Japan’s lessons for Europe

Demographyis not destiny, at least not entirely. Over centuries, policy canaffect fertility decisions, and migration can transform a country, asthe experience of the United States shows. Over shorter time horizons,however, demographic trends must be taken as given, and can have aprofound impact on growth. Yet demographic factors are often neglectedin economic reporting, leading to significant distortions in assessmentsof countries’ performance. Nowhere is this more apparent than in Japan.Withreal output – the key measure of economic performance – having risen byonly about 15% since 2000, or less than 1% per year, Japan easily seemsthe least dynamic of the worlds’ major economies. But given Japan’sdemographics – the country’s working-age population has been shrinkingby almost 1% per year since the start of this century – this result isremarkable.In fact, Japan’s growth rate per working-age person wasclose to 2% – much higher than in the US or in Europe. Though the USeconomy grew more than 35% since 2000, its working-age population alsogrew markedly, leaving the annual growth rate per working-age person atonly about 1%.That indicator – growth rate per working-age person –is not widely used by economists, who instead focus on GDP per capita.By that measure, Japan is doing about as well as Europe and the US. But,while per capita indicators are useful for assessing a country’sconsumption potential, they do not provide an adequate picture of growthpotential, because they include the elderly and the young, who do notcontribute to production. Even in Japan, with its high life expectancy,those over the age of 70 do not contribute much to output.So, givenits rapidly declining potential, Japan has been extraordinarilysuccessful. A key reason is that it has put a growing proportion of itsworking-age population to work: unemployment is today at a record low ofless than 3%, and almost 80% of those who could work have a job,compared to about 70% for Europe and the US.Japan’s achievement offull employment and high job growth over the last two decades is all themore noteworthy in view of near-permanent deflation during this period(most prices are still lower today than they were 15-20 years ago). Thisshould give food for thought to those who maintain that deflationimposes unbearable economic costs.The Japanese experience holdsimportant lessons for Europe, where the demographic future looks a lotlike Japan’s past. The eurozone’s working-age population has not grownat all in recent years, and will soon start to decline at a rate similarto Japan’s over the last generation. It seems unlikely that immigrationwill alter the trend. In recent years, Europeans, like Japanese, haveproven to be highly resistant to large-scale immigration, which is whatwould be required to offset demographic decline.Moreover, theeurozone has now settled on a current-account surplus of around 3% ofGDP. That is similar to the level long seen in Japan (except for theshort period in the aftermath of the 2011 Fukushima Daiichi nuclearmeltdown).A first lesson of Japan’s experience is that, despite theeurozone’s difficulty generating inflation in an ageing societycharacterised by excess savings, growth is not necessarily out of reach.Rather, given Japan’s record of growth without inflation, the EuropeanCentral Bank should recognise that its target of “close to 2%” inflationmight not be so important after all. In any case, the particularitiesof the eurozone’s structure mean that the ECB will have no choice but tohalt its bond-buying operations in a year or so. This means that theECB will not be able to follow in the footsteps of the Bank of Japan,which continues to purchase large volumes of government bonds, withoutany visible pick-up in inflation.Another lesson from Japan is that acountry with a large savings surplus can handle a large public debt,because it can be financed internally. That does not necessarily meanthat it is desirable to run up the debt. Japan’s debt-to-GDP ratio nowexceeds 150% of GDP (taking into account the large financial assets ofthe government-owned savings institutions), and continues to rise, owingto large fiscal deficits.This brings us to a final key lesson fromJapan: in a low-growth economy, the debt-to-GDP ratio can quickly spinof out control. Fortunately, it seems that this lesson already has beenlearned, with the average deficit in the eurozone now amounting to onlyaround 2% of GDP. The deficit cap imposed by the Stability and GrowthPact (3% of GDP) seems to have had at least some impact in terms ofstabilising the debt ratio.The structure of the eurozone imposeslimits on the use of both fiscal and monetary policy. This shouldprevent the excessive build-up of debt, ultimately making it easier forthe eurozone to manage a future in which the only way to sustain growthis to capitalise fully on the economy’s declining demographic potential.– Project Syndicate* Daniel Gros is director of the Centre for European Policy Studies.