Japan's Secular Inflation Trap
Declining Labor Participation Rates and the Wage-Price Spiral
KS Advisory - Insights - March 18, 2024
The Bank of Japan must act and adjust monetary policy. Additionally, it is likely to move from the last major bank to tighten policy to the only central bank that will continue to tighten policy while other major central banks will be easing. This is the most probable scenario unless Japan finds a lasting solution to its declining labor participation rates.
Japan’s labor supply has plateaued, presenting one of the most significant challenges to its economic resilience. Since the early 1990s, Japan has captivated observers with its unique trajectory, defying many pessimistic forecasts. However, as is often the case with secular trends, the anticipated negative spiral appears to be manifesting at a slower pace than initially calculated.
This negative spiral is intricately linked to Japan's debt burden and demographic composition. Despite being a fraction of the size of the USA in terms of landmass (0.2% compared to 6.1%), Japan has emerged as one of the most remarkable post-WWII economic success stories.
Source: www.cia.gov
Source: data - OECD, Worldometer, chart - KS Advisory
However, past achievements do not guarantee future prosperity. Japan's economic miracle has been waning for decades due to the challenge of a steadily shrinking working-age population. Economic projections, such as those provided by the Japan Research Institute (JRI), indicate a decline in both growth and unemployment, alongside a puzzling decline in inflation, which seems incongruent with the significant challenges posed by declining labor force participation rates.
Source: data OECD, chart - KS Advisory
While there has been some progress since 2018, with Japan now hosting a record number of foreign nationals (3.2 million), further action is needed in immigration and integration policies to mitigate the formidable headwinds created by a diminishing labor force. Barring substantial changes to immigration policies, Japan's demographic trend is unlikely to reverse course.
The complexity of Japan's economic predicament necessitates a multifaceted response. Authorities across various policy domains must coordinate efforts, ranging from immigration and integration policies to family planning and the long-neglected monetary policy lever. Without a concerted effort to address these challenges, Japan risks transitioning into a secular inflationary wage-price spiral, with far-reaching implications for its economy and financial markets.
Source: Japan Research Institute
Source: Data BoJ, Chart - KS Advisory
References:
- IMF - "Shrinkonomics: Lessons from Japan," GEE HEE HONG, TODD SCHNEIDER, March 2020
- Nippon News - "Japan as an 'Immigrant Nation': The Need for Frankness on Recent Policy Changes," September 21, 2023
- Japan Research Institute
- Bank of Japan
