The International Monetary Fund has a checkered past on giving Asia advice. Ask officials from Jakarta to Seoul about this, and you’ll get an earful. Now, it’s Japan’s turn to get some dubious guidance from the Washington-based institution.
That advice, handed out by IMF Managing Director Kristalina Georgieva at a press conference on Monday, is to raise Japan’s consumption tax.
In fact, Tokyo had just done exactly that – to disastrous effect. Last month, it hiked consumption tax to 10% and promptly saw the dangers of tightening fiscal policy amid a global trade war: a 14.4% plunge in retail sales in October and a heightened recession risk.
Still, the IMF bigger-picture warning is prudent. A fast-graying population and, among major economies, the world’s biggest debt burden – two and a half times economic output – is a dangerous combination. It is the stuff of credit downgrades and surging debt yields.
Yet – given how highly taxed workers’ salaries in Japan already are – the IMF’s suggested hikes, to 15% and then 20% over time are, well, nuts.
Japan needs to deal with this issue in ways that don’t penalize the consumption needed to hasten gross domestic product.
Tokyo’s plight matters for two reasons. One, a debt reckoning in the world’s third-biggest economy would reverberate everywhere. Two, Japan’s experience will soon enough be shared by other major economies including South Korea, Hong Kong and, eventually, China.
Korea, for example, just recorded for the third quarter the lowest-ever fertility rate anywhere – 0.88 kids per woman. Seoul, home to one in five South Koreans, had the country’s lowest rate, 0.69.
In Japan’s case, there’s an argument that increased productivity and automation can save the day. The earth’s balance is fragile enough today, never mind in 2050 when 9.7 billion people are expected to walk the planet. Japan really is humankind’s laboratory for figuring out how to produce greater output and wealth with fewer people.
Indeed, some thinkers see the glass as half full.
“In a world of rapidly expanding automation potential, demographic shrinkage is largely a boon, not a threat,” says Adair Turner, a senior fellow at the New York-based Institute for New Economic Thinking. “Our expanding ability to automate human work across all sectors – agriculture, industry, and services – makes an ever-growing workforce increasingly irrelevant to improvements in human welfare. Conversely, automation makes it impossible to achieve full employment in countries still facing rapid population growth.”
Labor, consumer pools dry up
The IMF differs. It warns that “a rapidly aging population and shrinking labor force are hampering growth.” Its economists say that the aging workforce could knock 1 percentage point off annual GDP for the next three decades.
The number of working-age Japanese in the labor force is now the highest since the 1960s. As of 2018, the ratio of open jobs per applicant was 1.6, meaning it’s about to surpass an all-time record reached in 1963. Japan, it follows, is literally running out of even moderately skilled labor, denting productivity and top-line GDP.
Japan’s population began contracting in 2010. Since then, it’s lost more than 1.4 million people. Between 2010 and 2011 alone, the US added 2.3 million bodies to its future workforce.
Looking ahead, things look even more dire. By 2040, more than a third of Japanese will be over 65, the worst old-to-young ratio in the world. Today, Japan is home to roughly 126 million people. By 2065, the United Nations reckons there will be at least 28 million fewer inhabitants.
It means that, over time, Japan will have fewer people making goods and performing services and fewer people buying them. In the last year, there were nearly 68,000 fewer high schools around the nation than 12 months earlier. Fewer houses are being built as demand drops. As Moody’s Investors Service pointed out this week, demographic dynamics are stretching local-government budgets for schools and social welfare programs.
Fewer babies, meantime, are making this a secular trend, not just a cyclical one. In 2018, the number of newborns fell to a record low of 918,397, the third straight year of sub-1 million births.
“What this describes is an economic doomsday machine,” warns US economist Robert Samuelson, author of Untruth: Why the Conventional Wisdom Is (Almost Always) Wrong.“The increasing number of older Japanese has already put enormous pressure on the government’s budget.”
Since 1991, he says, public social spending — mainly for retirement pensions, health care and long-term care — has doubled as a share of gross domestic product, from 11% of GDP to 22% of GDP in 2018.
Japan’s debt burden might seem less dire if there were enough young workers taking over for retirees, what economists call the “replacement rate.”
But there aren’t.
In light of this, Japan’s 10-year government bond yield is at an impossibly low 0.11%. Compare to 1.8% in the US. This is odd, considering Japan’s debt-to-GDP ratio is approaching 250% while America’s is 106%. And, considering that Japan is bleeding workers, while the US is comparatively stable.
Japan’ shaky solutions
Prime Minister Shinzo Abe’s government has sought to fill the gaps by importing more foreign labor. He’s nearly doubled the inflows in the last five years. Yet the 1.45 million foreign workers in Japan right now are a drop in the proverbial bucket of what’s needed to deepen the labor pool. Japan also is having a hard time wooing talent put off by inflexible labor laws, long work hours and high living costs.
Abe’s Liberal Democratic Party also is relying on sale tax hikes to stabilize the national balance sheet. This, too, has been a bit of a wash. A 2014 increase to 8% from 5% resulted in a mild recession, prodding Tokyo to draw up fiscal stimulus packages.
In plain English, that means a step aimed at reducing debt ended up increasing it.
Will last month’s hike to 10% require a similarly costly response? Likely yes, given that real wages fell in eight of the first nine months of 2019. Exports plunged 9.2% in October from a year ago as US President Donald Trump’s China tariffs upended Asian supply chains.
South Korea is in a similarly precarious place, both in the short and long runs. Trump’s trade assault on China is slamming South Korea’s all-important export engine. The bigger problem is how South Korea risks following Japan down a demographic rabbit hole.
Korea’s standing as the world’s 11th-biggest economy is being jeopardized by declines in the working-age population. Just as in Japan, this impedes growth, imperils innovation and leads to spiraling health-care costs.
What makes Korea’s record-low fertility rate so worrisome is how hard Seoul is working to stabilize things. It’s spending billions of dollars a year: free nurseries, subsidized childcare leave, cash stipends. But still, there is no baby boom.
But for now, Japan’s economic scale and massive debt load take precedence, as the IMF’s special attention attests. It’s time for Tokyo to find a way to raise tax revenues via growth and new job creation – preferably from a new generation of scrappy startups that create jobs and new wealth. Big tax increases are the wrong idea at a moment when Japan needs economic tailwinds, not headwinds.
The IMF erred terribly in the 1990s when it advised Indonesia, Thailand and South Korea to hit the fiscal brakes amid a financial crisis. Tokyo is hardly there yet. But Japan would be wise to go its own way, incentivizing new growth areas rather than killing demand with ill-timed tax increases.