Japan: The Economic Implications of an Aging Population

Haruhiko Kuroda

Council on Foreign Relations

November 15-16, 1996

I am delighted to participate in this conference. I would like to speak in my personal capacity about the Japanese case of a rapidly aging population and its economic implications. That Japanese society is rapidly aging is well known. What is not well known is the sheer speed and extent of that process. People over 65 made up only about 7 percent of the population in 1970; the figure reached 15 percent or so in 1995, and it will surpass 25 percent by 2020. Even based on a somewhat optimistic estimate for the birthrate, it should be one of the highest among oecd countries.

The reason Japan's population has aged so rapidly and is expected to continue to do so is twofold: rapidly prolonged life expectancy coupled with a substantially reduced birthrate. Immediately after the war, average life expectancy among Japanese people was the lowest, and up until 1965 Japanese life expectancy was on the lower side compared with European countries. However, Japanese life expectancy had surpassed that of all Europeans by 1980 and reached a staggering 83 years for women and 77 years for men in 1994. Of course, long life expectancy is a blessing and perhaps indicates the quality of medical care or social care in Japan.

The decline in the birthrate is another matter. Japan's total fertility rate declined sharply during the early 1950s and settled around two per couple in the late 1950s. Then it started to decline again in the middle of the 1970s reaching 1.46 in 1993. This recent decline is creating a host of problems, including falling population and the aging of the population in the next century.

The causes of the recent birthrate decline are more complex and difficult to analyze than those of the life expectancy increase. We can only say that the number of children a married couple has has not changed in the last 20 years, but age at first marriage and the number of unmarried people have both increased substantially.

In any case, it is not easy to raise the birthrate artificially. If we accept the low birthrate scenario, the Japanese population will indeed become aged in the next century. The elderly will reach a peak of 33.3 percent of the population in 2050, a situation we have never before seen in any country of the world.

Certainly, such a rapidly aging and substantially elderly society will face many problems(economic as well as social. Most commonly mentioned are the crisis in the pension system and the reduction in the private saving rate. Many economists warn that because of these two problems, Japan will have huge twin deficits--fiscal and balance of payments deficits--in the next century.

I disagree. Of course, I freely admit that Japan's current fiscal situation is serious and perhaps the second worst among g-7 countries next to Italy. Public works spending is too high; revenue transfer to local authorities is too extravagant; but these problems should be solved separately from the problem facing the pension system.

I agree, too, that Japan will face a serious pension problem in the next century. You can call it a pension crisis, but I think we can and will solve the problem. And if we are successful in solving the pension finance problem, I predict that the much feared shrinkage of private saving will not materialize. Let me explain.

The so-called pension crisis is on the surface a fiscal problem, but in essence it is really a social and economic problem. It is social because it involves generational conflicts, and economic because increased social security burden on fiscal deficit may jeopardize sound economic growth. Since the Japanese pension scheme is based on a partially funded insurance system, and since the Japanese population is rapidly aging, there is a large income disparity between generations.

According to a simulation of the lifetime ratio of contributions to and benefits from employee pension insurance, those who were born before 1965 will receive benefits greater than their contributions. Here I include not only direct contributions paid by a worker but also contributions to the employee pension insurance made by a company, because in the economic sense whether it is paid by a worker or a company doesn=t matter. Those born after 1965, on the other hand, will receive benefits totaling less than their contributions. At the two extremes, those who were born before the Second World War are quite fortunate, while those who will be born from now on will be very unhappy.

This situation, which some economists label "generational war," is not conducive to sustaining Japan's pension system. Reforms must be made.

A notable reform was implemented in 1994. Retirement age was raised and future pension benefits were reduced. At the same time, a planned escalation of contributions was somewhat reduced. However, the financing recalculation was based on highly optimistic birthrate forecasts, which have appeared increasingly unrealistic in view of the recent decline in the total fertility rate. Also note that the aforementioned simulation of generational disparity is based on that optimistic estimate.

So Japan must further reform the pension system. The first and foremost revision to be made is a further raising of pension age to 65 or more. In so doing, however, we have to take into account the wide disparity of income and health among elderly people. The future pension system should be more flexible, reflecting this diversity. Among other possible revisions, I can point out the possibility of further reduction of pension benefits coupled with some adjustment in pension contributions.

Incidentally, you may be interested in the way outstanding pension fund savings will fluctuate in the future. According to the calculations based on the optimistic birthrate scenario, employee pension schemes will continue to show some surplus, albeit a dwindling one, so that outstanding pension fund savings will not decline, even in the next century. However, this is somewhat deceptive, since if deflated by prospective inflation, outstanding amount will peak out as early as 2003. One cannot expect ever-abundant Japan's pension funds.

On the issue of future household savings rates, many economists, notably Professor Charles Horioka, a professor at Osaka University, have argued that Japan's savings rate, currently about 13 percent, will dramatically decline in the next century as the population ages. After all, elderly people do not save much. Some economists add that even younger people cannot save much because their social security and tax burden would be so heavy under the proposed reforms.

I am not so pessimistic. For one thing, elderly Japanese do save. They seem to dissave only after reaching 80 years of age! The portion elderly people who work is far higher in Japan than in other developed countries. The mandatory retirement age, as well as the age at which one may begin collecting a pension would be raised, and more flexible participation in the work force by elderly people could be expected. Then it is not so unrealistic to assume that they will continue to save as they have done. Excessive social security and tax burdens are, in any case, unlikely to be accepted, so I think younger people can and will save as before.

Consequently, Japan's savings rate will not decline dramatically even in the next century as many economists have argued, although I accept that the rate will gradually decline. You can continue to rely on Japanese private savings to a certain extent.

In conclusion, I will summarize my argument as follows.

First, the aging of Japan's population will continue and reach unprecedented level in the next century.

Second, Japan will face a pension crisis or a pension "difficulty," but we will solve it.

Third, the Japanese savings rate will not decline as much as is often predicted.