Masaaki Shirakawa: Demographic changes and macroeconomic
performance - Japanese experiences
Opening remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2012
BOJ-IMES Conference, hosted by the Institute for Monetary and Economic Studies, at the
Bank of Japan, Tokyo, 30 May 2012.
* * *
I. Introduction
Good morning. I am very pleased to have a lot of participants from central banks,
international organizations, and academia in this year's annual BOJ-IMES Conference. On
behalf of my colleagues at the Bank of Japan, I am privileged to welcome you all here in
Tokyo.
The theme of this year's conference is "demographic changes and macroeconomic
performance." On the theme, I am sure that Japan is the most notable case that provides a
basis for discussion. Japan's population and the working-age population - that is, the
population aged between 15 and 64 years - came to decline after their peak-years in 2007
and in 1995 respectively. The share of the population aged 65 years or older rose rapidly to
23% in 2010 from 12% in 1990 (Chart 1). In the meantime, Japan's economic growth
gradually slowed during the past two decades mainly for two reasons. In the former half of
the period, the Japanese economy was hobbled by the crippling effect of the burst of the
bubble. In the latter half, the rapid population aging hampered the Japanese economy
through a variety of channels. In an attempt to illustrate that, I frequently rely on the
cross-country comparison of growth rates including Japan. Among G-7 countries, the
Japanese GDP growth rate per working-age population - an indicator least affected by
demographic changes in the short run - was the highest. By contrast, the Japanese per
capita GDP growth rate was almost the same as the average, and the Japanese GDP growth
rate, which is subject to the decreases in the total population, was below average (Chart 2).
Neoclassical growth theories normally do not distinguish the overall population from the
working-age population due to analytical simplicity. However, without taking into account the
distinction between the two variables explicitly, the very challenges that Japan is currently
faced with will be outside the scope of analysis.
In the macroeconomic policy discussions in other economies, Japan's experiences are
frequently cited, and a lot of lessons are drawn over the past decade. However, a general
conclusion obtained in such policy discussions without considering the differences in the
demographic factors between Japan and other economies could sometimes be misleading.
Various challenges posed by demographic changes have been and will be among the
paramount issues lying ahead for a broad group of countries including Japan. For example,
growth rate of the Chinese working-age population has slowed since the late 1980s, and is
projected to turn negative by 2020 (Chart 3). Other Asian economies will also find
themselves in the midst of population aging in due course. It is a must-face reality which is
just yet-to-come. Looking at Europe, in the Euro-area peripheral countries, immigration
contributed to the expansion of the populations until 2007. Conversely, after the global
financial crisis, the immigration momentum was lost and some countries in the region are
now faced with even some emigration while suffering from lower economic growth owing to
the lower population growth or even because of the declining population.
Rather than trying to cover all of the relevant topics under the theme of demographic
changes and macroeconomic performance in my remark, I focus on Japan's experience of
population aging that, I hope, will help ensuing discussions in this conference, because
Japan can be addressed an "advanced country" in a sense that it has been faced with
various challenges that stem from population aging ahead of other countries. I begin by
explaining demographic changes in Japan briefly, and then move on to identifying the issues
related with macroeconomic performance. Finally, I will touch on the policy implications of
demographic changes.
II. Demographic Changes in Japan
I begin by pointing out four relevant facts in order to consider the linkage between Japanese
demographic changes and macroeconomic performance.
First, in former times, the Japanese population growth rate was high, and the Japanese
working-age population was remarkably large. Today, this may sound way beyond our
imagination. However, in the aftermath of World War II, overpopulation was considered a
challenge to cope with. For example, Japanese emigration to Brazil by sea was restarted in
1952 and continued until 1973. It is usually understood that Japan's period of high-growth
began in the mid-1950s and ended in the early 1970s. The expansion of the working-age
population, in tandem with the free trade regime, provided strong grounds for rapid growth. A
comparison of the Japanese population by age group between the beginning and the end of
the high-growth era clearly points to a rapid increase in the Japanese working-age population
taking place during the period as confirmed by Chart 4 showing a blip moving upward in the
population pyramid. For your reference, the average growth rate of the total population and
the growth rate of the working-age population from 1955 to 1975 were 1.3 percent and
1.9 percent, respectively. A quick cross-country comparison can confirm that Japan's
population and the growth rate of the working-age population in those days were relatively
high, or sometimes even the highest, among the advanced countries.
