How Does Japan’s Aging Society Affect Its Economy?

Japan, the world’s third largest economy, is experiencing the issue of population aging to an unprecedented degree. More than 20 percent of Japan’s population is over 65 years old, the highest proportion in the world. By 2030, one in every three people will be 65 or older, and one in five people will be 75 or older. The rapid aging process in Japan is striking because of the high rate of economic growth and changes in family and social structures in the post-war period.

The decline in Japan’s fertility rate has been attributed to several factors such as changing lifestyles, people marrying later in life or not marrying at all, and the economic insecurity of younger generations. Increasing life expectancy is another driving force behind the aging trend. Fifty years ago, life expectancy at birth was about 72 years; it has since climbed to 84 years.

There are two fundamental aspects behind Japan’s aging population. One aspect is the increase in the proportion of the elderly in the total population. The other is the slower growth of the population, arising directly from the declining fertility rate. The former affects Japan’s economic performance by increasing the social security burden. The latter has a direct impact on economic growth by reducing the labor force, which is a major factor in production. “A rapidly aging population and shrinking labour force are hampering growth,” warned the IMF in its latest country report on Japan. The IMF also calculated that the impact of aging could drag down Japan’s average annual GDP growth by 1 percentage point over the next three decades.

The causal effect of aging is leaving its mark on the macroeconomy of Japan, especially the labor force and capital accumulation. Due to the nation’s aging and shrinking population, there is an increased need to address the labor shortage. People eventually retire and leave the workforce as they start aging, and at present, there are not enough young people in Japan to fill this vacuum owing to the decline in the fertility rate as well. This further implies that some of Japan’s big industries – like motor vehicles and electronics – do not possess the manpower to continue at the current level of production. If Japan cannot maintain its levels of production, it may subsequently lose its spot as the third largest economy in the world.

The issue of aging is also likely to make untenable the seniority system among the labor force, in which wages increase in proportion to length of service with a company. This leads to fewer promotion opportunities and also damages workers’ morale. Due to a decrease in the working age population, Japan also hopes to see higher female labor force participation under tightening labor market conditions. Prime Minister Shinzo Abe is currently pursuing such a path, which has been called “Womenomics,” where companies are pressured and incentivized to hire more women and give more leadership positions to women.

As Japan’s population is aging, the Abe administration finds it difficult to balance its conservative views on immigration with the need for younger and skilled workers to boost the Japanese economy. Therefore, the nation came up with the idea of allowing more foreign workers in a controlled manner. A new regulation that came into effect in April 2019 created two residence/visa status types for foreign individuals working in sectors that are suffering from labor shortages. However, the impact of the 2019 amendment to the Immigration Act cannot be assessed easily. It is important to keep in mind that the countries targeted as possible sources of labor for Japan will also face their own labor shortages, especially in the caregiving sector, in the near future.

A study by the UN Population Division released in 2000 found that Japan would need to raise its retirement age to 77 to maintain its worker-to-retiree ratio. Currently, retirees are largely well off and are reaping the fruits of a long and laborious life. However, it is unlikely that the benefits they enjoy now can be sustained for future generations. Aggravating the growing labor force shortage are the rising expenses associated with aging, like caregiving needs for the ill and the fact that older people will require extra medication and hospitalization.

Abe’s administration has also vowed to tackle this crisis by taking steps to support young couples in raising children, for instance, making preschool education free. His government has set a target of increasing the fertility rate back to 1.8 by 2025 – a goal unlikely to be achieved so soon, given that the rate was just 1.43 in 2017.

The government should pursue structural and labor reforms, which will aim at increasing the nation’s productivity despite the declining labor force supply. More elderly people and women should be encouraged to play active roles in the labor force.

Healthier individuals are better able to work longer and with more energy, which suggests that protecting older individuals’ health will intensify their productivity and labor force participation. In addition to savings in healthcare costs, effective health promotion programs will therefore lead to gains in productive labor hours and output. A healthy population will also lead to higher savings rates, lower medical expenses, and increased foreign direct investment. The government has also come up with an idea of making Japan an “age-free society” in which people 65 and older will not be considered senior citizens and will rather be encouraged to stay healthy and keep working.

The 2019 Revision of World Population Prospects, released in June 2019, predicts the proportion of people aged 65 years and older in Japan will increase from the current level of 28 percent to 38 percent by 2050. Although the rapid aging of the population is a major challenge to the Japanese economy, its negative impacts on savings and investment can be largely reduced by stimulating labor-augmenting technological change and extending the working life of the elderly.