Fundamental Signals

We usually don't cover macro in our newsletters. This is an one-off experiment. Let us know if you do / don't like this type of content (info@distilla.ai).

Editor's Notes:

• Low birth / aging - "In the early stages of demographic transition, there's a tendency to remain sanguine"

  • 45% born after 2000 in Japan won't have grandchildren > "intergenerational irresponsibility" > fiscal / growth sustainability

  • Elders adopt tech slower, elders consume less

  • Slowing productivity growth, due to misallocation of public funding caused by "gray hair democracy" / "regional imbalance"

• Root cause of low birth rate in East Asia - "Strong positive correlation across countries between birth rates and the share of housework and childcare undertaken by men"

  • 996 culture in China and focus on getting kids to elite universities may sustain low birth rate in China for years to come

• Investment implications:

  • Unclear if Japan can really overcome these deep structural issues to revitalize economy - short run equity attractiveness due to valuation, FX, governance improvement, while fundamental life-long employment / slow tech adoption / counterproductive social norms persist

  • China's low birth / aging demographic problem is deeply social (not pure economic or policy-correctable) and will likely persist - avoid investing in companies heavily depending on newborns / young consumers. Impact on broader productivity growth will be minimal for a few years, until political / social consequences eventually lead to economic problems (but it's highly likely that Chinese gov will be able to anticipate and avoid this in the medium term, given its regime and ability to learn from Japan's past lessons).

This article distills crucial lessons from Japan's four-decade economic journey, offering valuable insights for Korea's current challenges, particularly concerning demographic shifts, the aftermath of economic bubbles, and productivity growth. Drawing on the experiences of the former Governor of the Bank of Japan, it explores why Japan's reforms have been slow and provides "food for thought" on how Korea can proactively address its own economic trajectory, focusing on social norms and long-term societal will rather than just financial incentives.

Below is the transcript from Lessons from Japan’s 30-Year Economy│SHIRAKAWA Masaaki (Former Governor of the Bank of Japan), last week in Korea

What Economic Parallels Exist Between Japan and Korea?

The Korean translation of the book, "Memoirs of My Five Years as Governor of the Bank of Japan During a Turbulent Period Between 2008 and 2013," published last year, sparked a common question from Korean reporters: "Will the Korean economy follow the same economic path as that of the Japanese economy over the past four decades?" Today, I will elaborate on answering this crucial question.

The Japanese economy experienced a high-growth period from the mid-1950s to the early 1970s, with an average growth rate of about 10%. This was followed by a decline, yet growth remained relatively high. The late 1980s saw an extraordinary economic boom, known as the bubble economy, which subsequently burst, leading to a severe financial crisis and low growth. The period from the early 1990s to today is often termed the "lost decades" or "lost three decades," though I believe this characterization of the Japanese economy is not entirely accurate.

Key Similarities Between Japan and Korea

Several critical similarities connect the economic trajectories of Japan and Korea:

1. Past High Economic Growth: Both countries recorded enviably high economic growth in the past. Japan, four decades ago, mirrored what China is today. As Harvard professor Ken Rogoff noted in his book, "The Age of Illusions," from the late 1970s to the early 1990s, there was widespread fear that Japan would eventually overtake the United States as the world's predominant trading and economic power.

2. Export-Oriented Manufacturing: Both economies have historically relied on an export-oriented manufacturing sector. In Japan, this sector wielded significant influence in economic policy debates, sometimes disproportionate to its share of the economy. From a central bank perspective, calls to prevent yen appreciation often posed a challenge.

3. Severe Demographic Changes: Crucially, both nations face profound demographic shifts. Japan's working-age population peaked in 1995, declining by 15% since. Its total population peaked in 2009. Korea's working-age population and total population peaked in 2012 and 2020, respectively, indicating Korea is roughly 20 years behind Japan in demographic trends. The fertility rate, a key determinant of future population, is astonishingly low at 0.6 in Korea and 1.2 in Japan, both far below the replacement level of 2.1.

These general similarities, particularly in demographic challenges, explain why Korean reporters frequently ask about Japan's economic lessons.

What Are the Primary Causes of Japan's Economic Stagnation?

In my view, Japan's declining economic growth rate stems from three essential causes.

How Did the Burst of the Bubble Economy Impact Japan?