Second, the rapid pace of decrease in the growth rate of the Japanese population and that of
the working-age population were globally unprecedented. The trend of a population depends
crucially on the birth rate and the death rate (Chart 5). The Japanese total fertility rate
declined substantially after the 1950s, and reached 1.39 in 2010, a lower level compared to
that in other advanced countries. The Japanese death rate also declined substantially after
World War II and reached 6.0 (per thousand persons) in 1979. Then it increased gradually
and reached 9.5 in 2010.
Third, interestingly, the recurrent declines in the total fertility rate have long been regarded as
a one-off aberration for each point in time. Such mis-recognition led to the recurrent
overestimation in the official projection of the fertility rate every five years, which has been
used in the actuarial valuations for the Japanese public pension system, since the year 1976
(Chart 6). In the official projections, the long-run fertility rate have even been assumed to rise
to two in due course until 1992 when the projection was revised downward well below two for
the first time.
Fourth, in addition to the delay in recognition of the ongoing demographic changes,
comprehension of the far-reaching implications of the changes was even more delayed.
Consequently, it took further time for Japanese people to take the measures to respond to
the expected demographic changes. Incidentally, if you look back at 1992, the White Paper
on the National Life Style published by the government that year was titled, "The Advent of
Society with Low Birth Rates: Its Effect and Response." With hindsight, Japan around that
time was painfully looking for ways to recover in the aftermath of the bubble economy. At that
stage, I recall that most Japanese people along with economists did not grasp the gravity of
population aging coupled with a low birth rate for Japan's economy as properly as we later
came to realize. In that regard, for example, a database on Japanese news paper articles
indicates that articles on population aging or a low birth rate started increasing in the 1990s.
However, it was only until in the middle of the 2000s, articles on population aging or a low
birth rate outnumbered those on asset price bubbles or non-performing loans (Chart 7). Up
until around that time, the working-age population had declined for about ten years.
III. Effects of Demographic Change on Japanese Economy
In the light of Japan's experience, I will elaborate on three aspects, first, the economic growth
rate, second, inflation and, third, the current account balance, of the impact of demographic
changes from the viewpoint of macroeconomic performance.
Economic growth rate
At the outset, I pick up the most paramount consequence of demographic changes for the
Japanese economy, among others, that is, the economic growth rate.
The economic growth model supposes that everyone works at a given intensity. With a
labor-augmenting technological change, in the long run steady state, per capita variables
grow at the rate of technological change, and aggregate variables grow at the rate equal to
the sum of population growth and technological change. In aging economies, including
Japan, where the working-age population has started decreasing, the labor force also
declines, given the participation rate being held constant. Because the scarce labor force
imposes a natural constraint on labor supply, the marginal product of capital declines
accordingly. As a result, macroeconomic growth would be impeded. With this idea in mind,
the Japanese economic data in the past decade indicates that the workforce declined by
0.3 percent point, labor productivity increased by 0.8 percent point, and they add up to real
GDP growth rate increase by 0.6 percent1 (Chart 8). Having said that, while such an analysis
would provide a useful first-order approximation to consider the effects of population aging
and the declining population, for the sake of policy consideration, we need slightly more
realistic approaches that incorporate other factors.
The first factor is the possibility that labor participation may adjust to the demographic
changes in the long run. For example, the labor participation rate of Japanese females was
notably lower than that in other advanced countries. In particular, Japanese females in their
30s participate in the labor market noticeably less, which was creating a stark M-shaped
curve in the participation ratio over ages in the past and in the present as well. However, the
gap between Japan and other advanced countries in the depth of a dip on the M-shape is
dissipating in recent years (Chart 9).
