Into theunknownA special report on JapanNovember 20th 2010

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The Economist November 20th 2010 A special report on Japan 1

Japan is ageing faster than any country in history, with vast conse­quences for its economy and society. So why, asks Henry Tricks, is itdoing so little to adapt?

highest and its birth rate (1.4 per woman) isamong the lowest anywhere. In the next40 years its population, currently 127m, isexpected to fall by 38m. By 2050 four out often Japanese will be over 65.

Like Yubari, Japan is also deeply indebt. But whereas Yubari’s �scal problemsarose from a huge public­spending splurgeaimed at wooing back its young people (atone point it had an international �lm festi­val and 17 cinemas), Japan at the start of itsjourney into the demographic unknownalready has one of the highest debt­to­GDP

ratios in the world.Japan is already full of Yubaris. Be­

tween 2000 and 2005 the number of peo­ple living in small towns and villagesacross Japan fell by 10m. Only shimmeringcities like Tokyo continue to swell, buteven they will start to look old within afew decades.

What matters most for Japan’s eco­nomic growth prospects is the decline in itsworking­age population, those aged 15­64,which has been shrinking since 1996. Forabout 50 years after the second world warthe combination of a fast­growing labourforce and the rising productivity of its fam­ously industrious workers created agrowth miracle. Within two generationsthe number of people of working age in­creased by 37m and Japan went from ruinsto the world’s second­largest economy.

In the next 40 years that process will gointo reverse (see chart 1, next page). The

Into the unknown

FOR a glimpse of Japan’s future, a goodplace to visit is Yubari, a former mining

town on the northern island of Hokkaido,which four years ago went spectacularlybust with debts of ¥36 billion ($315m). It is aquiet spot, nestled in a valley at the end ofa railway line. When the coal mines wereworking 40 years ago, 120,000 peoplelived there. But the mines have long sinceclosed, and now there are only 11,000 peo­ple left, almost half of them over 65.

The town hall is like a morgue, with fewlights on. In the past four years the numberof civil servants has been cut in half, theirsalaries have shrunk by a third and theynow have to mop their own �oors, theycomplain. The town has embarked on an18­year austerity drive to repay its debts.The public library has already closeddown. This autumn six primary schoolsmerged into one.

Even so the townspeople look anythingbut defeated. A group of 80­year­olds chat­ting in one café is the backbone of the localphotography club. Delighted to have anaudience, they show o� black­and­whitepictures taken in the 1950s, with childrenswirling around the school playground onice skates.

Like Yubari, Japan is heading into a de­mographic vortex. It is the fastest­ageingsociety on Earth and the �rst big country inhistory to have started shrinking rapidlyfrom natural causes. Its median age (44)and life expectancy (83) are among the

An audio interview with the author is at

Economist.com/audiovideo/specialreports

A list of sources is at

Economist.com/specialreports

Generation changeAfter decades of churning, Japanese politicshas started to move. Page 3

On the down escalatorA shrinking population makes it harder torekindle growth and end de�ation. Page 4

Insiders and outsidersJapan’s fabled corporate culture is ill­suitedto a smaller workforce and a knowledge­based economy. Page 5

Corporate euthanasiaTo boost productivity at home, Japan needsto kill o� some of its old, unpro�table com­panies. Page 7

Recharging the batteriesJapan has a strong innovative streak, butneeds to use it better. Page 8

Social insecurityJapan’s social­security bill is getting out ofhand. Page 9

Friends and neighboursNearby economies are booming, but Japan’sforeign relations are getting more complicated. Page 10

The dearth of birthsWhy are so few young Japanese willing toprocreate? Page 12

Bring on the cultural revolutionTo stop the genteel decline, Japan needsradical measures. Page 13

Also in this section

AcknowledgmentsThis report bene�ted from the insights and help of manypeople in addition to those mentioned in the text. Theauthor would like to thank in particular: Thomas HoyDavidsen, Mariko Fujiwara, Goshi Hosono, TomoakiIshigaki, Masafumi Ishii, Je� Kingston, Amie Nagano,Akihiko Nagashima, Takehiko Nakao, Kevin Plastow, BrianSalsberg, Toru Sashida, Tatsuya Terazawa and HiroshiYamakawa.