The collapse of Japan's asset bubble, unprecedented in modern global economic history, severely impacted the economy. For instance, commercial property prices in Osaka plummeted to nearly 10% of their peak value. While the immediate economic fallout is well-documented, the long-lasting legacy of this collapse, particularly underestimated by external observers, is crucial. Japanese companies significantly reduced hiring regular employees, opting instead for non-regular workers with lower wages and limited job security. This shift contributed to widening income inequality and a sharp decline in the marriage rate, subsequently leading to a lower fertility rate. Thus, the burst of the bubble is partly responsible for Japan's current demographic challenges, leaving an enduring imprint on society.

How Has Rapid Aging and Declining Population Affected Japan's Growth?

Rapid aging and a declining population have profoundly influenced Japan's economic growth. Since its peak in 1995, the working-age population has decreased by approximately 50%. This demographic drag is evident when comparing growth rates among G7 countries. Japan ranks highest in GDP per working-age individual but among the lowest in overall GDP growth. This stark contrast highlights the significant burden a shrinking labor force places on aggregate economic performance.

What Role Did Slowing Labor Productivity Growth Play?

Slowing labor productivity growth, one of the two fundamental drivers of economic expansion alongside population growth, has also contributed to Japan's economic challenges. While Japan's productivity growth is comparable to that of the United States or Germany, it has nonetheless slowed over time. A major contributing factor is Japan's longstanding system of lifetime or long-term employment. This system effectively served as a social safety net during the high-growth period.

However, by the late 1990s, the economic landscape had transformed with the burst bubble, a falling yen, and the advent of the IT revolution. While lifetime employment kept Japan's unemployment rate relatively low, it also delayed the necessary reallocation of labor across firms and industries. Moreover, the lack of diversity in corporate management, a characteristic of traditional Japanese companies, proved ill-suited to the demands of globalization and rapid technological change.

Why is the Severity of Demographic Change Often Underestimated?

Among the three causes, demographic change draws significant interest from a Korean audience. What I want to emphasize is that people often take many years to fully grasp the severity of this issue. In the early stages of demographic transition, there's a tendency to remain sanguine, even when casually discussing the topic. In Japan, it is only relatively recently that the gravity of the situation has truly been recognized.

Even today, there is no broad consensus on the implications of population decline. Public discourse tends to fall into two main camps:

• Optimistic View: "Don't worry, technology such as robotics and AI will solve the problem."

• Pessimistic View: "We don't know how to raise the fertility rate, and there may be no effective measures. It may already be too late to change course."

Personally, I subscribe to neither view, as I will explain shortly.

How Do Economists View Population Decline and Productivity?

When discussing demographic change, it's essential to distinguish between aging and population decline. For most citizens, the impact of aging is readily recognized through personal experience, such as caring for elderly parents. The consequences of population decline, however, are more subtle. Despite retirees' pension income heavily depending on the output of the working-age population, population decline unfolds like a slow-moving picture, its severity not easily understood, especially in its early stages.

Economists, for the most part, have been relatively optimistic. Their typical argument often states: "What matters is per capita income, which determines individual well-being. As long as we maintain productivity growth, we do not have to worry about a declining population." This argument is technically correct, but only as a definitional point about economic growth. The real question is whether productivity growth can be sustained in a society with a shrinking population. Many economists tend to overlook two crucial issues: the complex interplay between demographics and productivity, and the significant role of structural factors, often termed social norms or implicit social contracts. Both are equally important. Yet, for those who do not live in a society experiencing population decline, it is difficult to vividly imagine the situation.

How Does Population Decline Specifically Slow Productivity Growth?

Based on Japan's experience, I would like to highlight three mechanisms through which population decline can lead to slower productivity growth.

How Do Aging Populations Influence Voter Preferences and Public Spending?

Aging influences productivity growth through changes in voter preferences. As the population ages, political pressure often shifts government spending away from critical areas like basic research and education, redirecting it toward social welfare programs. This reallocation reduces public investment in areas that drive long-term productivity and innovation. This phenomenon is frequently referred to as "gray hair democracy."

Why Do Older Generations Adopt New Technology Slower?

Economy-wide productivity growth heavily depends on society's ability to embrace new technologies. While technological innovation offers immense potential to raise productivity, older generations generally adopt new technologies at a slower pace. My personal experience, often asking my daughters for help installing new IT devices, reflects a broader societal trend in this regard.

How Does Population Decline Delay Resource Reallocation Across Regions?

Population decline also hampers productivity by slowing the reallocation of resources across regions. As illustrated by mapping data, many municipalities in Japan are losing population, with growth concentrated in a few areas like Tokyo. When a municipality's population falls below a certain threshold, maintaining public infrastructure such as roads, hospitals, and elementary schools becomes increasingly costly and inefficient. The economic scale of a location is a key determinant for productivity. However, political and social constraints frequently delay necessary adjustments to these imbalances.

