Meeting Japan’s intertwined challenges of population ageing and high government debt

By Randall Jones and Haruki Seitani, Japan Desk, OECD Economics Department

With faster growth in the past six years, Japan’s real GDP growth in per capita terms has converged toward the OECD average and job creation has been strong. However, labour productivity and per capita income are well below leading OECD economies (Figure 1), while Japan faces challenges of rapid population ageing and high government debt. The 2019 OECD Economic Survey of Japan explores ways to address those challenges.

Japan’s population is projected to decline by one-fifth to around 100 million by 2050, while the elderly population will reach 79% of working-age population, remaining the highest in the OECD. One important challenge of the demographic change is a shrinking labour force. Assuming constant labour market entry and exit rates, Japan’s labour force would drop by a quarter from 67 million to 51 million by 2050 (Figure 2). Reforms of labour policies and practices to remove obstacles and disincentives to work for men and women of all ages would limit the decline in the labour force.

Demographic change is also having a big impact on the fiscal situation. Public social spending doubled from 11% of GDP in 1991 to 22% in 2018, surpassing the OECD average. Twenty-seven consecutive years of budget deficits have driven up gross public debt from 60% of GDP to 226%, the highest ever recorded in the OECD area. Population ageing is projected to raise social spending by another 4.7% of GDP over 2020-60. An illustrative analysis indicates that fiscal consolidation beyond the government’s FY 2025 primary surplus target is necessary to stabilise government debt (Figure 3).

Those challenges are
intertwined. Weak economic growth, due to low productivity and declining labour
force, makes it difficult to ensure fiscal sustainability. Distortions in tax
and benefit systems impede employment, particularly of women and the elderly. Against
this backdrop, the main messages of this Survey
are:

Bold structural reforms, including improved
corporate governance and policies to make small and medium-sized enterprises
more dynamic, are needed to boost productivity and promote inclusive growth as
labour inputs decline.
Fundamental labour market reform is a priority
to enable Japan to make full use of its human resources, thereby mitigating the
impact of a shrinking labour force.
Achieving fiscal sustainability requires a
detailed consolidation plan that includes measures to control spending in the
face of rapid population ageing and gradual hikes in revenue, beginning with
the 2019 consumption tax hike.