WASHINGTON, April 12 (UPI) -- "I have seen the future, and it works" wrote Lincoln Steffens, fatuously, after his visit to the newly Soviet Russia. Today, if you want to see the future working you should look at Japan, which demographically and in terms of the business cycle is where we will be a decade from now.
Demographically, as is well known, Japan is facing in the next 5 years the aging problem that the West will face in the mid 2010s. By 2005, one fifth of Japan's population will be 65 or older; meanwhile, fertility has dropped to 1.3 children per woman, well below replacement level. Like most advanced societies, Japan thus has an actuarial problem in its social security system, with the labor force slipping by 0.7 percent per annum between now and 2025, but Japan's problem is occurring a decade ahead of everybody else's schedule.
The famous Japanese savings rate, 20 percent in the 1970s, has in the last decade dropped precipitously to around 4 percent, not much above the level in the United States, although the accumulated "stock" of savings at around $13 trillion is, relative to the economy, much larger. A decade of very low interest rates, combined with a decade of economic stagnation, has caused this, but the demographic transition, as the aging cohort of Japanese moves out of the prime savings years must also have had an effect.
With low savings and an economy that (as repeatedly forecast here in 2001-02) is sputtering into recovery, Japan would appear at first glance to be in a similar cyclical position to the United States, but this is not so. The Japanese economic slowdown was not one of the mildest on record as in the U.S., it lasted for more than a decade, from 1990 till late in 2002. The Japanese stock market is not 11 percent down from its all time high (the Dow Jones index) or 25 percent down (the S&P 500 Index) but by the Nikkei still, after a considerable recovery, fully 70 percent below its 1990 all time high of 39,000.
Unlike the United States, Japan has suffered more than a decade of asset price deflation, in stocks and real estate, in spite of an easy money policy that has lasted since the middle 1990s. Unlike in the United States, all traces of overvaluation and bubble have finally been washed out of the system, and both stocks and real estate in Japan rest on a firm foundation of sound value. Of course, commentators warn continually of the possibility of deflation, and of the debt overhang in the Japanese banking system, but just as at the top of a bubble all risks are ignored, so near the trough of a downturn all risks seem insuperable.
The overhang of bad debts in the Japanese banking system is at this stage easily manageable. The bubble real estate loans of the late 1980s are now at least 14 years sour, and so have mostly been written off long ago. Today's bad debts relate to industrial and service sector companies, such as the supermarket chain Daiei, that have run into the difficulty owing to over-expansion in the 1980s and a decade of stagnation thereafter. In such extreme circumstances, as the U.S. 1930s notoriously proved, even sound companies will get into difficulty.
If you're a Japanese bank, therefore, economic recovery and a rebound in the stock market make your troubles magically disappear. Economic recovery converts doubtful debts of battered but viable companies into sound loans, while the stock market rebound increases the value of your very large stock portfolio holdings and thereby your capital -- you cannot recognize such stock profits in the balance sheet directly, but it is a simple matter to arrange with a friendly neighboring bank to sell some of your holdings to it and buy some of its holdings in return, thus capitalizing both banks. This is not the soundest way to run a banking system, but it beats leveraging yourself to the hilt with derivatives contracts, as the largest U.S. banks and housing finance institutions have done.
The other notorious and allegedly insoluble problem in the Japanese economy is the fiscal deficit, largely a product of insane infrastructure spending schemes to prop up the ailing construction industry and attempt to get Japan out of the 1990s recession, combined with a prolonged economic downturn that has reduced revenues. At its peak in 2002, the Japanese fiscal deficit was 10 percent of gross domestic product, and Japanese public debt is now 140 percent of GDP. Bears on Japan, too numerous to count in the U.S., then go on to explain that the Japanese demographic transition, and the un-funded social security payments it brings, will inexorably increase this debt, to 780 percent of GDP by 2050 in one exceptionally pessimistic scenario, resulting in default and disaster.
Once again, the attempt to paint Japan like Argentina won't work -- as Moody's demonstrated last week by raising Japan's debt rating to AA+, only one notch below the AAA maximum. The Japanese budget for 2004 increased public spending by only 0.4 percent in nominal terms, far below the 3-4 percent likely increase in GDP for the year. Since the Japanese tax system, like most, has "bracket creep" that increases tax yields more than proportionately as incomes increase, the budget deficit is likely to decline sharply, and to remain declining as long as the current government is in power and the economy continues to expand.
Prime Minister Junichiro Koizumi stated on assuming office in April 2001 that his number 1 priority was to eliminate wasteful government spending and bring the budget closer to balance; against the powerful Japanese bureaucracy and the opponents within his party it has taken him some time, but he has now begun to achieve this goal, and so long as he remains in office it is likely that the goal will continue to be approached.
