Japan's golden age: what to make of the age demographic.

• Author: Lo, Chi

Contrary to conventional wisdom, the effect of Japan's aging population on the economy and the asset market could be positive in the short- to medium-term. In the short-term (three to five years), Japan's shrinking population (expected to start falling by 2007) will shrink the labor force, tighten labor market conditions, and lower the jobless rate. On the back of a structural economic turnaround, a tighter labor market will push up wages, boost inflation and, hence, nominal GDP growth, which is essential for the asset market growth.

In the medium-term (ten to twenty years), the declining birth rate will lower the dependency ratio (thus lessening the burden on the workforce), and the rising female labor participation rate will offset some of the decline in the labor force. These forces will boost household savings and consumption, giving Japan a new window of growth opportunity. But Tokyo needs to embark on new and drastic policy initiatives soon to tackle the aging population's dire long-term effects.

SHORT-TERM BOOST TO NOMINAL GDP

Japan's jobless rate has fallen to 4.2 percent now from a peak of 5.8 percent in March 2003. The number of unemployed peaked in December 2001 at 3.67 million. It has since fallen steadily to 2.83 million in the third quarter of 2005.

The improvement in the job market came first from the decline in the labor force, which fell by 1.3 million persons between the end of 2001 and the end of 2004. Employment fell by 40,000 in the same period. Then job growth picked up, with the number of employed rising by almost one million in the first three quarters of 2005.

While job market improvement due to a shrinking labor force may be cold comfort under normal circumstances, it is different for Japan. Japan has to live with a falling population, but the resultant natural decline in the labor force will tighten the labor market as the economy recovers under structural improvement.

The upcoming retirement of the baby boomers will create a bottle-neck condition in the labor market. The jobless rate will thus continue to fall in the next few years, unless there is a negative demand shock. There are now 6.8 million people in the 56-58 age range, including five million workers (7.5 percent of the labor force). These baby-boomers will reach Japan's typical retirement age of sixty years old starting in two years. With employment growth expected to remain steady under the secular economic rebound, this will put downward pressure on...