first question, even if we focus on demographics, which are relatively easy to
predict going forward, we can confirm that the conditions that the underlying factors affecting
Japan's growth are going to change dramatically. The average growth rate has declined from
4.3 percent in the 1980s to 1.5 percent in the 1990s and further to less than 1 percent in the
2000s (Chart 7).
The economic growth rate consists of two components: the rate of growth in the number of
workers and the rate of growth in labor productivity, which represents an increase in the
value added by each worker. We can project future growth rates by forecasting these two
components. Of the two, the rate of growth in the number of workers started to decline in the
2000s, and decreased at an annual rate of 0.3 percent on average during that decade.
Based on long-term projections of demographic trends and assuming that current labor
participation rates by gender and by age group will not change, the rate of decline in the
number of workers will increase further to 0.6 percent in the 2010s, 0.7 percent in the 2020s
and 1.3 percent in the 2030s. The impact of such population decline is serious, especially in
regional economies (Chart 8). As for the other component, labor productivity, the average
growth rate over the past 20 years has been around 1.0 percent. Excluding the 1990s, during
which the economy was significantly affected by the legacy of the bursting of the bubble, and
choosing a period characterized by relatively favorable economic conditions, the labor
productivity growth rate was 1.5 percent from 2000 to 2008. Given that there are no
significant differences in productivity growth rates among advanced economies, we may be
able to assume that the average productivity growth rate in Japan will stay between
1.0 percent and 1.5 percent. Assuming this and that the rate of decline in the number of
workers will be as just described, the annual rate of economic growth in the 2010s will
remain somewhere between 0.5 percent and 1.0 percent and become around zero percent in
the 2030s. Medium- to long-term growth rates will have a significant impact on the fiscal
situation. The sovereign debt crisis in Europe provides us with an important lesson - that
fiscal credibility can change in a discontinuous manner (Chart 9). We must work seriously
with strong determination to strengthen our growth potential.
Need to work and create value added
How can we strengthen our growth potential? I have just explained that the rate of growth in
the number of workers and the rate of growth in labor productivity together constitute the
economic growth rate. As for the number of workers, it is difficult to expect a dramatic
improvement unless demographic trends change. However, it is still possible to slow the
pace of the decline in the number of workers by making it easier for elderly people and
women to participate in the workforce. As for the second variable, raising labor productivity
growth means increasing the value added per worker. The key, therefore, is to continuously
capture potential needs and to provide more goods and services that people will find worth
purchasing.
More specifically, there are three important aspects to be considered. First, it is important to
make the best use of the major trend towards globalization. It goes without saying that it is
important to aggressively capture demand overseas, especially in fast-growing emerging
economies. At the same time, it is important to take active steps to open up markets and
society. With more inflows and outflows of people, goods, and capital, there are more
chances of coming up with new ideas and business opportunities.
Second, efforts to cultivate new domestic demand are also critically important. Senses of
values and lifestyles have been diversifying not only for the elderly, as explained earlier, but
also for all generations. It is important that businesses expand domestic markets by working
to capture such potential demand and measures such as deregulation are taken to prepare
the environment for firms to take on these challenges.
Third, in order to dynamically implement a dual strategy of expanding business globally and
exploring domestic demand, it is necessary to shift labor and capital smoothly to businesses
with high growth potential. This means more effective use of human resources and capital
within firms and improvement in economic metabolism on a macroeconomic basis. To
mobilize resources in such a way without causing social stresses, it will be necessary to
strengthen outplacement support schemes, make it easier to start new businesses, and
improve safety nets. More than anything, it will be important to share a sense of values within
Japanese society, which should include acceptance of the need to improve the economic
metabolism and support for people taking on new challenges.
"Hollowing out of domestic industries"?
I would like to briefly touch upon recent concerns about a hollowing out of domestic
industries, which are also related to the economic metabolism.
To start with, expansion of production overseas is not unique to the current phase but rather
a trend that has played out over the past twenty years (Chart 10). Until the middle of the
1980s, Japan increased its global market share by expanding exports. Since the second half
of the 1980s, Japanese firms have increased their overseas production partly as a response
to intensifying trade friction. Thereafter, they have continuously reviewed their global
production networks to optimize the division of work between home and abroad while taking
into consideration changes in demand structure and cost structure as a consequence of
globalization. As a result of such management decisions by firms, the pace of expanding
production overseas increased and this trend continues today.
This shift of production sites overseas has decreased domestic employment in the
manufacturing sector. We need to create more employment opportunities in the economy as
a whole by enhancing growth in domestic demand-related sectors, such as service sectors
that create more employment than other sectors, by making use of the resultant idle labor
force (Chart 11). Within the manufacturing sector, given the significant gap in labor costs
between home and abroad, it is necessary to promote a division of labor, with production and
assembly sites for mass production expanded overseas and domestic operations focusing on
more profitable businesses as well as cutting-edge technologies and business ideas.
