April 29, 2012
The Washington Post has a practice of running a story ever month or so about Japan facing a demographic nightmare because its population is living longer. The idea is that this will impoverish the nation’s youth, imposing a crushing burden for caring of the elderly. Of course those who know arithmetic know better.
This month’s feature began by telling readers:
“The ominous demographics of this aging nation have long been seen by Japanese as a distant concern, not a present-day one. But that mind-set is being called into question by a prime minister who says that a crisis requiring immediate sacrifices has already begun.
In recent months, Prime Minister Yoshihiko Noda has staked his job and bet his support on a tax increase designed to fund Japan’s soaring social security costs.
And the potential tax hike is only a sneak preview of the burdens to come as Japan grows into the world’s grayest society, a nation where two decades from now seniors will outnumber children 15 and younger by nearly 4 to 1.
Economists and government officials say that Japan, in the coming years, will probably raise the retirement age, again increase taxes and trim spending on everything from education to defense, all to care for its elderly.
Young Japanese — those entering the workforce amid two decades of stagnation — will face the greatest burden: They will earn less in real terms than their parents, pay higher pension premiums, receive fewer social services and, eventually, retire with a less-generous pension package.”
Okay, let’s unpack this one a bit. First, by every measure Japan’s economy is operating far below its potential capacity. Why on earth does it need tax increases to pay for anything right now? This makes zero sense.
Japan can simply continue doing what it has been doing, running large deficits and having it central bank finance them by buying up government bonds.
Is there a problem with this? Japan has been seeing deflation for much of the last two decades. The interest rate on 10-year government bonds is hovering near 1.0 percent.
If Prime Minister Noda is arguing that the country needs to raise taxes he either does not understand economics or has a hidden agenda that the Post article did not discuss. In the current economic situation it is quite obvious that there is no need whatsoever to raise taxes. A tax increase would actually hurt the economy by reducing demand and employment.
Let’s consider the longer term issue. According to OECD data, productivity growth in Japan has been increasing at the rate of 1.8 percent a year over the last two decades. If this continues, output per worker will be 150 percent higher in 2050 than it was in 2000.
If the ratio of workers to retirees falls roughly 3 to 1 over this period to roughly 1 to 1, as the article tells us, and the pension system provides Japan’s workers with a pension equal to 50 percent of the income of the average worker (Social Security benefits equal 40 percent of the average wage) then the after Social Security tax wage will be roughly 80 percent higher in 2050 than it is today.
If we look at the issue more closely, this almost certainly understates the likely gains. First, as the work force shrinks productivity growth is likely to accelerate. This would occur for two reasons. First, the least productive jobs (e.g. the midnight shift at the 7-11) will simply go unfilled, thereby raising average productivity.
The other reason is that a smaller population will reduce pressure on the natural environment and infrastructure. If the population declines by 50 percent, then the share of the population who will be able to live in houses with ocean views will double. Also traffic jams will be much less serious, trains will be less crowded and people will have to spend much less time commuting. Some of these gains are likely not to be included in official statistics since they are not designed to pick up these sorts of quality improvements.
Also, it is likely that the share of the population that is employed will increase. This will be both true among the under 65 population, as more women enter the workforce, and also many healthy older Japanese may decide to work later in life. If Japan can achieve that same employment to population ratio among its age 16-64 population as Iceland has today, this pace of productivity growth would allow after-tax living standards to double over the years from 2000-2050.
Finally, the issue about trimming spending on education may seem less of a concern when we remember that the whole story is that number of children in Japan is plummeting. Why wouldn’t Japan trim spending in education. In short, this means that the tax increases needed to fund a larger population of retirees will be in part offset by the lower taxes needed to support a smaller population of children.
In short, there is not really a plausible story whereby a declining population will cause future generations of Japanese to be poorer than the current generation. Of course inept economic management could well bring about this result, but that is a very different story.
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