1

2 A special report on Japan The Economist November 20th 2010

2 working-age population will shrink soquickly that by 2050 it will be smaller thanit was in 1950. Unless Japan’s productivityrises faster than its workforce declines,which seems unlikely, its economy willshrink. This year it was overtaken by Chinain size.

The impact will become even clearer in2012 when the �rst members of the 1947-49baby-boom generation hit 65. From thenon, some believe, demography will seri-ously aggravate Japan’s other D-words�debt, de�cits and de�ation. Unless the re-tirement age rises in lockstep with life ex-pectancy, ageing will automatically pushup pension costs, further straining public�nances. Shigesato Takahashi, a seniorgovernment demographer, says it will�rock the foundations� of Japan’s social-security system. It may also entrench de�a-tion. A shortage of workers might push upwage costs, but companies will be loth toinvest in new factories.

This will make Japan a test case of howbig countries across the world should han-dle ageing and population decline. West-ern Europe’s working-age population is al-ready shrinking, though not as fast asJapan’s. East Asia, too, will watch Japan in-tently. Its industrial-growth model hasclosely resembled Japan’s in its post-warboom, rising on the same tide of an ex-panding workforce and export-led produc-tivity gains. Japan has been called the leadgoose in that V-formation. For now, as Flor-ian Coulmas, a population expert at To-kyo’s German Institute for Japanese Stud-ies, puts it, Japan is �the oldest goose�. But

South Korea’s and China’s working-agepopulations too will soon start to shrink.

One of the unfortunate side-e�ects ofageing in Japan is that it will be the youngwho su�er the most. Although unemploy-ment levels may remain among the lowestin the rich world, many of the jobs will belowly ones. The children of the baby-boomers are currently entering their 40s,which creates a secondary bulge at themiddle-manager level of Japanese busi-ness. Because of a seniority-based pay sys-tem, this puts a huge strain on businesscosts, leaving less money to provide youngpeople with training and good jobs.

It is sometimes said that Japan’s risk ap-petite mirrors that of its baby-boomers. Inthe prime of their working lives they want-ed to conquer the world with their pro-ducts. Now, in their 60s, they want a quiet-er life. The same seems to go for the

country as a whole.Yet to support them in their retirement,

and provide the generations that followthem with the economic opportunitiesthey need, Japan cannot a�ord to drift.When there is no ambulance to answer apensioner’s anguished telephone call, assometimes happens in Yubari, the conse-quences become all too clear. When cou-ples �nd they cannot a�ord to care for abedbound parent, let alone a young child,demography becomes a social disaster.

Sirens wailingThis special report will argue that Japanmust tackle this issue head on. It needs agrand plan for an ageing population.�From a business standpoint, right nowthe threat [of ageing] overwhelms the op-portunity,� says Yoshiaki Fujimori, head ofGE in Japan. �Most people are aware of it,but they don’t know how to cope with it.�Boosting productivity to counter the ef-fects of a shrinking workforce will requirea cultural revolution, especially in busi-ness. Embracing the markets opening up inAsia will mean overcoming 150 years ofmistrust of Asia (heartily reciprocated).

There are two reasons for guarded opti-mism, though. One is that, unlike a lot ofrich countries, Japan has not forsaken itsindustrial heritage. It has a cohesive work-force and it can still come up with innova-tive products.