We must, of course, pay due attention to the risk that the expansion of production overseas
will adversely affect the domestic economy. For example, the shift could suddenly accelerate
for certain reasons, including the appreciation of the yen, such that its pace surpasses a rate
consistent with a trend increase in overseas demand. Another risk is that core firms and
factories abandon domestic production sites.
It is true that the appreciation of the yen creates a need for serious adjustments to export
industries. At the same time, there are also benefits from the yen's appreciation. For
example, the appreciation has clearly caused a reduction in the cost of imports, which have
increased significantly due to increased imports of crude oil and LNG after Japan's nuclear
plants stopped operations. We have also seen more Japanese firms availing of the yen's
appreciation to make strategic moves to expand business globally, as evidenced by an
increase in outbound M&A activity (Chart 12). Credits of foreign direct investment income
currently total 3.4 trillion yen per year, 0.7 percent of nominal GDP. Although such income
has somewhat increased compared to the past, the amount of overseas investment and the
rate of return are still small compared to other countries (Chart 13). When domestic
investment opportunities are limited, it is vitally important to improve returns from overseas
investment, particularly foreign direct investment. In any case, the negative impact of the
yen's appreciation tends to be noticed more than positive effects in Japan because
domesticdemand related firms, which are natural beneficiaries of the yen's appreciation, have failed to
develop successful business plans to reap such benefits. In other words, in order to
overcome concerns about a hollowing out of domestic industries, ultimately we must work to
strengthen our medium- to long-term growth potential.
Making accommodative financial environment lead to growth
As is clear from what I have said so far, strengthening of growth potential will be achieved by
substantive efforts to work and increase value added. In this regard, some argue that
"stopping deflation comes first and that can be achieved easily through monetary easing."
However, a rise in inflation without a pick-up in real growth rates will not improve living
standards or fiscal balances. The real issue is how to raise the real growth rate. Past
experiences show that prices rise later, after economic growth picks up in real terms. To use
the analogy of the human body, prices are like its temperature, while growth potential is its
fundamental strength. Raising the temperature without improving the fundamental strength is
not possible. Even if it were successfully done temporarily, there would be side-effects. In
fact, in Japan, a strong correlation has been observed between the potential growth rate and
the expected rate of inflation (Chart 14).
In the past even some prominent academic economists in the United States have argued
that "stagnant growth and deflation in Japan can be solved easily by implementing significant
monetary easing." After experiencing difficulty restoring U.S. economic growth after the
Lehman shock, however, they revised their understanding on the issue considerably and
even apologized and withdrew their past criticisms of Japan.
In any case, Japan's financial conditions are extremely accommodative. Nominal interest
rates and even actual funding rates of firms, such as real interest rates on corporate bonds
adjusted using inflation expectations, are lower in Japan compared to those in the United
States and Europe (Chart 15). In a related context, some argue that "insufficient provision of
money by the Bank of Japan is the cause of deflation and the yen's appreciation," citing the
size of the monetary base, which is the total amount of currency provided by a central bank.
As Chairman Bernanke of the U.S. Federal Reserve has also pointed out, I, too, do not
consider the monetary base to be an appropriate indicator for monetary easing. Still, even
the size of the monetary base as a proportion of nominal GDP is larger in Japan than in the
United States and Europe (Chart 15). As all of you present today must sense through your
business activities, we are not in a situation where business fixed-investment and purchases
of foreign currency-denominated assets are constrained by the amount of cash and deposits
or the level of interest rates. The bottom line when it comes to our problem is how to make
use of the current extremely accommodative financial conditions in order to strengthen
growth potential.
III. The roles and challenges of central banks
The Bank of Japan is not alone: other central banks of advanced economies are in a similar
situation. Europe is dealing with the sovereign debt problem and the United States is in the
process of balance sheet repair. In such circumstances, both Chairman Bernanke of the U.S.
Federal Reserve and President Draghi of the European Central Bank have repeatedly
pointed out that central bank measures are not a panacea. Having said that, I am not
denying the importance of the role played by central banks. On the contrary, there are many
things that only central banks can do. What is important is that the government, the private
sector, and the central bank play their respective roles properly. What, then, are the roles of
a central bank?
Financial globalization and central banks
In recent years, it is becoming increasingly important for a central bank to have a global
perspective when seeking to conduct monetary policy appropriately to achieve price stability.
Coming back to the basics of how monetary easing stimulates demand, one channel is to
bring future demand forward by urging firms to make investments now while interest rates
are low. Another channel, if lower interest rates result in the depreciation of the currency, is
to capture overseas demand.
Once interest rates fall to almost zero, however, it becomes difficult to increase the benefit of
making investments now. Moreover, when interest rates in other advanced economies are
also close to zero as in the current situation, there is limited room left to make use of
overseas demand, at least among the advanced economies. In sum, the two channels of
monetary policy both become less effective. Given that emerging economies have high
growth rates and interest rates, monetary easing in advanced economies is expected to have
stimulative effects through an increase in exports to emerging economies if the currencies of
advanced economies depreciate against those of emerging economies on the whole. At the
present time, however, many emerging countries adopt fixed foreign exchange rates with
currencies pegged to the U.S. dollar and the United States faces balance-sheet repair
problems. What actually happened was that monetary easing in the United States, instead of
stimulating domestic economic activity, contributed to overheating in emerging economies
and a rise in international commodity prices, which resulted in more inflationary pressures
and adverse effects on private consumption in the U.S. economy.