What Role Do Social Norms and Structural Adaptability Play in Economic Outcomes?

When discussing how to boost productivity, the focus is often on technology and innovation, such as increasing digital investment. While undoubtedly important, this is only half the story. We must also consider whether society is capable of embracing flexible resource reallocation and adapting to new technologies and innovations. This brings us to the second overlooked issue: the importance of social norms, institutions, and structural adaptability in shaping economic outcomes. I will illustrate this with two examples.

How Do Social Factors Affect Birth Rates?

A significant portion of the cost of raising children stems from the foregone income of mothers who must interrupt or abandon their careers. A striking observation is the strong positive correlation across countries between birth rates and the share of housework and childcare undertaken by men. Unfortunately, Japan and Korea rank at the very low end in both birth rates and men's participation in domestic responsibilities. Interestingly, many Asian countries with low birth rates, including China, Hong Kong, Korea, and Japan, share a Confucian cultural heritage and intense competition for entry into elite universities. These facts suggest that birth rates are shaped not only by economic incentives but also by deeply embedded social norms.

How Do Japan's Long-Term Employment Practices Hinder Dynamism?

Japan's long-term employment practice, though its influence is waning, remained dominant among large traditional firms until relatively recently. Workers under this system are often referred to as "salarymen," a term that implies an unlimited commitment to work anytime, anywhere, and to accept any role within the company. While this system functioned well during Japan's high-growth years, today it tends to hinder economic dynamism for several reasons:

• It delays the smooth reallocation of labor across firms and industries.

• It discourages open innovation, as both the workforce and corporate culture tend to become homogeneous.

• Most importantly, it is unfriendly to female workers. The old system implicitly assumes the presence of someone, typically a spouse, who supports the worker's unlimited commitment. Declining birth rates and the underrepresentation of women in management roles in Japan are, in part, consequences of this outdated employment model.

Why Has Reform Been Slow in Japan?

Given everything discussed so far, it is natural to ask why reform has been so slow in Japan, despite the clarity of the underlying problems. I believe there are three main reasons.

How Did the Misdiagnosis of the Problem Delay Reform?

For many years, the issue was framed as one of low inflation or deflation. The prevailing narrative stated: "Low growth is caused by deflation. Deflation is a monetary phenomenon. Therefore, the solution is simply to print more money." This explanation was strongly supported by mainstream US academics and appealed because it was easy to understand and the proposed solution involved no real pain or sacrifice. However, even if the inflation rate increases to positive territory, the underlying problems of demographic change and productivity growth due to structural factors remain unsolved.

What Role Does Resistance to Changing Social Norms Play?

Social norms and practices are deeply embedded in society and require a long time to change. People naturally resist altering long-standing habits. While many companies recognize the need for reform, they remain constrained by legacy employment systems. Efforts are underway to shift strategies, but meaningful change takes time.

How Has the Absence of a Sovereign Foreign Currency Crisis Affected Reform Efforts?

For better or worse, countries that have faced sovereign foreign currency funding crises have often been compelled to implement sweeping reforms. This may be familiar to Koreans who experienced the Asian financial crisis of 1997 and 1998. Other examples include the Nordic banking crisis and Greece during the European debt crisis. Japan, by contrast, has not faced such external pressure. In fact, until very recently, Japan held the world's largest net international investment position, which provided a buffer against external demands for reform.

What Are the Key Implications and Lessons from Japan for Korea?

Having outlined the causes of Japan's declining growth rate and the reasons for delayed reform, I will now reflect on possible implications and lessons for Korea.

I do not intend to offer any concrete policy proposals. My understanding of the Korean economy and society is limited, and more importantly, outsiders cannot fully grasp the subtle dynamics of a country's institutions, culture, and social fabric—elements essential for designing effective policy responses. Like any other country, Korea faces complex challenges, but the solutions must originate from within, from those who best understand the nuances of Korean society and its economic interactions. My hope is simply to offer some food for thought that may help stimulate discussion.

Why is Early Action on Demographics Crucial for Korea?

Demographics will undoubtedly and increasingly have a profound impact on the economy. Although people tend to underestimate its full implications in the early stages, based on Japan's experience, my advice regarding efforts to prevent a decline in fertility rate is: the sooner, the better. Once "gray hair democracy" takes hold, it becomes extremely difficult to shift the prevailing present-oriented mindset, or what might be called "intergenerational irresponsibility."

