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Interim Report IR-01-009/February Aging in Japan

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Interim Report IR-01-009/February Aging in Japan International Institute for Tel: +43 2236 807 342 Applied Systems Analysis Fax: +43 2236 71313 Schlossplatz 1 E-mail: [email protected] A-2361 Laxenburg, Austria Web: www.iiasa.ac.at Interim Report IR-01-009/February Aging in Japan: Causes and Consequences Part II: Economic Issues David E. Horlacher ([email protected]) Revised and updated August 2002 Approved by Landis MacKellar ([email protected]) Project Leader, Social Security Reform February 2001 Interim Reports on work of the International Institute for Applied Systems Analysis receive only limited review. Views or opinions expressed herein do not necessarily represent those of the Institute, its National Member Organizations, or other organizations supporting the work. Contents Introduction .......................................................................................................................1 I. GDP and the Distribution of Income and Assets ......................................................2 A. Size and Growth Rate of GDP ..............................................................................2 B. Income Distribution...............................................................................................4 C. Distribution of Assets............................................................................................5 II. The Growth of Physical Capital Will Slow...............................................................6 A. Savings Rates........................................................................................................6 1. Levels and Trends in Savings Rates..................................................................7 2. Factors Influencing Future Savings Rates.........................................................8 3. Research on Japanese Savings Rates ................................................................8 (a) Are Japanese Savings Rates Really That High? ..............................................8 (b) Why Are Japanese Savings Rates so High? ....................................................9 (c) What Other Factors Might Explain Japanese Saving Rates?.........................16 (d) Will Aging Cause Japanese Savings Rates to Fall? ......................................22 B. Consequences of a Falling Savings Rate.............................................................27 1. Wealth to Disposable Income Ratio................................................................27 2. Investment .......................................................................................................27 (a) There will be a Deficit in Japan’s Current Account ......................................30 (b) There Will Be a Surplus in Japan’s Current Account ...................................32 III. The Supply of Labor and Human Capital May Fall............................................33 1. The Growth of the Labor Supply ....................................................................33 2. The Composition of the Labor Force Is Changing..........................................37 (a) The Proportion of Employees is Rising.........................................................37 (b) Most Employment Will Be In the Tertiary Sector ........................................38 (c) Distribution by Levels of Human Capital......................................................38 3. Most Labor Force Participation Rates Are Falling .........................................41 (a) Labor Force Participation ..............................................................................42 ii (b) The Labor Force Participation of Most Young Adults Will Decline ............43 (c) The Labor Force Participation of the Elderly Is Falling................................45 4. Institutional Factors Affecting Labor Supply and Demand ............................47 (a) Seniority-based Wages ..................................................................................48 (b) The Official Retirement Age .........................................................................49 (c) International Migration..................................................................................51 IV. The Growth of Total Factor Productivity Is Slowing .........................................51 V. The Pension and Health Systems ............................................................................55 A. The Social Security System.................................................................................56 Public Pensions .......................................................................................................58 (a) Contributions .................................................................................................59 (b) Benefits..........................................................................................................60 (c) Financing Pensions ........................................................................................61 (d) Distributional Effects of the Pensions System ..............................................63 (e) Impact of the Pension System on Labor Supply............................................66 B. The Health System ..............................................................................................66 (a) The Role of Population Aging in Rising Health Costs..................................67 (b) The Medical Finance System ........................................................................70 C. Welfare................................................................................................................71 VI. Economic-Demographic Models of Aging in Japan...........................................71 A. Overlapping Generations Models........................................................................72 1. Auerbach, Kotlikoff, Hagemann and Nicoletti (1989)....................................72 2. Hviding and Merette (1998)............................................................................73 3. Fougere and Merette (1999)............................................................................74 B. Models Specifically Developed to Study the Japanese Economy.......................75 1. Meredith (1995)...............................................................................................75 (a) The Baseline Scenario ...................................................................................76 (b) Policy Simulation ..........................................................................................76 2. Yashiro et al. (1997b)......................................................................................77 (a) The Baseline Scenario ...................................................................................78 (b) Policy Analysis Simulations..........................................................................79 3. Miles and Cerny (2002)...................................................................................81 4. Mulheisen and Faruquee (2001)......................................................................81 5. MacKellar et al. (2002) ...................................................................................82 iii Discussion (by Landis MacKellar)..................................................................................82 Annex 1: Studies of the Determinants of Japanese Savings .......................................86 Annex 2: Economic-demographic Models of Aging in Japan ....................................90 References .......................................................................................................................91 iv Abstract This survey reviews current research on the impact of present demographic trends -- population aging combined with slower overall population growth -- on Japan's economic future. Among the conclusions that emerge are the following: • Japan has been successful in combining rapid economic growth with a high degree of economic equality. However as its population ages its income distribution will become more unequal. But this will be due to a greater weight being given to the elderly where income is distributed most unequally. There is not likely to be any significant increase in inequality within age groups. • Much of the research reviewed here has to do with the relationship between population aging and household savings in Japan. This research has tended (some might say narrowly) to confirm the relevance of the life cycle hypothesis, leading to the conclusion that population aging will reduce the household saving rate. There is unanimity that population aging will negatively affect government balances through the rising system dependency rate of the public pension system and, less significantly, rising health care costs. Thus, all projection exercises studied here have concluded that projected demographic trends will reduce the aggregate saving rate. • Much less attention has been devoted to investment than to saving. All projection exercises reviewed here have concluded (or, perhaps more accurately, assumed) that the impact of demographic trends on investment will be less significant than their impact on saving, with the result that the current account surplus will diminish, and may eventually turn into a deficit. • The traditional Japanese labor market system of lifetime employment, seniority-based compensation, and mandatory retirement at an early age is already coming under pressure due to aging of the labor force. The opportunity costs of distortions and institutional factors that affect
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