May 18, 2016 9:00 pm JST
Commentary

Leslie Young -- Abe's quiver needs Cupid's arrow

Japan's birth rate has been low for many years, while life expectancy has been high. The result is a demographic structure that is fantastically skewed. This is best conveyed by the statistic that sales of diapers for incontinent older people now exceed sales for babies.

Piled onto this well-known problem are two others: many younger Japanese women are not getting married, and a significant number of young Japanese, especially men, are hiding for years -- even decades -- in their bedrooms, refusing to see even their parents, who leave meals outside their doors. Hikikomori, as the Japanese call it, is thought by sociologists to affect up to 1 million young men.

These sociological peculiarities have severe economic consequences. When an economy's population ages and declines, it needs less of everything. This problem is exacerbated in advanced economies, which produce consumer goods via roundabout processes, using machines that are produced by other machines, as well as requiring infrastructure (railways, roads, bridges and power stations) that is produced in the same way. These first, or "younger," stages of production are designed to mature slowly into consumption goods through later processing.

Through heavy investment by earlier generations Japan has built up a large stock of industrial capital and infrastructure -- in other words it has a relatively "youthful" industrial structure with a lot of physical capital in forms that will be helping to produce consumer goods for many years to come. When the population stabilizes, and then declines, there will be less demand, not only for consumption goods, but also for capital goods and infrastructure.

These younger stages of production will eventually have to be scaled down in proportion to the reduction in demand for consumption goods. Meantime, there is little demand for workers in the younger industries. This leads to economic stagnation.

Japan's fundamental economic problem is this discrepancy between its human and its industrial demography: an undersupply of young workers and an oversupply of the means for completing the younger stages of production.

This problem is exacerbated by the demographic ageing process. Many older people with very long life expectancies are trying to eke out their retirement savings by drastically cutting back their daily consumption. The reduction in the number of Japanese getting married and leaving home to start new households has greatly reduced the demand for apartments, furniture, household appliances and so on.

The resultant reduction in the number of children means there is falling demand for infant food and clothing, schools, teachers and universities. China and South Korea also have low birth rates and will eventually face the same problems as Japan.

Past attempts to stimulate the Japanese economy through fiscal policy increased state funding for infrastructure and encouraged industrial companies to invest. But Japan already has too much infrastructure and industrial capital, so this process has piled up debt, but not the capacity to service it.

It was to alleviate this debt that Prime Minister Shinzo Abe imposed a consumption tax. However, the tax has reduced consumer demand, exacerbating the country's economic problems.

Balance sheet

As a whole, economies save -- that is, provide for future consumption -- by building up their capital stock at home and/or their claims on other countries by holding their financial assets. Financial systems issue instruments such as bank deposits, bonds and equities that allow populations to hold capital stock indirectly in the form of financial claims. Young workers accumulate these indirect claims on capital stock when they work and save. Then they fund their retirement by selling off their financial assets to younger generations of workers.

In Japan, the ratio of younger workers has been falling, which reduces overall demand for the economy's physical capital, so its price has tended to fall, entrenching deflation. The physical capital was financed using debt issued by financial institutions, so their balance sheets come under pressure as the collateral backing this debt falls in value. This has led these institutions to reduce debt issuance to fund new investment. As the economist Richard Koo has pointed out, this analysis suggests that Japan's economic stagnation is the result of a balance sheet problem.

Inflation could alleviate this problem by raising the purchasing power of younger generations of workers relative to retired workers, effectively expropriating the assets of the latter, but stimulating the economy. Japan's central bank is trying to engineer inflation by expanding the money supply.

However, this has not halted deflation because the additional money is created through injection into the financial system. Unfortunately, the money is either staying there, creating asset inflation without stimulating the economy, or heading abroad to be invested in financial assets overseas.

To combat deflation, the answer is to inject money directly into consumer budgets, not through the financial system, while remaining aware that monetary stimulation will eventually lose its effectiveness in an economy that is open to international capital flows.

Another lesson is that the state needs to focus on ensuring a sustainable demographic structure. In particular, working women should be encouraged to have more children, for example by making workplaces child-friendly, with creches and supervised play areas for children after school. Such measures have enabled Sweden to maintain high female participation in the workforce alongside quite high fertility rates.

Abenomics, the program of reforms introduced by the prime minister to address Japan's growth problems, has three "arrows" -- fiscal stimulus, money creation and economic restructuring. The first two arrows do nothing to address the fundamental imbalance between the demographic structure of Japan's population and its industry.

The third can help do so, for example by increasing the participation of older people and women in the workforce. But what is really needed is a fourth arrow, namely that of Cupid. What the Japanese really need is more sex and more babies!

Leslie Young is professor of economics at the Cheung Kong Graduate School of Business in Beijing.

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