In this way, in an increasingly globalizing world, there is a possibility that a central bank will
find that unintended effects of its monetary policy eventually come back on itself through their
effects on overseas economies and financial markets. In the end central banks should
conduct monetary policy based on their assessment of economic and price developments in
their respective countries and regions. At the same time, it is also becoming more important
than ever to make decisions after considering the complex interdependence of the different
parts of the global economy.
Against a backdrop of increasing globalization, the task of maintaining financial system
stability is equally important as monetary policy for a central bank. As can be seen in foreign
exchange trading volumes, massive capital flows are moving around the globe beyond
national borders. Even without actual movements of capital, derivatives transactions transfer
risks across borders. Although some see such financial transactions negatively, given the
progress in globalization in terms of the real economy and associated needs to hedge
various risks associated with economic transactions, such as interest rate risk, foreign
exchange risk and credit risk, simply dismissing financial transactions will not help to improve
the situation. In addition, as evidenced by the sovereign debt crisis in Europe, the very
credibility of sovereign states is being questioned this year. In such circumstances,
maintaining stability in the global financial system is becoming the most important
prerequisite for global economic growth. On the topic of global financial system stability,
while strong commitment by national governments is necessary, central banks have also
been doing their utmost in this regard. One example is the coordinated actions by six central
banks, including the Bank of Japan, regarding U.S. dollar liquidity, which were announced at
the end of November. As a contingency measure, the central banks also agreed to establish
bilateral swap arrangements so that liquidity in non-domestic currencies other than the U.S.
dollar could also be provided in each jurisdiction. I should also add that central banks are
contributing to the ongoing efforts to revise financial regulation and supervision frameworks
to prevent recurrence of financial crises like the one in 2008, by preventing the accumulation
of financial imbalances.
The bank's policy conduct
Finally, I will explain the Bank's recent conduct of monetary policy (Chart 16).
First, the Bank has been pursuing powerful monetary easing under the comprehensive
monetary easing framework implemented in the fall of last year. The Bank has also
repeatedly expanded the size of the Asset Purchase Program and intends to proceed with
additional purchases of approximately 13 trillion yen over the next year.
Second, the Bank has been doing its utmost to ensure financial market stability. Its provision
of ample funds immediately following the earthquake as well as the U.S. dollar
fundssupplying operations I have just mentioned are good examples of such efforts.
Third, in an extraordinary measure for a central bank, the Bank is proceeding with fund
provision to provide support for strengthening the foundations for economic growth. This is
aimed at encouraging firms to make use of the accommodative financial environment, by
providing financial institutions with long-term funds at a low interest rate and taking
advantage of their expertise in identifying business opportunities.
Concluding remarks - importance of adapting to changes and strengthening growth
potential
I have almost used up my time. My message today can be summarized into the following five
points. First, we need to recognize that Japan currently faces major changes - globalization
and rapid population aging - which have a significant impact on its economy. Second, in
order to maintain existing living standards in Japan for the next generations, our economy
must strengthen its capacity to adapt to these major changes and strengthen its growth
potential. Third, deflation will be overcome by strengthening growth potential. Fourth, in order
to strengthen growth potential, firms' willingness to take on challenges is vital and there is a
need to prepare the environment to encourage firms to do so. Fifth, the Bank of Japan will
also continue to consistently make contributions from the monetary side with the aim of
achieving sustainable growth with price stability.
Incidentally, in October next year, Japan will host the Annual Meetings of the World Bank
Group and International Monetary Fund. This is a big event with more than ten thousand
participants from the existing 187 member countries. Japan hosted these meetings in 1964
when the country was still an emerging economy filled with the energy associated with high
growth. In that year there were a series of historic events in Japan which enhanced people's
confidence: becoming a member of the OECD on April 28; hosting the Annual Meetings of
the World Bank Group and International Monetary Fund from September 7 to 11; launching
the Tokaido Shinkansen on October 1; and holding the opening ceremony of the Tokyo
Olympic Games on October 10. Almost half a century has passed since then and, in the fall
of next year, Japan will again provide the venue for discussion among global leaders tackling
various problems, this time as a mature advanced economy. Japan experienced the bursting
of a bubble twenty years ago and currently faces rapid population aging ahead of other
countries. In that sense, Japan is well positioned to present a new growth model to the rest
of the world as a mature economy and the global frontrunner in terms of population aging. I
sincerely hope that, in 2012, Japan will show the rest of the world its vision and
determination to continue to shine as a mature economy and, more than anything else, the
people of Japan will regain hope and courage. In this regard, the Bank of Japan will do its
utmost in close cooperation with you. Thank you for your attention.
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