A Japanese demographer recently shared some sobering figures. He calculated the proportion of people who do not have grandchildren, rather than just children:

• For those born in 1940 (now age 84), the figure is 15%.

• For those born in the 1970s, it rises to 39%.

• For those born in the 2000s, it reaches 45%.

We are entering an era in which nearly half of the population may not have grandchildren. This implication is sobering. Human beings are both egoistic and altruistic, but as this demographic trend continues, it may become increasingly difficult for people to imagine and empathize with future generations. This erosion of intergenerational bonds is deeply concerning, not only for economic growth but also for fiscal sustainability.

How Can Society's Will Shape Economic Trajectory Beyond Financial Incentives?

The long-term trajectory of an economy is not predetermined by natural law; it is shaped by the will and determination of society. What matters most is society's ability to set the right agenda and confront its fundamental challenges. In this regard, economists often focus narrowly on financial incentives, but I have come to believe that social factors play a far greater role than acknowledged in standard economics textbooks. Earlier, I mentioned the low share of housework and childcare undertaken by men in both Japan and Korea, a factor that contributes to low fertility rates. This may point to deeper cultural patterns that both societies will need to address going forward.

Even if Korea experiences low inflation or mild deflation in the future, it should not be a cause for alarm, provided that the financial system remains stable. Truly dangerous episodes of deflation are confined to intervals such as the Great Depression in the 1930s, when the financial system collapsed. After I left the Bank of Japan in 2013, its balance sheet expanded hugely, but the inflation rate did not respond until recently. The 10-year average growth rate before and after the huge increase in the central bank's balance sheet remained the same, at 0.6%.

How Can Korea Balance Innovation and Social Cohesion?

Human beings are complex, sometimes overly optimistic, other times overly pessimistic, especially about the future of their own country or society. This has certainly been my observation in Japan. I do not align myself with either the optimist or the pessimist.

For the basic philosophy of the future direction for the Japanese economy, we are constantly torn between two aspirations. On one hand, we aspire to build an innovation ecosystem like Silicon Valley. On the other hand, we worry about the social fragmentation caused by extreme inequality in the United States. Each country must find its own model of development. What is needed is a reasonable consensus on the kind of society and economy we wish to build, one that acknowledges both our strengths and our weaknesses.

What Are Korea's Strengths and How Can They Inform Its Future?

Earlier, I spoke about the weakness of the "few pessimist" narrative in Japan. But we must also recognize the strengths of our own economy and society. These strengths are often overlooked precisely because they are embedded in our daily lives. Japan's traditional strength used to be technology, but nowadays the US and China are leading in this field. A recent survey targeting Asian countries, which I happened to read, made me aware of Japan's strengths: Japan is perceived as the most trusted country, even though China and the US are perceived as the most influential. This trust is a valuable asset for Japan, suggesting potential for an important role in certain areas.

The same holds true for Korea. You may or may not be aware of how the Korean economy is currently viewed in Japan. Of course, Korea's extremely low birth rate has received wide coverage in Japanese media, but more often, Korea is discussed in a positive light. For example, the fact that Korea's per capita income has surpassed that of Japan is frequently noted. Korean companies are seen as highly globalized, with Samsung being a commonly cited example, often compared to Japan's once mighty economic firms. A typical explanation I hear in Japan is that Korean corporate leaders possess a global mindset from the outset, perhaps because Korea's domestic market is small compared with that of Japan. In this context, the global success of K-pop is also frequently mentioned. I cannot say for certain how accurate these explanations are, but the key point is this: Forming a reasonable consensus about the future begins with a clear understanding of both our strengths and our weaknesses.

In this respect, the recent statement from the Japan-Republic of Korea summit meeting in Tokyo is particularly promising: "The two leaders agreed to establish a framework for consultation between the two governments to share knowledge and work together with a view to finding solutions for common social and economic issues facing both countries, such as regional revitalization, declining birth rate and aging population, rapid population decline, agriculture, and ensuring resilience against disasters." I completely agree with this. I hope the dialogue between our two countries will be strengthened.

Thank you so much for your kind attention.

Disclaimer: This content is generated using AI, synthesizing public data (filings, reports, news) and social media (Reddit, X). It may contain errors, inaccuracies, or hallucinations. Nothing herein constitutes financial advice. This newsletter is for informational purposes only; please consult a qualified professional and conduct your own due diligence before making any investment decisions.