The other reason for hope is political.Japan made a huge bid for fresh thinkinglast year when it ended the one-party rulethat had, in e�ect, been in place since 1955.The Democratic Party of Japan (DPJ) thatwon the 2009 election, now led by NaotoKan, has bungled much of its �rst year ino�ce, but its victory alone was a clear indi-cation of voters’ growing impatience withpolitics as usual. Now the party will needto show that it can deliver. 7

1From pyramid to kite

Source: National Institute of Population and Social Security Research

Japan’s population by age group, m

1950

6 4 2 0 2 4 6+–

100+

80

60

40

20

0

Male Female

2055 forecast

6 4 2 0 2 4 6+–

100+

80

60

40

20

0

2005

6 4 2 0 2 4 6+–

100+

80

60

40

20

0

Issue Date: 20-11-2010 Zone: UKPB Desk: SR Output on: 11-11-2010----16:20 Page: SR2 Revision: 0

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The Economist November 20th 2010 A special report on Japan 3

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MANY Japanese businessmen will tellyou that the biggest problem a�ict­

ing their country is lack of political leader­ship. In the past 20 years there have beenno fewer than 14 prime ministers, most ofthem forgettable. If governments whosetenure has averaged a year and a half havebeen unable to tackle pressing problemslike de�ation and stagnation, it is no won­der they have steered away from slower­burning issues such as demography. Ac­cording to Takeshi Sasaki, a political scien­tist at Gakushuin University, the entirepolitical class is ducking the issue, not leastbecause ageing citizens constitute such apowerful voting block. �The generationalissues are evaded by all political parties.They remain unconsciously wedded to20th­century demography,� he says.

Yet lately politics has started to look abit more promising. In September 2009 theDemocratic Party of Japan (DPJ) swept topower after a landslide election victory.Voters threw out the Liberal DemocraticParty (LDP) that had governed Japan withbarely a break from 1955 to 2009, ending ade­facto one­party system.

The DPJ’s chosen prime minister, YukioHatoyama, badly �u�ed the party’s �rstnine months in o�ce, but hopes picked upin June when Naoto Kan took his place.After a run of four consecutive prime min­isters whose father or grandfather hadheld the same job in the past, Mr Kan wasthe �rst without political connections inthe family. A former patent lawyer and sonof a salaryman, he also represents thegrowing in�uence of middle­aged urbanvoters increasingly prevailing over ageingrural ones who had been among the LDP’score supporters.

The porridge partyAt 64 Mr Kan can hardly be called the faceof young Japan, but his government ap­pears to re�ect a long­overdue genera­tional shift in Japanese politics. That shiftwas vividly shown up in the DPJ’s internalelection in September when a wily old fox,Ichiro Ozawa, who heads the biggest fac­tion among the party’s MPs, sought to un­seat Mr Kan but was decisively rejected bythe DPJ’s rank and �le.

It is not easy to make ideological sense

of the DPJ, a loose confederation of inter­est groups with ideas ranging from �scalconservatism to Fabian­style socialism,pro­Americanism to China­hugging. Itsmost popular policy since coming to pow­er has been to hold televised hearings oncutting government waste. Yet it has madelittle headway on its promise to reduce thepower of bureaucrats, especially in minis­tries such as agriculture, health, educationand justice.

Some of its politicians are economicliberals but felt obliged to attack the pro­market policies of Junichiro Koizumi, theLDP’s most reform­minded recent primeminister, when his legacy became bitterlyunpopular during the �nancial crisis of2008. Mr Kan talks of a �third approach� toeconomic policy, not exactly echoing the�third way� of Britain’s Tony Blair but witha strong emphasis on improving socialsafety nets to help ease the potential painof vigorous pro­growth policies.

Yet underlying this apparent confusionof ideas is a liberal trend struggling toemerge, says Koichi Nakano, a political sci­entist at Sophia University. �The DPJ be­lieves in a society that is less conformistand less risk­averse. The LDP tried to con­

trol society through the bureaucrats.�Haruko Satoh, another academic,

thinks the change re�ects the emergence of�popular sovereignty� in Japan. She notesthat voter turnout in the elections of 2005and 2009 was higher than during the 1990sas people sought to overturn the old sys­tem. This may bring more legitimacy topolitics, she argues: �Democratic participa­tion is replacing quiescent obedience.�

Something similar seems to be happen­ing in regional politics, too, which remainsstaggeringly dependent on federal lar­gesse; by some estimates, 80% of spendingin the 47 prefectures is ordered by the cen­tral government. In 2008 reform­mindedprefectural governors from several partiesformed a group called Sentaku, aimed atreducing interference from Tokyo bureau­crats. In Osaka, Japan’s second most popu­lous region, the governor, Toru Hashimoto,aims to merge the city and the prefecture togive it Tokyo­like economic clout. In a bidto get round his recalcitrant assemblymembers, he has also formed a politicalparty that he hopes will thrive on his per­sonal popularity with voters.

