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The Impact of Japanese Shrinking Population On Its Economic Growth

Indranil Enkhtuvshin
10 min readJan 27, 2022

Keywords: Population decline of Japan, potential growth rate, labor input, capital inflow, total factor productivity, foreign direct investment

Resource: Reuturs.com
Credit: Reuturs.com

Japan’s declining population is imposing a big risk of irreversible economic stagnation. It is crucial for Japan to find an effective solution to maintaining its economic growth under a shrinking and aging population. In order to study the relations between the population decline and economic growth, the impacts of labor input and capital flow on the economy are analyzed in this paper. The first part of the paper explores what is economic growth and the background of Japan’s fertility rate decline since the 1940s. The second part goes through the population decline’s impact on economic growth. In the last paper, the possible solutions to the problem are presented. The journal articles that were published in the Bank of Japan Working Paper Series and the Cabinet Office of Japan’s 2001–2003 economic reports on the economy under declining population are used to write this paper.

Economic growth is the change in the evaluation of the country’s output of goods and services. Long-term economic growth is determined by the number of workers and their productivity level. Between 2016 and 2050, the world population is estimated to grow by 28%. However, some countries are experiencing a population decline that is so great, which could impose a possible threat to their economic growth. One of the nations with a high declining population rate is Japan, its population is expected to decrease from 128 million to 88 million by 2065. By 2050, only 49% of Japan’s population will join the workforce as opposed to 63% for the rest of the world. Japan’s population is shrinking and it has a strong impact on the national economy. The population decline can either turn into a positive or a negative influence on the economy due to GDP growth relative to the rate of decline in the population. GDP growth rate is calculated by population number times GDP per capita’s equation. As a result of GDP per capita, also known as GDP/person, the labor productivity and individual standard of living are measured. If population decline does not meet up to or be greater than GDP/person, a country’s GDP will decline, termed as economic recession. Therefore, the main measurement of economic growth is not the total GDP of a country, but its GDP per capita (The Economist). Although between the time of 2003–2007 American total GDP growth was greater than Japan’s, its GDP growth per capita was lower. Between 2009–2017, Japan’s population was in decline at 0.9%, however, because of its GDP per capita, the standard of living of a Japanese rose around 13.8%. Despite the fact that Japan’s population was in a 0.9% decline, the total GDP growth was 12.9%. Japan was successful in growing its economy despite the fact that its population is in decline between 2009–2017. However, the big question of “What impacts does population decline have on economic growth in the long-term?” arises.

Fertility-rate decline

Shortly after World War II until the late 1950s, Japan’s fertility rate began to drop steeply. In a decade, the total fertility rate of 1947’s 4.5 children per woman declined to 2.0 children per woman in 1957 (Tsuya 2017). From the mid-1970s, Japan’s birth rate further began to drop. Ever since 2000, the fertility rate of Japan has been “fluctuating between 1.3 and 1.4 children per woman” (Tsuya 2017). In 2008, Japan’s population peaked at 128 million. The fertility rate in Japan, from the beginning of the 1990s, started to fall below 1.5%. As of 2022, the number of children per woman is 1.368 which is a -0.37% decline (Macrotrends 2022). Japan now already has two million fewer people than in 2008 and it has been the biggest population decline since 2013. It is due to COVID-19’s tight border controls resulting in a fall in resident foreigners. The number of people departing Japan surpassed the number of people entering the country. However, there are far more elements that are influencing the population decline than that of foreign residents. According to Sachiko Iijiima and Kazuhito Yokoyama, the major factors that are contributing to the population decline in Japan are “declining marriage rate, an increase in the average age of those getting married, economic burden, childcare burden, later childbearing, and infertility” (Iijiima, Yokoyama 2018). During the first period of Japan’s fertility decline, there were a high number of marriages, but the couples were having fewer children. However, during the 1970s the birth rate declined and the numbers began to drop due to sudden decreases in marriage rates. In Japan, childbearing outside marriage is a very rare phenomenon, so it means that unmarried people are almost never likely to have children. Also, Japan has one of the oldest populations in the world. The elderly population of Japan is rising at a higher rate. As of 2021, “people aged 65 or older accounted for 28.73%” of Japan’s population, which is up 0.32% point from 2020 (Japan Times 2021). A low fertility rate will result in few children, which means in the future there will be “few working-age adults to drive economic growth and support the large proportion of elderly” (Tsuya 2017). The government of Japan is planning to keep the population from declining below 100 million by 2060. However, there is a projection that by 2060 almost 40% of Japan’s population will be elderly and the nation’s population will steadily decline to 87 million. According to Shiro Armstrong, the researcher of Australian National University, “no other country in the world has yet experienced the demographic problem as acute as it is for Japan and the whole world will be watching for lessons’’ (Armstrong 2016).

