Can Japan Avoid Long-Term Economic Decline?

For nearly 50 years in the wake of the devastation of the Second World War, Japan’s economy was the envy of the world, rising from the ashes to become the world’s wealthiest large economy by the early years of the 1990s.  However, Japan’s economic miracle came to a crashing halt in the early 1990s and, for the past 25 years, Japan has been mired in a prolonged period of stagnation and decline.  Since 1992, the Japanese economy has expanded by just 0.8% per year, one of the worst performances of any economy around the world during that period.  Two main factors have contributed to this long-term stagnation.  First, Japan’s demographic situation has changed dramatically since the decades following the Second World War and today, Japan has a population that is both shrinking and becoming much older.  Second, the rise of rival Asian export-based economies such as South Korea, China and Southeast East has reduced or eliminated the domination that Japanese manufacturers once enjoyed in many of the world’s leading export markets.  Now, the question is, can the Japanese economy pull out of its 25-year-long slump, or is stagnation and decline inevitable for the world’s third-largest economy.

After a series of economic stimulus measures raised Japanese economic growth to 1.7% in 2012 and 1.4% in 2013, there were hopes that Japan was on the path towards more consistently high rates of economic growth.  However, over the past three years, the Japanese economy has grown by an average of just 0.5% per year.  In 2016, the Japanese economy expanded by 1.0%, its best performance since 2013.  However, growth slowed consistently over the course of the year, suggesting that 2017 will be yet another difficult year for Japan.  On a positive side, export growth accelerated last year, boosted by a weaker yen and stronger demand in key export markets such as the United States, China and Europe.  Moreover, the government of Prime Minister Shinzo Abe has continued with its efforts to stimulate economic growth in Japan, boosting government spending in recent months in order to offset the drag on the economy caused by the fact that Japan’s domestic market was shrinking along with its overall population.

There is no question that demography will continue to play a massive role in the future of the Japanese economy.  In fact, no other large economy faces such a daunting demographic challenge as Japan.  Earlier this decade, the total population of Japan peaked at 128 million, double the number of people that lived in Japan just before the Second World War.  However, in recent decades, Japan has had one of the world’s lowest birth rates and has accepted almost no immigration, resulting in Japan’s population beginning to shrink in recent years.  In fact, by the year 2050, the total population of Japan is forecast to have declined to just 97 million, a figure that represents a 25% decline from the country’s current population.  Moreover, Japan’s working-age population is forecast to decline from 76 million today to just 50 million by the year 2050, a decline of 34%.  Not only will this result in a dramatic decline in the number of workers in Japan, but it will also result in a remarkable shrinking of the country’s domestic market.  This will leave Japan ever-more dependent upon exports as a means of generating economic growth, but labor shortages will significantly reduce Japan’s export competitiveness. 

With Japan’s population continuing to decline, and with competition for export markets becoming increasingly fierce, Japan will find it difficult to generate significant levels of economic growth in the coming years and decades.  At present, Japan’s growth ceiling (the rate at which Japan’s economy can grow before overheating) has fallen to just 1.5%, the lowest of any large economy in the world.  In the coming decades, this might fall all the way to 0%, meaning that Japan will be condemned to a prolonged period of economic decline.  Already, we have seen many examples of this decline, such as the significant fall in comparative wealth levels of Japanese consumers and Japan’s loss of export competitiveness vis-à-vis both its emerging markets and developed economy rivals.  With Japan’s economic outlook deteriorating, Japan’s geopolitical situation will be undermined, as it has been the success of the Japanese economy that has been the leading pillar of its geopolitical strength in East Asia for the past 125 years.  Moreover, Japan’s dire situation serves as a strong warning for other major economies that are also facing demographic-induced declines, including Europe and even China.