In the car­manufacturing city of Na­goya, Takashi Kawamura, a mayor with ataste for tropical shirts, enjoys strong popu­larity for trying to halve assembly­mem­bers’ salaries to pay for a city tax cut. Citi­zens have called for a referendum that maylead to the assembly’s abolition. Mr Ka­wamura has also helped establish a localpolitical party to �ght for the tax cuts. �Ifpeople stand up, they can change society.This is the miracle of democracy,� he says.

Both these politicians have cast them­

Generation change

After decades of churning, Japanese politics has started to move

Can Kan turn the tide?

Lower house, 2009

2A majority to lead with

Source: Psephos

Japan’s Diet election results, seats by party

Lower house, 2009

Upper house, 2010

DPJ and allies318; 109

Others22; 28

LDP andallies140;105

4 A special report on Japan The Economist November 20th 2010

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selves as crusaders, to good e�ect. But thathas not happened at the national level. MrKan and his crew come across as earnestrather than electrifying. There is still adearth of leadership.

Whenever Mr Kan was doing well inthe opinion polls since taking o�ce, hisgovernment has quickly squandered theadvantage. On one occasion he carelesslytalked about raising consumption taxesbefore elections to the upper house in July,which could have lasting consequences.Partly as a result, the DPJ lost its upper­house majority. It now faces a �twistedDiet�, meaning it lacks enough support inboth the upper and the lower house to

pass and implement legislation on its own.It may be forced to form ad hoc coalitionswith the LDP and other parties even to getnext year’s budget through. Any sign ofweakness, and Mr Ozawa may once againtake pot shots at Mr Kan.

Against that bleak scenario, some LDP

members, such as Yoshimasa Hayashi,hope that the Kan government will scrapits plans to tighten regulation of the labourmarket and increase child bene�ts, and in­stead include some of the LDP’s proposalsin its budget plans. That, they say, mightdissuade the LDP from blocking the DPJ ev­ery inch of the way.

Given the political quagmire, economic

policy in the next few years is likely to re­main a matter of muddling through. Con­ceivably Mr Kan’s government may notlast its term, which runs until 2013. Even so,the looming demographic challenges pre­sent an opportunity that Mr Kan shouldseize. The day he took o�ce, he likened hiscabinet to a ragtag militia that helped over­throw the Tokugawa shogunate at the startof the Meiji era in the late 19th century. If hecan persuade Japanese voters that dramat­ic change is needed to secure not only theirfuture but their children’s and grandchil­dren’s as well, last year’s election may startto look like another turning point in Japa­nese history. 7

FOR several decades after the secondworld war it was boomtime for Japan’s

economy as a new generation of workersentered the labour force. Brilliant entrepre­neurs like Soichiro Honda and Akio Moritaat Sony set about building the future. Apioneering baroness, Shidzue Kato, forceda male­dominated parliament to legislatefor easier birth control. Condoms becameso widely available that the birth ratehalved in the decade from 1947­57.

That meant fewer young mouths tofeed on rising salaries, thanks to a senior­ity­based system under which pay auto­matically increased with age. As the work­ing­age population rose from 50m in 1950to 75m in 1975, savings boomed and com­panies channelled them into breakneckgrowth. That was more or less the patternof Japan’s economy into the 1990s, evenbeyond the bursting of the �nancial bub­ble in 1990. Growth did not peak until 1996.

Now turn this picture on its head. In1995, just before the economy started tolose steam, the working­age population hitits high point, at 87m. Since then it has fall­en sharply. If current trends continue, in 20years’ time it will have dropped by 20m,according to the National Institute of Popu­lation and Social Security Research. By2050 it will have fallen below 50m, form­ing an almost perfect bell curve in one cen­tury. Among rich nations, only Germanywill su�er a similar fall (see chart 3).