Population decline’s impact on economic growth

According to the Cabinet Office of Japan’s research on “Prospects of Economic Growth under Aging and Declining Population”, population decline is affecting the economic growth in the following ways: slowing the economic growth, affecting the public sector through a decrease in tax revenues, and discouraging work and business investments. A long-term trend of Japan’s real economic growth rate and the per-capita economic growth rate has been on a downward trend. The average economic growth rate in the 1960s was 10.0%, in the 1970s 4.4%, in the 1980s 4.3%, and in the 1990s 1.3% (Cabinet Office of Japan 2003). In theory, the per-capita economic growth rate should be higher than the aggregative economic growth rate during a population decline, however, this is not the case in Japan. The Cabinet Office of Japan explains the cause of the downturn in economic growth rate to the ‘decline in potential growth rate’, which is “the rate of growth that an economy can sustain over the medium term without generating excess inflation” (Reserve Bank of Australia 2019). In short, the “potential growth rate” reflects Japan’s economic growth capacity from a longer-term perspective (Bank of Japan). During World War II, the potential growth rate stood at above 4%, after the economic bubble of the late 1980s, the rate fell to slightly above 2%. In the report of the recent 2017’s data, the potential growth rate of Japan is at the range of 0.5–1.0 percent (Bank of Japan). The main determinants of economic growth include many factors such as “human resources, natural resources, capital goods and technology” and they can determine the “economy ranging from foreign direct investment to public expenditure, etc.” (Boldeanu and Constantinescu, 330). In order to study the relations between the population decline and economic growth, it is crucial to analyze the changing impacts of labor, capital, and capital stock on the economy under the shrinking population of Japan. The analyses that have been made by the Cabinet Office of Japan on the labor input and capital inflow have all shown that the birth-rate decline is decreasing the main determinants’ contributions to the economic potential growth rate.

Labor input

Population decline will decrease the productive population, in other words, the labor input to economic growth will begin to decline. The productive population is decreasing faster than the total population. Therefore, the shrinking population of Japan poses a risk of “slowing the economic growth through slowing the growth of labor” (Cabinet Office 2003). According to the Cabinet Office of Japan’s statistics, the labor input in the 1980s made an average positive contribution of 0.5%, however, from the 1990s it started to make a negative contribution. In the early 2000s, the negative contribution rate was 0.5%. The decrease in the number of potential workers and drops in working hours are considered to be the reason for the recent years of labor input’s negative contributions. Another reason would be the “slow growth and decrease in the number of productive population that resulted from the fertility rate decline” (Cabinet Office 2003).

Capital Inflow

The positive contribution of capital input has declined from 2% down to 1.5% between the 1980s-1990s. The slow growth of capital stock due to “businesses refraining from business investment due to a decline in their expected growth rate” has been the sole reason for capital input’s decline (Cabinet Office 2003). One of the crucial contributors to the potential growth rate is the growth of capital stock. However, its growth has slowed down because of “the changing economic system responding to a new environment” (Cabinet Office 2003). Therefore, capital stock plays an important role in sustaining economic growth. When it comes to the accumulation of capital, the national savings, and the capital inflow are the main sources. When a nation is experiencing a decline in birth rate and the population is aging, the national savings rate begins to be reduced. According to Maiko Koga’s journal article on the decline of the savings rate of Japan in the Bank of Japan Working Paper Series, Japan’s household saving rate indicated a sharp decline in the 1990s due to the “significant impact of demographic factors” (Koga 2005). Their data shows that there have been two consecutive major shocks in the span of the sharp decline of the national savings rate. The first shock was when the baby boomers, Dankai-generation, had shifted to an older age. The second shock, understood as a permanent shock, was the large increase in households aged 65 and over that has been the result of a declining birth rate. In Japan, the relation between the savings rate and investment rate are almost parallel to each other, except in the 1980s. Therefore, “the investment trend is greatly determined by the trend of domestic savings in Japan” (Cabinet Office 2003).

Solutions

The shift in population does influence economic growth and Japan is experiencing an acute demographic problem that no other country has experienced before. Therefore, Japan should make proactive efforts to ease the negative impacts of a shrinking population on economic growth. According to the Cabinet Office of Japan in 2003, one of the strategies for sustainable economic growth under a declining population is to reallocate the sectors that include low productivity labor force, management resources and capital to higher-productivity sectors by “expanding private sector’s business areas through regulatory reform” (Cabinet Office 2003). Therefore, in order to boost labor productivity, the force participation rates of women and elderly people should grow. It is crucial for Japan to establish a work environment that is friendly to women with children because it is effective to create such an environment because it contributes to the overall factor productivity. If the total factor productivity rate is high, the economy can grow despite the fact that its labor force is decreasing. Also, it is important to increase labor productivity because the positive per-capita can be maintained even if the overall economic growth rate declines. Second, foreign direct investment in Japan is important for economic growth under population decline. In the early 2000s, the ratio of accumulated amounts of foreign direct investment to nominal GDP was standing at 1.2% (Cabinet Office 2003), however, as of September 2021, the average number of foreign direct investments to nominal GDP from 2019 to 2021 was at 0.8% (CEIC 2021). Japan was expecting an increase in foreign direct investment from the 2020 Tokyo Olympics, nonetheless, the pandemic has occurred, leaving Japan to adopt an adaptable policy to increase the foreign direct investment. Therefore, Japan should find a creative and flexible way to overcome the pandemic’s hit on foreign direct investments. Japan should adopt policies that are effective in boosting labor productivity under declining numbers of the labor force and maintaining foreign direct investment under pandemics.

Conclusion
The population decline of Japan is expected to have a negative effect on the economic growth in the long-term by imposing a risk of decline in labor productivity due to the labor shortage and sharp decline in national savings. Labour productivity plays an important role in maintaining the GDP per capita even when the economic growth rate decreases and national savings, which is the capital stock of a nation, is important for attracting foreign direct investments. Pandemic has brought a big hit on Japan’s foreign direct investments and the fertility rate decline that has been going on since the 1940s is now imposing a big risk on the rise of labor shortage. Therefore, Japan should adopt policies that are effective in maintaining foreign direct investment despite the pandemics and create work environments that are suitable for women and the elderly.

Works Cited

Japan
Economy
Demographics
Economic Growth
Japanese Economy

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Indranil Enkhtuvshin

Written by Indranil Enkhtuvshin

32 Followers

International student at Nagoya University’s School of Humanities. I mostly post essays and short-research papers I have written for my assignments. Mongolian.

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