Metabolizing Japan, The World's Oldest Nation

from STRATFOR

-- this post authored by Reva Goujon

Getting old can be a drag, for both people and nations. As people age, they tend to become less physically active. This leads to loss of muscle mass and the gain of fat, which causes the body's metabolism - the process of converting nutrients into energy - to decrease. When the population of a nation ages, a similar effect plays out. The labor pool dwindles, fatty debts build up, and the nation's economic muscle, or labor productivity, atrophies, leading to a decrease in the nation's metabolic rate and slower growth overall.

The National Bureau of Economic Research released a study in July that examined how an aging population can impair economic growth. In analyzing the economic response to aging in the United States since 1980, the study emphasized a drop in labor productivity as the chief economic consequence of a graying society and estimated that the aging of a society can shave as much as 1.2 percent off gross domestic product growth, a considerable amount given that a 2 percent growth rate in an advanced industrial economy is a cause for celebration these days.

Demographics matter - a lot. This is a big part of why central bankers in the developed world are banging their heads against the wall trying to concoct new monetary and fiscal cocktails to stimulate growth when even crawling to 2 percent growth seems like an uphill battle. A graying society simply cannot burn off as many calories as economists, politicians and voters would like. Tackling the roots of demographic decline is no easy task, either. Population growth is considered stable at a 2.1 total fertility rate, meaning mom and dad are producing enough offspring at least to replace themselves. But a more urbanized world means a higher cost of living and tighter living quarters, leaving less physical and financial room to seat a big family around the dinner table. And as more women seek higher education and professional careers, childbearing gets put off until an age when fertility drops. Add to this picture longer life expectancy enabled by advancements in medicine and technology, and you have yourself a demographic crunch.

The Corporate Culture Makeover

If any country knows this problem well, it is Japan, with a total fertility rate of 1.4 births per woman (compared with 1.9 for the United States, 1.6 for China, 1.4 for Germany and 1.2 for South Korea). With 26.3 percent of its population at 65 years of age or older, Japan is the oldest nation in the world. Its population peaked at 128 million in 2010. By 2040, Japan's senior citizens will make up 36 percent of its citizenry, and the country will have a working-age population of roughly 50 million. As Japan ages, health care and pension costs have ballooned, and the country's debts are heaping on top of a dwindling tax base.

Japanese Prime Minister Shinzo Abe and his eponymous economic plan rested on the theory that aggressive monetary easing, a more agile fiscal policy and a series of structural reforms combined would stabilize inflation, reboot consumption and ultimately snap Japan out of its 20-year economic slump. But Abenomics has flopped. Despite the Bank of Japan's massive buying spree of government debt, the yen has held its strength, prices continue to drop, and a deflationary spirit continues to grip the Japanese consumer. As more of Abe's political capital is absorbed by the lackluster results of this monetary and fiscal policy mix, the demographic time bomb is ticking on structural reform.

Unlike some of its aging peers in Canada, Europe and the United States, Japan is unlikely to warm to the idea of opening the door to foreign workers to address its growing labor scarcity. The isolation of the archipelago has given Japan the time and space to develop a high degree of ethnic homogeneity, and the Japanese are keen on preserving the purity of their national character. Japan's extreme reluctance to integrate outsiders even applies to immigrants of Japanese descent.

Japan had the opposite problem in the early 20th century, when it was trying to relieve itself of overpopulation and resource scarcity by encouraging Japanese emigration. A large number of Japanese ended up on the other side of the world in Brazil, now home to the world's largest Japanese diaspora. When Japan loosened its immigration policies in 1990 by offering long-term visas to members of the Japanese diaspora, tens of thousands of Japanese Brazilians traveled to their ethnic homeland for work only to end up returning to Brazil several years later when they found it too difficult to live up to the societal norms in Japan. If Japan already has trouble accepting its own ethnic kin, assimilating other foreign nationalities into the labor force will be a tall order.

Rather than trying to persuade its citizenry to become more tolerant of outsiders, Japan is looking to address the more pressing issue of bringing more Japanese women into the workforce. Part of this campaign entails right-setting gender stereotypes in Japan's kawaii or "cute" pop culture and getting male-dominated corporate hierarchies to get used to dealing with women in higher positions.

But encouraging more female labor participation is a bit of a double-edged sword. For Japan to try to increase fertility rates and employ more women in the workforce simultaneously, it needs to ensure the latter goal does not end up directly undermining the former. Child care can be prohibitively expensive, and Japanese corporate culture encourages excessively long working days, averaging 80 hours a week. Skyscrapers in Tokyo and Osaka are lit up through the wee hours of the morning as workers straggle out to catch a couple of hours of sleep before returning the next day to repeat the same drill. When an employee's worth is based on working long hours, and when knocking off before colleagues do is considered socially unacceptable, little time is left to spend time with family, much less focus on growing one.

The Abe government is trying to push legislation to cap overtime hours and obligate employees to take at least five days of paid annual leave, but it will take a more fundamental re-engineering of Japanese corporate culture to convince workers that they are not being disloyal to their colleagues by leaving the office at a decent hour. Until then, working mothers will be a rare commodity in Japan, and napping in meetings will remain a common and socially acceptable practice.

When Japan moved from feudalism to industrial capitalism during the Meiji Restoration in the late 19th and early 20th centuries, a social contract with the citizenry under the auspice of the emperor emphasized loyalty across the industrial organization of the economy. A heavily paternalistic corporate culture developed as a result and was reinforced following Japan's defeat in World War II. As part of this social hierarchy, Japanese conglomerates were expected to fulfill a promise of lifetime employment and wage growth based on seniority for their employees. These cultural norms have persisted to this day to the detriment of Japan's heavily insulated domestic industry. Large corporations had no choice but to move their operations overseas to make a profit and avoid getting saddled by high labor costs at home. A productivity gap has thus widened significantly between the soto (outside) and the uchi (inside) firms that leaned on a massively intertwined political bureaucracy to protect their interests in the tightly knit keiretsu business structure.

