Japan’s economy is doomed by the irreversible forces of its demographics. It is a simple observation that a decline in the population of a country causes its economy to contract. In Japan’s case, that contraction is advanced by the way the working-age population is declining (by aging), by the debt burden of the nation, and by changes in the competitiveness of the world around it. Simple economic analysis leads to the conclusion that Japan is destined to suffer declining prices as it contracts.
We can predict with confidence that Japan’s economy will contract and that prices will fall for at least the next 15 years. Investors who have been betting on Japanese stocks cannot bet on long-run growth of the companies they are buying, or on increasing profits.
We recognize that up until Thursday’s sharp selloff in Japanese equities, the bet on the Nikkei had paid off handsomely for those brave enough to go there. However, we believe that the surge of equity prices in Japan in the past several months was a short-term pop that cannot be sustained by fundamentals for very long. Abenomics cannot defeat demographic doom.
Demographics of Doom, explained
The National Institute of Population and Social Security Research projects that Japan’s working-age population will decline over the next 17 years, to 67.7 million people by 2030 from 81.7 million in 2010. We select 2030 as the endpoint of today’s discussion because almost all the people who will be in the working-age population by 2030, 17 years from now, have been born already. Immigration and emigration are trivial. The 17-per-cent decline in the working-age population is a certainty, not a forecast. It averages out to a decline of 0.9 per cent a year. In addition, these official projections show a rise in the population aged over 64 to 36.9 million in 2030 from 29.5 million in 2010. If the labour-force participation rate stays constant, we estimate the number of people seeking work in the economy will fall to 56.5 million by 2030 from 65.5 million today and 66 million in 2010.
What happens when a nation’s population declines and the proportion of working-age people decreases? In the first, simplest, level of analysis, the production potential of the economy declines: Fewer workers can produce fewer goods. This does not mean GDP must decline; productivity gains could offset a decline in the labour force. Also, an increase in the labour-force participation rate could mute the effect of a declining working-age population. However, even if the labour force participation rate were to rise to 100 per cent by 2030 from 81 per cent today (which it cannot, because some people have to care for the old and the young, and some are disabled or lack adequate skills or education), there would be fewer workers available in 2030 than there are today.
With fewer people working, the burden of servicing the public-sector debt will be higher for each individual worker. We project that the debt-to-GDP ratio and the debt-per-worker ratio will grow unabated over the next 17 years and beyond. Also, the rise of the ratio of retired workers to 32 per cent of the population from 23 per cent means that people who are still working in 2030 will have to give up a rising share of their income to support retirees. The disposable income of the declining number of workers will fall faster than the decline of production and employment. Overall demand of workers will decrease – with their disposable income – faster than output for the next 17 years at least. Demand will also fall as new retirees spend less than in their earning years.
Based on demographic factors alone, the decline of aggregate demand between now and 2030 will exceed the decline of output, creating persistent and widening excess capacity in the economy. Prices must fall in an economy where slack is steadily increasing. In addition, advancing technology will likely increase output per worker in the future. With overall demand and output falling, productivity gains will lower labour costs and add to downward pressure on prices. Disinflation and deflation are the companions of demographic decline.
With the public-sector debt service burden absorbing an increasing amount of declining private savings, and with more of those savings being used to support the aging population, savings available to fund investment are declining. In any case, who needs to build more factories or invest to raise productivity to make fewer goods and services for a shrinking population? Investment, already falling for the past 15 years, will drop more in the years ahead.
Why did the Nikkei rally so much?
We believe that a rush of domestic cash out of the Japanese government bond (JGB) market is behind the Nikkei’s rise since Japan’s December election. Prime Minister Abe and Bank of Japan Governor Kuroda have pledged to “do whatever it takes” to achieve 2 per cent inflation in two years. If you believe that, then JGB yields are unsustainable even at present levels. Marginal money will stay away from bonds, and some private investors – and most foreigners – will move cash out of fixed income anticipating that bond yields must rise. With the return on cash negligible, money will go to work either in equities or abroad. So domestic cash flows induced by official efforts to end deflation boosted the Nikkei, trashed bonds and weakened the yen – temporarily.
On our outlook, the 23-year decline in the Nikkei – it is still down 62 per cent from its December, 1989 high – will extend. Neither Abenomics nor the Bank of Japan’s QQME policy can defeat this: Demographics doom Japan to dismal deflation and economic depression. This is no place to bet on equities in the long term.
Carl Weinberg is the founder and chief economist of High Frequency Economics, an independent economic research firm based in Valhalla, N.Y. www.hifreqecon.com