The second effect comes from the gap between the per capita growth rate and the growth
rate per working-age population. The economic growth model by Solow supposes that a
nation's population coincides with that nation's labor force. In practice, as population aging
advances, the gap between the population and the labor force grows larger. In the process of
an increase in the share of the old non-working population, the per capita growth rate would
be lower than the growth rate per working-age population. The growth rate per working-age
population is important from a viewpoint of the supply capacity; however, the growth rate per
capita is a more important indicator when we think about the income level of an average
consumer who supports aggregate demand for goods and services in the macroeconomy.
Even if the growth rate per working-age population is high, as long as the per capita growth
rate is decreasing, downward pressure to demand could impede macroeconomic growth.
Third, we may need to consider the so-called "spending wave" hypothesis (Chart 10). For
one reason, the Japanese asset price bubble was caused by Japanese baby boomers who
experienced their peak spending years, particularly, for mortgages. During the bubble period,
they indeed actively purchased their homes. Likewise, demographic changes, among other
factors, were highly responsible for the decrease in domestic car sales after the late 1990s.
On the other hand, the progress in population aging means that the elderly increase demand
for services, such as medical and nursing care. Currently, the population aged 60 years or
older accounts for around 40% of Japanese consumption. Their shares in the Japanese
consumption are projected to increase further. If Japanese firms change their products in
responding to such increase in the potential demand, their efforts should slow the reductions
in the potential growth rate.
The fourth factor arising from demographic changes could come into play through fiscal
balance (Chart 11). Rapid population aging is the dominant factor in increasing a fiscal
deficit. Obviously, the continued population aging increase a fiscal deficit through the
decrease in the growth rate of tax revenues reflecting the decrease in the economic growth
rate and through the increase in the social security related expenditure, such as medical
services, nursing services and public pension. If the uncertainty regarding the future fiscal
balance increased, that could restrain the consumption by working-age generations.
Demographic changes also affect fiscal balance through a political process. Population aging
will necessarily mean the aging of voters. If the elderly have a higher voting percentage
compared with the young, and if the elderly have a stronger preference for sustaining the
current social security system, then a fiscal deficit tends to increase reflecting the elderly's
preference.
Fifth, demographic changes may affect the portfolio selection of households (Chart 12).
Especially, we need to examine the effects of an increase in the number of elderly people on
the selection of households' financial assets, from a viewpoint of who and how to supply risk
money, which is an indispensible engine for economic growth. However, the determinants of
households' financial asset portfolio include not only age, but also labor income. Moreover,
households choose their asset portfolio while making decisions on their housing purchases
simultaneously. We do not have empirical studies based on Japanese micro-data enough to
answer the following questions, such as, all else being equal, whether the elderly prefer
stocks or whether they tend to sell their stocks and buy into the bond market for safer
assets.2 Looking ahead, further studies on that area are much awaited.
So far, my analyses focus on the effects of demographic changes on macroeconomic
performance of the Japanese economy as a whole. In practice, demographic changes, such
as population aging or a low birth rate, advance unevenly across regions. For example, the
population growth rate, the working-age population and the share of the population aged
65 years or older vary substantially from region to region (Chart 13). Behind the dispersion in
prefectural growth rates, regional fiscal balances and the strategies of financial institutions lie
uneven developments in demographic changes across prefectures.
Rate of price increase
Next, I elaborate on the linkage between demographic changes and deflation from a
viewpoint of macroeconomic performance. Seemingly, there would be no linkage between
demography and deflation. But it may not be the case. A cross-country comparison among
advanced economies reveals intriguing evidence: Over the decade of the 2000s, the
population growth rate and inflation correlate positively across 24 advanced economies
(Chart 14).3 That finding shows a sharp contrast with the recently waning correlation between
money growth and inflation (Chart 15).4 How could we square those facts with each other?
To some extent, the correlation between population growth and inflation could in part be
explained by the co-movement caused by business cycles. In some advanced economies in
Europe and North America, it could be the case that the fluctuations in economic activity
would vary the size of an output gap, creating pressure up or down on inflation while
attracting or discouraging immigration that amplifies variations in population. That
hypothesis, however, appears to be impertinent in some countries including Japan where the
impact of immigration on the total population is extremely small and thus can be disregarded.