Since it is a social taboo for Japanese domestic firms to lay off their workers and since corporations have to wait until the traditional retirement age of 60 before they can start slashing senior salaries, corporations resort instead to hiring contract workers without benefits and for significantly less pay, creating a growing underemployment epidemic among young Japanese workers. This is another area in which the Abe government (as well as that of his reform-minded predecessor, Junichiro Koizumi) has been trying to make changes. In the interests of boosting competitiveness along with consumption, both administrations sought to break through political barriers to pressure companies into doling out pay and promotions based on merit instead of seniority. Corporate giant Hitachi has been among the first of Japan's national champions to ditch the seniority wage and promotion system in favor of merit-based performance, and others are being prodded to do the same. But this will remain a slow and piecemeal transformation so long as Japan's mammoth political bureaucracy under the Liberal Democratic Party remains deeply intertwined with a plodding Japan Inc.

A Resilience Born of Innovation

This is not to say Japan's demographic destiny and debt burden spell doom. Japan is still a wealthy country with one of the highest GDP per capita rates in the developed world. So long as Japan can chip away at these structural impediments to regain economic competitiveness in high-value sectors, even a low GDP growth rate can balance against a shrinking population to maintain a high GDP per capita. The average Japanese citizen can still enjoy a high standard of living under these circumstances, whereas China, just two decades behind Japan in this demographic crunch, will be dealing with a labor squeeze on a much larger scale, with far less political and social cohesion and much wider income inequality.

Japan may have fallen into corporate malaise, but it has not lost its talent for innovating its way out of major challenges. Japan's national character - forged by life on the resource-poor and isolated archipelago - is shaped by its ability to overcome constraints, even ones of epic proportions. When the United States took the lead in prying open a feudal and technologically backward Japan in the mid-19th century after more than two centuries of isolation, the country rapidly modernized economically and militarily and recentralized politically under the 1868 Meiji Restoration. Within another quarter century, Japan was already on track in its near abroad to secure the strategic approaches to the island. Within another quarter century, Japan's military was on the hunt for labor and resources to feed its expanding empire under the banner of a Greater East Asia Co-Prosperity Sphere. When Japan overreached in its imperial aims and suffered massive destruction and an occupation by the United States at the end of World War II, the shattered nation not only lived up to the emperor's call to "endure the unendurable," but it also transcended that call by absorbing the core tenets of American democracy without sacrificing the island's pillars of shared responsibility and social harmony. Within another quarter century, the postwar Japanese economic engine had taken off, earning Japan the rank of second-largest economy in the world and an economic sphere of influence that stretched around the globe. If any country can produce big change under high stress and in little time, it is Japan.

Japan's technological prowess marries neatly with the country's demographic challenge. Technology is a big part of the remedy to a shrinking labor pool, a deep aversion to immigrant labor and a pressing need to boost labor productivity. From cuddly robotic Robear nurses to replace human caregivers to Pepper, the humanoid robot that can read human emotions, Japan will be a valuable case study for other aging societies on how to do more with less through robotics technology and advanced manufacturing. Stiff competition from China, South Korea, Taiwan, Germany and the United States in this field will act as an additional catalyst on Japan's reform to the keiretsu system. Over time, we can expect to see a new generation of Japanese corporate executives team up with political reformers to take on a formidable bureaucracy backed by senior voters who are still clutching to the legacy economic model.

Legacy shedding is a necessary part of Japan's 21st-century evolution. The process of Japanese military normalization currently underway is a natural reaction to China's growing assertion overseas and the United States' attempt to share more of the regional security burden with its strategic allies. The Japanese emperor's recent appeal to the public to permit abdication, thereby diluting the divinity of the role, is yet another legacy that Japan will adapt while preserving the paternal spirit of the imperial palace.

Transcending the Demographic Crunch

It is far easier for observers in the West to lament and even exaggerate Japan's challenges than it is to give credit to the underlying strengths of the nation. Japan and the United States both carry gargantuan debt burdens, but Japan is far less externally exposed since it owns nearly all its debt. Alongside the United States, Japan has maintained its reputation as a financial haven and is one of the largest creditors in the world. The country's labor pool is shrinking, but the country is still wealthy and will readily develop and embrace technological solutions to its problems. Japan cannot shake its extreme aversion to immigration, but the homogeneity and harmony of Japanese society has also made it one of the safest and most trusting places in the world. The extreme emphasis Japan places on loyalty in the corporate world cripples companies that cannot break social taboos to fire low-performing employees, but the glaring absence of loyalty in many employer-employee relationships in the United States is a key factor that limits wage growth and dilutes product quality as workers jump from firm to firm. What Japan structurally lacks in entrepreneurism, it can still make up for in innovation and craft.

The looming demographic challenge is by no means unique to Japan, but the Japanese will be the first in the world to confront it head-on while the rest of the world anxiously takes notes. Japan has a long record of borrowing lessons from the outside and transcending to new heights at stunning speeds, all while preserving a Japanese-ness often worthy of emulation. The Japanese have a saying, kishi kaisei, to wake from death and return to life. Japan has already awoken from its moribund years and has a mass of ambition to throw at its challenges. As Japan readies itself for revolution once again, this formidable island nation will define a new way of living in a shrinking world.

"Metabolizing Japan, the World's Oldest Nation" is republished with permission of Stratfor.