Broad pessimism evoked by Japan’s shrinking population may be misguided. Takeo Hoshi shows that productivity growth is a far more important determinant of economic growth and that Japan’s demographic handicap may actually be an advantage in encouraging productivity-boosting innovations.

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The year 2018 represents a milestone for many reasons. A decade has passed since the global financial crisis, and it was 20 years ago that massive nonperforming loans led to a banking crisis in Japan. The current imperial era—Heisei—has entered its third decade, and Japan will usher in a new era next year following the abdication of Emperor Akihito.

China launched its reform and opening-up policy four decades ago, and the global protest movement came to a head 50 years ago in 1968. Looking further back, this year represents the 150th anniversary of Japan’s modernization drive, launched by the Meiji Restoration of 1868.

Japan has come a long way over the past century and a half. The country’s population in the early years of the Meiji era (1868—1912) was just 35 million; it grew to 50 million by the Taisho era (1912—26), increased to 60 million during Showa (1926—89), and topped 100 million in 1967. Today, it has reached 127 million.

Per capita gross domestic product at the start of Meiji was around $750 (in 1990 prices, adjusted for purchasing power parity and consumer price inflation) and doubled to $1,500 in 1916. It doubled again to $3,000 in 1957—despite the shock of World War II—and swelled to over $20,000 by the mid-1990s, buoyed by the Japanese economic miracle.[1]

The population began to decline during the first decade of the new millennium, and it is forecast to dip below 100 million by 2050. If the trend continues, the number of people in Japan will plummet to 50 million—the same level as during the Taisho era—by 2115.

The peaking of the population has been accompanied by economic stagnation. While Abenomics has succeeded in checking the free fall, with GDP growth most likely having rebounded to nearly 2% in 2017, most economists believe the expansion will be short-lived.

How will an aging, dwindling population affect Japan’s future growth? Will population decline inevitably drag the economy down with it and cause the country to disappear? My conclusion, as I will explain below, is far from pessimistic. In fact, a smaller, older populace—rather than inviting demise—can actually become a source of new economic vigor.

Components of Growth

In thinking about how population decline affects economic activity, it is useful to examine each of the three factors that contribute to GDP growth, namely, the growth rates for population, labor participation (the labor force as a percentage of the total population), and productivity (output divided by labor force). The economic growth rate is the sum of these three components.

The table below gives the figures for these components from 1956 to 2015. Clearly, there has been a significant dampening of economic growth over the past six decades. The economy expanded by around 8% during the 1950s and 1960s before leveling off to 3%—4% in the mid-1970s and slowing further to around 1% since the mid-1990s.

Population and Productivity as Factors Contributing to Economic Expansion

(% growth)

Even during the period of high economic growth, higher population (the sum of the figures for “population” and “labor participation”) directly contributed only 1 to 1.5 percentage points. The remaining 7 points or so came from gains in productivity. The growth rate dwindled substantially between 1976 and 1995, but increases in the labor force and total population remained largely unchanged during those two decades.

Demographic factors began contributing negatively to GDP growth from the late 1990s, although by less than 0.1 point. More noticeable was the substantial slowdown in productivity growth during the two “lost decades” of economic stagnation in Japan.

These figures reveal that population growth was not, in fact, a major contributor to the Japanese “miracle.” At the same time, they suggest that there is no need to be overly anxious about the dwindling and aging of the population today. These demographic trends will hamper economic growth, to be sure, but the challenges they present will by no means be insurmountable.

After all, productivity growth played a far bigger role in determining economic growth—both during the high-growth years and the subsequent slump—than demographic factors. Population growth is not necessary for robust economic growth, and neither will a shrinking populace doom the nation to stagnancy.

The “Problem” of Overpopulation

In fact, it was only recently that a dwindling population came to be seen as constraining growth. An editorial carried by the Yomiuri Shimbun 70 years ago on September 14, 1948—when the population topped 80 million—offers interesting insights into how the “population problem” was perceived at that time.

The “problem” being discussed then was one of overpopulation. The editorial claimed that a burgeoning population far in excess of the 50 million considered “appropriate” for Japan’s land area and topography was the biggest factor behind Japan’s aggression. Now that the population had bulged to an unprecedented level of 80 million, the editorial called on policymakers to address the fundamental causes behind the “irrational” and “irresponsible” choices families are making to have more children, to prevent Japan from making the same mistake again,

Even with a population of just 80 million, the primary demographic challenge at the time was considered one of overpopulation. Since then, Japan experienced a period of high economic growth, enabling the country to not only sustain a population of that size but to allow over 100 million people to lead affluent lives.

It was not population growth that triggered an economic boom but vice versa; a prosperous economy created the conditions enabling a larger population. In this regard, it should be clear that the prosperity we enjoy today in Japan can reasonably be sustained even with moderate improvements in productivity.

Japan’s shrinking, aging population is simply being made a scapegoat for a slumping economy. Of far greater significance in expanding the economy is a boost in productivity, which will require the unleashing of private-sector dynamism through deregulation and other economic reforms.

What will such reforms look like? While I will not go into details, my 2013 book, “Why Did Japan Stop Growing: Policy Options for Japan’s Revival” (in Japanese), [2] co-authored with Anil Kashyap of the University of Chicago, points to the need to inject new vigor into the economy through deregulation, liberalization, and the repeal of policies preventing healthy competition (masquerading as social safety nets) and to allow businesses to more quickly embrace innovative ideas and new technologies.

The demographic challenges facing Japan should not be seen as a drag on the economy; in fact, they may even become an impetus for growth, unleashing innovations that bolster productivity.

For example, the Bank of Japan’s Outlook for Economic Activity and Prices published in July 2017 reports that industries facing the biggest shortage of workers were the ones most actively investing in labor-saving information technologies. It would not be surprising, therefore, for an economy with a plummeting working population to turn most aggressively to investments that boost productivity.

With artificial intelligence expected to displace human workers in the near future, a declining population can actually be considered good news, as it facilities the bold introduction of technologies with the potential to induce fresh growth.

So instead of nervously eyeing Japan’s demography with a sense of foreboding, we should look upon our aging, shrinking population as a blessing that will improve—not hurt—our chances of leading the world in the productivity revolution.

Translated from “Jinko-gen, koreika iiwake ni sezu,” Keizai Kyoshitsu, Nihon Keizai Shimbun , January 9, 2018. Courtesy of Nikkei Inc.

[1] Figures calculated by British economist Angus Maddison.
[2] The book is based on two reports (in English) by the same authors, published as policy reports by the Nippon Institute for Research Advancement: “Why Did Japan Stop Growing?” (January 2011) and “Policy Options for Japan’s Revival” (June 2012).