What would the future be like, if the population around you slowly shrank by 25% in the next 35-years? This is what confronts the youth in Japan, where the Health Ministry in Tokyo has released forecasts showing the country’s population falling from 127 million today to 95 million by 2050 (Exhibit a). Look around you and imagine 1-in-4 people gone. How has this happened? The math is quite simple, sadly. In 2014, 1.001 million people were born in Japan and 1.269 million people died, leaving the country with 268,000 fewer people. What we are witnessing unfold today in Japan is a function of the country’s long-term fertility rate that has fallen from the 2.1 replacement rate in 1970, when 2 million were born, to 1.4 in 2014, which produced half as many births. The net result is that Japan is aging rapidly; the population over the age of 70 is expected to rise from 20 million today (16% of total) to 32 million in 2050 (30% of total). Having struggled for decades with overcrowding, the impact of aging is evident in Japan’s real estate market, where Ministry of Internal Affairs’ data in 2013 shows a record high vacancy rate of 13.5% or 1-in-8 of dwellings. Nomura Research Institute expects the situation to deteriorate further, with vacancies reaching 21.0% in 2023 or 1-in-5 of total dwellings in Japan (Exhibit b).
If you are wondering if this sort of situation has the capacity to cause lower aggregate demand and, in turn, deflation, you are not only correct, but also worthy of being called a forward-thinker. High five. The link between demographics and deflation is surprisingly recent, with Anderson et al (2014) at the International Monetary Fund (IMF) first finding that “aging tends to exert deflationary pressures through changes in nominal wages as labor force participation declines, triggering adjustment in the price of capital and land.” Katagiri et al (2014) further identified a “negative correlation between inflation and demographic aging,” with numerical simulations showing that “aging over the past 40 years in Japan generated deflation of about 0.6 percentage points annually.” These are big numbers that corroborate with Juselius and Takats (2015) at the Bank for International Settlements (BIS), who determined that increases in the relative share of the working age population explain “around half of the total average reduction in inflation from its peak” between the late 1970s and early 2000s. There is logic to these recent findings. After all, older populations tend to suppress inflation by spending less than younger consumers, especially as it relates to large durable goods orders that have the greatest impact on headline spending figures. And when aggregate demand is falling, as observed in Japan, companies compete to retain share and lower prices, which creates deflation; the force that central bank monetary policy is trying to eliminate with little success.
Is there something unique in Japan that is causing its people to kill off their population? Many readers will ask this question next. After all, the Japanese people, by all measures, are a hard-working, intelligent, curious lot with a deep reverence for their ancestry and national heritage. How to explain? Unfortunately, Japan is less of an exception and more of a rule. If one compares the demographic situation in Japan with other advanced nations, the biggest difference is timing: the baby-boom in Japan occurred when much of the world was enmeshed in the Great Depression. Japan is simply ahead of the curve. As a result, much of what Japan is experiencing ‘today’ can be expected to play-out in the world’s existing economic centers ‘tomorrow,’ where declines are already being observed. This is true in Germany, for example, where the total population is expected to decline from 80 million to 74 million by 2050, as the group over 70 years of age will increase from 16% to 26% of the total. One obvious answer is immigration. Migrants account for more than 20% of the workforce in Australia, Sweden, and Switzerland, for example, while the foreign-born population of 45 million in the U.S. equal 17% of the workforce and 14% of the population, including ~45% of the entrepreneurs in Silicon Valley. But, immigration does not provide a total solution either. Just consider the case of Greece, where deaths have outnumbered births since 2012 and population increases have been entirely driven by immigration. The result? Greece defaulted on its debt last summer: the working population of 3.7 million simply can’t support the 11.0 million person country that includes 4.1 million pensioners and unemployed. More restructuring will be required. The point, to quote John Maynard Keynes (1937), is that “a change-over from an increasing to a declining population may be very disastrous.” Such was the situation in the Great Depression. But those concerns were resolved for Keynes and his contemporaries by World War II, the deadliest military encounter in world history. The architects of today’s economic policy had the luxury of ignoring the questions of aggregate demand altogether.
Exhibit a. Japan Population Forecast
Source: Japan Ministry of Health (2015).
Exhibit b. Japan Vacancy Rate
Source: Nomura Securities (2014).