On that ground, business cycle fluctuations have had a minimal impact on demographic
changes. A closer look at the case of Japan confirms the increasingly positive correlation
between inflation and population growth since the 1990s (Chart 16). That would reflect the
momentum towards real income creation being undermined by population aging.
As I have discussed, repercussions of the bubble-burst, the rapid aging and stagnation of
productivity have been underway in Japan. Against the backdrop, the real per capita GDP
growth rate has remarkably declined from somewhere around four percent back in the 1980s
to almost one percent these days (Chart 17). With the yet-to-accelerate population aging well
envisaged for the foreseeable future, the decline in the real GDP growth rate could
undermine the medium- to long-term expectations for potential growth, giving rise to a lower
permanent income of households.
The decrease in potential growth, which effectively means a stagnant supply capacity, gives
rise to a lower permanent income. On the flip side, the corresponding contraction in
aggregate supply would offset such decline in aggregate demand. Simultaneous changes in
aggregate demand and aggregate supply keep the price level unchanged. I reemphasize the
fact, however, that the public had long remained by and large unaware of the dangers
created by demographic changes but, over time, the awareness has slowly been phased in.
Along with such gradually phased-in public awareness, yet-to-materialize declines in GDP
growth have also been factored in, precipitating today's decrease in aggregate demand and
all the forward-looking responses have come into play behind Japan's deflation.5
In the meantime, the real per capita GDP growth rate in most of American and European
advanced economies has declined to Japan's neighborhood range (Chart 17).
Looking ahead, aging and the declining working-age population are expected to continue in
those American and European countries. I cannot entirely rule out the looming menace that
may unveil itself into downward pressure on inflation rates if such demographic changes are
to undermine the momentum toward income creation in the economy.
Current account
The final issue that I am taking up from a viewpoint of macroeconomic performance and the
demographic changes is the current account. Some argue that, as signaled by the swing to a
deficit of the Japanese trade balance in fiscal year 2011, the current account balance will
also turn into deficit over time (Chart 18). I disagree with such views.
The swing to a deficit in the trade balance reflected the declines in exports and increases in
imports, both of which are driven by temporary factors: Exports subsided resulting from the
disruption to the supply chains due to the Great East Japan Earthquake. The sharp increase
in imports of liquefied natural gas and other fossil fuels was needed to meet the increased
demand from thermal power plants, which substituted nuclear power lost by the accident.
In general, the current account broadly reflects the savings-investment balance of the
economy. On one hand, as for savings, a higher elderly population share in the economy
would reduce the aggregate savings rate as a life-cycle model indicates. On the other hand,
population aging affects investment at least through two channels. First, if a decrease in the
labor force substitutes for capital, domestic investment could increase. Second, a decrease
in domestic demand due to the declining population reduces domestic investment. If
population aging shifts consumption towards the service industry where firms find it hard to
substitute labor for capital, the second effect will dominate the first effect. Anyway, the
Japanese income balance recorded 12.4 trillion yen, or 2.5 percent of nominal GDP on
average from the year 2002 to year 2011, which reflects the net international investment
position of 253 trillion yen as of the end of 2011, or more than 50% of nominal GDP. Those
figures suggest that the Japanese current account surplus will continue for the time being.
IV. Can Japan Respond to Demographic Changes?
Demographic changes have affected the Japanese economy slowly but steadily and
profoundly. Downward pressure on the Japanese economic growth rate resulting from
various channels reflecting the continuing population aging will persist in the foreseeable
future. With the pressure underway, should we live with the dwindling economy and quietly
accept it as the fate that we cannot escape? My answer is definitely no. The effects of
population aging on an economy can vary, depending on the flexibility of that nation's
economy and society. The current difficulties come not from the continued population aging
itself, but from the delayed response to it. On that ground, I emphasize that, if society
correctly recognizes the challenges coming from demographic changes, and if society judges
that changes in the systems are needed, we should find remedies in our hands. I offer a
couple of options for possible changes if Japanese people are determined to take action.