The long term future for Japan is beginning to emerge, and it is largely an attractive one. The economy will continue to expand at a moderate rate, and the stock market will continue to outperform the U.S. and most European markets (though it will of course decline if, as is likely, the U.S. market takes a sharp and long-overdue drop.) The banking sector will continue to deal with its problems, helped by an increasingly solid capital base and the return of many of its marginal borrowers to soundness. The yen will rise, as the Bank of Japan ceases its frantic purchases of U.S. Treasury debt, realizing that propping up U.S. fiscal and economic improvidence is neither politically necessary nor economically attractive. The extraordinary strength of the Japanese export sector will diminish, but the Japanese domestic economy, no longer handicapped by an appallingly expensive distribution system, will enjoy a sustained and well-earned boom, fueled by imports that become ever-cheaper in yen terms, and yielding attractive returns to investors in domestic service industries.
As for the supposed demographic disaster, that is a chimera, fueled by Western assumptions about a society that has avoided many of the malignancies of the modern West. Japan never indulged in an excessive "youth culture" so older workers, while less venerated than 30 years ago, are still far from being tossed on the industrial scrap heap. The overall labor force participation rate in Japan is somewhat lower than in the United States, but the participation rate for male workers over 55 is significantly higher, in spite of the prolonged Japanese recession.
The Japanese female labor participation rate is around 10 percent lower than in the West, and the Japanese tradition of respect for the elderly leads to a much greater continuing connection with the previous generation than in the U.S., where the old retire to Florida. While Japanese women, according to opinion polls, resent the need to devote themselves to raising children, the combination of more stay-at-home mothers and more available grandparents greatly improves the quality of Japanese child-rearing over its Western equivalent.
The very low level of immigration in Japan is often held to be a disadvantage, as it forces the country to solve its demographic problem internally. However, the U.S. and European "solution," involving waves of youthful immigrants devoting their tax revenues to the care of geriatric locals, is pure fantasy; there is no reason whatever why the immigrants, once inside the country, should put up with such transfers.
In the homogenous Japanese society, there is more connection between the young and the old, far lower crime rates, and an understanding that, for the demographic transition to work, the young must pay somewhat higher taxes than they actuarially should, while the old must continue active in the labor force somewhat longer than they had expected. There is every sign that in Japan, a disciplined society, people already realize this.
Assuming neither Japanese polices nor Japanese reproduction patterns change significantly, Japan will become the first example of what in an optimistic scenario will be a universal pattern by 2100.
-- Population will gently decline, with a growth rate of perhaps minus 1 percent per annum, while its age distribution will be heavily weighted towards the old.
-- Working lives will be long, ending around 70 in most cases, while per child expenditure on education and youth development will be very high.
-- The society will be affluent, but will spend relatively little on infrastructure, as the declining population reduces pressure on roads, sewage systems and public transport -- in any case, the less wasteful parts of Japan's 1990s infrastructure tsunami will serve for decades if not centuries.
-- Real estate prices will rise more slowly than inflation, and housing standards will improve rapidly, as the cramped overcrowded Tokyo of the 1980s becomes a distant memory.
-- Although the society will be oriented towards the old, its devotion to the relatively few young will produce a market in satisfying the desires of pampered children. Japanese successes internationally with Pokemon and Yu-Gi-Oh show this to be already a major Japanese competitive advantage.
-- GDP will grow at perhaps 3 percent per annum per capita (2 percent from productivity improvements and 1 percent from deepening of capital usage). This will however result in GDP growth of only 2 percent per annum, slower than in the U.S. and in emerging markets, although probably faster than in western Europe. Hence Japan's relative economic importance will decline, particularly compared to the rapidly enriching societies of China and India.
-- Increasing domestic real wealth will produce a rapid improvement in the quality of life, both in terms of public goods such as environmental protection and private goods in terms of larger houses, second homes, etc.
-- Reflecting society's age distribution, there will be a dearth of entrepreneurship, although part of this gap may be filled by older entrepreneurs, in good health and with substantial savings. However, the economic and social costs of this lack will be compensated for by much lower crime levels than in the West, because of the society's age and homogeneity.
-- The society will be militarily weak, as it will have few young people (and will place a high value on them). It will satisfy international treaty obligations through cash transfers and possibly through hiring mercenaries. Fortunately Japan has little land and few natural resources; its wealth results from the abilities and hard work of its people. Thus if the world remains reasonably orderly it will be in no danger of invasion and only modestly threatened by terrorism.
-- Stock market beneficiaries will be those companies oriented towards domestic services, in particular health care relating to the older-oriented population, and towards high-income consumer goods such as luxury automobiles. In addition, Japan's current strength in video games, oriented towards its pampered and well educated children, will continue to include software as well as hardware, so through its video game Hollywood Japan will have an increasing impact on world culture.
As I said, Japan works. If we are lucky, and increase the world's wealth while controlling and in the long run decreasing its population, it may represent our long term future as well as its own.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, April 2004) -- details can be found on the Web site greatconservatives.com.
