AGE DOESN’T MATTER
Or so the maverick economists at CLSA argue in making the case that Japan is going to be among Asia’s brightest economic spots in the next ten years.
By Cesar Bacani

The claim that a rapidly ageing Japan is destined to become a second-rate economy has been repeated so often that it has almost become orthodoxy. “In about 2010, according to official projections, Japan will have fewer than half the workers per retiree it has today, a mere 2.5 people of working age for every pensioner,” wrote economist Milton Ezrati in the US journal Foreign Affairs in 1997. As a result, Ezrati, then chief investment officer at Nomura Capital Management, forecast an 18% fall in Japan’s standard of living. Others counted the cost in terms of a permanent cut of at least one-half percentage point off annual GDP growth. Former Japanese Finance Ministry official and academic Matsutani Akihiko went further. In his 2006 book, Shrinking Population Economics: Lessons from Japan, he predicted “negative growth” of 1.1% a year from 2009 through 2020.

Now, three years before doomsday 2010, CLSA Asia-Pacific Markets, the Asian investment banking arm of France’s Crédit Agricole, has advanced a revisionist view. “Neo-classical economists have got it all upside down,” wrote CLSA senior economist Sharmila Whelan in a recent research report aptly titled Power Without People: Rising to the Challenge. “By distilling growth down to the traditional inputs of labor and capital, they conclude that diminishing returns are inevitable for an ageing industrialized economy. They are wrong. Growth generates further growth if it is allowed to.” Whelan predicts that annual GDP growth in Japan will move into the 2.5% to 3% range over the next ten years, higher than the trend growth of 1.25% per year forecast by the Organization for Economic Cooperation and Development (OECD) for the next five years.

Time, as always, will tell. But if Whelan is right, investors and companies (and their CFOs) will have to rethink their decision to write off Japan in their forward planning. There are implications for the prospects of other ageing economies as well, notably Italy (where the number of citizens 65 years and older is projected to equal 43% of the working-age population by 2025, only slightly lower than 47% in Japan), France (41%), Canada, Germany, and the UK (all 36%), and the US (33%). Then there is China, which is seen in some quarters as likely to “grow old before it grows rich” because of its one-child-per-family policy. If Whelan’s thesis is correct, China can in fact grow old and rich.

Asian Maverick

Previously a regional economist at oil giant BP and international economist for Lombard Street Research in London, India-educated Whelan (she has a master’s in economics from Jawaharlal Nehru University) joined the maverick economic team at CLSA last year. The crew is led by iconoclast Dr Jim Walker, the Scottish economist who correctly predicted Asia’s 1990s growth surge, its financial crisis in 1997, and the astonishing take-off of China’s economy and markets in 2001, when most other economists had been ambivalent on the mainland’s prospects. Today, CLSA has turned bearish on China in the short term, describing the double-digit GDP numbers there as “symptoms of a late-cycle boom”. Instead, it has latched onto Japan as Asia’s brightest star, the doomsayers be damned.

Whelan’s argument in debunking the mainstream view rests on the proposition that population size is not a precondition for or a constraint on economic growth. What matters, she believes, is specialization through division of labor and innovation, not the quantity of labor and capital. She draws on history to prove her point. Venice had only 66,000 residents in 1171, yet it became the richest and most successful European economy from the 11th to the 16th century, outperforming far more populous France and England. In 1676, the Dutch Republic had only a tenth the population of France, yet its foreign trade was four times larger. The Dutch pulled this off through specialization, concentrating its labor force into high-productivity sectors like woolen textiles, shipping, and commercial agriculture, while outsourcing low-value activities like food production by importing them from abroad.

True, there is no historical precedent for a population that is shrinking in terms of total numbers at the same time that it is graying in terms of age, which is what is happening in Japan today. But Whelan points to the huge declines in the population of Europe in the 20th century after World War I and World War II as suggestive of long-term trends, since in war, most of the fatalities are the young who fight on the battlefield. At the end of World War II, Western Europe’s GDP was almost a fifth smaller than before the war, while Japan’s had shrunk by half. A decade on, Western Europe’s economy was a third larger than before the war, and Japan’s was 22% bigger – even as the working-age population remained static.

Dueling Theories

The view one holds of Japan’s future boils down to which theory of growth the observer subscribes to. The exogenous model predicts an economy’s long-term growth potential based on population growth, rate of investment, and the efficiency with which the economy employs capital and labor. “If all growth is explained by factor inputs and the growth of labor supply is slowing,” explains Whelan, “the rate of GDP growth must slow. Rich, economically advanced countries with slowing population growth are doomed under this model.”

Whelan is a follower of the rival endogenous growth model, which advances the notion that growth begets growth. This theory posits that demand for most goods is elastic and as more of the good is produced, its price will fall relative to other goods. The natural growth of output then leads to further demand. And if the real purchasing power of both intermediary and end consumer increases, the effective demand for the good and for all other goods also increases. “A crucial concept of endogenous growth is specialization through the division of labor,” says Whelan. “Greater output can be produced without additional labor and capital resources. In fact, an economy can grow with a stationary labor force.”

The “neoclassical economists,” says Whelan, argue that growth in Asian countries over the last 30 years and in Japan from 1950 to 1967 was driven exclusively by high investment and a young, well-educated workforce. They forget the equally important role that economic incentives played in this renaissance, such as trade liberalization in Asia and, in Japan’s case, the national commitment to catching up by closing the technological gap with the West and the government policy of promoting growth industries and exports. This, she contends, is why Japan moved forward, while Gambia in Africa was left behind. Both countries increased their capital stock per worker by 500% between 1960 and 1985, but output per worker in Gambia rose only 2% while that in Japan jumped 250%.

Can graying Japan continue to outpace the youthful Gambias of the world, given the heavy financial resources that must be diverted from investment to support its army of retirees? “Japan’s demographic profile going forward is a serious issue for pensions,” Whelan acknowledges, though she notes that the problem of underfunded corporate pension funds has been largely resolved. The burden falls mainly on the government, but if the economy grows as strongly as CLSA forecasts, it would have more room to maneuver in strengthening its fiscal position.

The key issue, for Whelan, is the capability of Japan – and by extension that of the ageing economies of the US, UK, France, Italy, and Canada, and prospectively China – to create “a knowledge-based economy through specialization and innovation”. CLSA put together an innovation and specialization scoreboard comprising 23 measures such as new science and engineering graduates per 1,000 population aged 20-29, broadband penetration, exports of high-tech products, and number of new US patents. Overall, Japan ranked ahead of the US, Germany, France, and the UK.

In the long run, Whelan asserts, robotics will keep productivity high, making up for the shrinking population and high labor costs. In the short to medium term, Japan’s economy will benefit from the “intense corporate restructuring and brutal competition combined with the political winds of change” of the past decade. There are new start-ups, increased M&A, and a new generation that is moving into management positions. Tax law changes now allow job agencies to provide insurance and health coverage to retirees who do part-time work, while reforms of inheritance and gift laws encourage the old to pass on part of their wealth to their children to fund such expenses as house-buying. Age may not matter, after all.