The first option is to make various efforts to increase the labor force. Setting aside the issues
that go beyond the mandate of a central bank governor, for example, whether to accept more
foreign workers, we can increase the labor force by raising the birth rate and/or the labor
participation rate. Interestingly, labor participation of female workers and the birth rate have a
positive relationship, according to a cross-country data analysis. Among 47 Japanese
prefectures, labor participation of females aged from 30 to 44 and the birth rate have a
positive relationship (Chart 19). Recently, labor participation of Japanese female and elderly
workers increased steadily. Efforts to increase the labor force have already started and some
progress has been made (Chart 20).
The second option is to adjust the supply-side structure with the ongoing changes in line with
the demand pattern. Typical examples on the domestic front include the response to the
potential demand from the elderly, such as medical and nursing services (Chart 21). In the
last decade, the population of aged 65 or over increased 33 percent in Japan and 16 percent
in the U.S. During the same period, spending on medical and nursing services increased
11 percent in Japan and 74 percent in the U.S. Those figures suggest the large potential
demand not only in the market of medical and nursing services but also in medical
equipment and other related investments in Japan.
Third, businesses should respond to the growing demand overseas by making the most of
the momentum towards globalization. If the Japanese economy is a "closed economy,"
Japan will not be able to avoid all the repercussions of the decreasing population. However,
Japanese businesses can grow by meeting the demand overseas, especially in economies
with higher population growth or in fast-growing emerging economies. One option to meet
the foreign demand is exports, while other options may include, for example, bolstering
foreign direct investment by Japanese businesses in pursuit of higher profitability which
would result in a surplus in the income balance. The real GDP increased by 0.6 percent
annually on average in the 2000s while, the real GNI excluding the terms of trade
gains/losses, an indicator comparable to the real GDP, grew more rapidly by 0.7 percent
(Chart 22). Of related matters, the ratio of Japanese foreign direct investment is notably
lower than that in other advanced countries. Room for increasing the ratio would be
substantial (Chart 23). Increases in the income balance surplus may require a renewed focus
on GNI, which summarizes the income earned by Japanese people. Finally, businesses can
better reallocate their capital in line with the aforementioned three options to raise
productivity. I have already referred to the growth rate of Japanese labor productivity, and
now I point out that the level of labor productivity is lower than that in other advanced
countries (Chart 24). Put differently, per capita income could increase substantially if
businesses reallocate their capital to be better aligned with the efficient allocations.
V. Concluding Remarks
I have explained how demographic changes affect the Japanese economy through various
channels. In retrospect, up until the global credit bubble-burst, both academics and policy
makers did not fully appreciate the significance of a bubble-burst. The Japanese experience
of a bubble-burst tended to be underestimated as an idiosyncratic episode. Likewise,
bystanders' apprehension about the ongoing demographic changes in Japan may, I fear, be
falling short of the mark. My sense is that full apprehension of the consequences of rapid
population aging, coupled with the low birth rate, is yet to be seen in light of the importance
of the issue. Economics has dealt with the issue of population, not to mention a few
examples such as, Petty's Political Arithmetic or Malthus's An Essay on the Principle of
Population. For the sake of economic policy formulation, basic research on demographic
changes and their policy implications is indispensable. I hope that this conference would help
contribute to the accumulation of such research. Thank you.
References
Fujiki, Hiroshi, Naohisa Hirakata and Etsuro Shioji, "Aging and Household Stockholdings:
Evidence from Japanese Household Survey Data," paper presented in this conference.
Katagiri, Mitsuru, "Economic Consequences of Population Aging in Japan: Effects through
Changes in Demand Structure," Discussion Paper Series 2012-E-3, Bank of Japan, Institute
for Monetary and Economic Studies, 2012.
Kimura, Takeshi, Takeshi Shimatani, Kenichi Sakura, and Tomoaki Nishida, "The Role of
Money and Growth Expectations in Price Determination Mechanism," Bank of Japan Working
Paper No.10-E-11, Bank of Japan, 2010.
Shirakawa, Masaaki, "Globalization and Population Aging: Challenges Facing Japan,"
Speech to the Board of Councillors of Nippon Keidanren (Japan Business Federation) in
Tokyo, 2011.
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