Labour is one of the two main sourcesof economic growth. If the number ofworkers drops, output per worker has to

rise to maintain the same level of produc­tion. There are ways to ease the demo­graphic strains, such as encouraging morewomen, foreigners and older people tojoin the labour force, or seeking out fast­growing markets abroad. But if productivi­ty does not increase enough to counteracta shrinking workforce, output�and even­tually living standards�will decline.

For now the fall in Japan’s labour forceis still accelerating. At the same time cheap­er competitors in the region are forcing Jap­anese exporters to cut labour costs. And Ja­pan has yet to recover fully from thewithering e�ects of the 2008 global �nan­cial crisis.

Japanese companies have been substi­tuting capital for labour for two decades,causing the overall number of hoursworked to drop, writes Richard Katz of theOriental Economist, a newsletter. �Since1991 all of Japan’s growth in GDP has beendue to higher productivityðIf Japanwants to grow faster, it has to increase pro­ductivity. Demography and lack of immi­gration rule out any other path.�

In that sense, the two �lost decades� ofeconomic stagnation in Japan since 1990may turn out not to be an aberration but ataste of things to come. �What goes aroundcomes around, and the same demographicpro�le that supported economic growthwill now begin to weigh heavily on Ja­pan’s economy. In fact, it will leave Japanwith the lowest rate of economic growthamong the large industrialised nations,�wrote Akihiko Matsutani of the National

Graduate Institute for Policy Studies in his2004 book, �Shrinking­Population Eco­nomics: Lessons from Japan�. He believesthe unprecedented speed of the decline inJapan’s working­age population has madethe slowdown worse, and having feweryoung workers may be a�ecting Japan’sability to innovate.

Argentina of the eastMr Matsutani is not the only bear about Ja­pan’s future growth rate. Japan has justbeen overtaken by China as the world’ssecond­largest economy. By 2050 Gold­man Sachs expects it to have been overtak­en by India, Brazil, Indonesia, Mexico andTurkey too. Takashi Inoguchi, a Japanesepolitical scientist, bleakly refers to Japan asa potential �Argentina of the east�. Like theLatin American country, it might go from

On the down escalator

A shrinking population makes it harder to rekindle growth and end de�ation

3For whom the bell tolls

Source: United Nations

Working-age population, m

0

20

40

60

80

100

1950 60 70 80 90 2000 10 20 30 40 50

France

Germany

Britain

Japan F O R E C A S T

The Economist November 20th 2010 A special report on Japan 5

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being one of the richest countries in theworld to becoming sadly diminished onlya few decades later.

Already there are signs that companiesmay be trimming investment because theylack con�dence in the future. As Mr Matsu­tani argues, when your workforce is grow­ing you can cover up for overinvestmentbecause the excess will eventually besoaked up. But when populations shrink,overinvestment gets worse over time, cre­ating a de�ationary spiral.

In recent years Japanese companieshave hugely increased their saving rate,which is now close to 10% of GDP, accord­ing to Takuji Aida, an economist at UBS inJapan. Some argue that this is a hangoverof the excessive debt built up during thebubble years. But Mr Aida says it may re­�ect caution over the shrinking popula­tion, the strong yen and poor economicprospects. One of his scenarios is that in 15years’ time companies will have saved somuch that they will have no net debts.That would be very bad for Japan’s futuregrowth. To compensate, the governmentmay have to borrow even more.

Japanese managers say they are al­ready feeling the strain from a shrinking

consumer base. Convenience and depart­ment stores have merged to achieve great­er economies of scale. Last year two largedrinks companies, Kirin and Suntory, triedto join forces to o�set declines in theirhome markets, though the merger talkscollapsed over ownership disputes.

GE Japan’s boss, Yoshiaki Fujimori,notes with exasperation that his companyhas not grown in the past �ve years, largelybecause of ageing. Elderly people go to bedearly, so they use less electricity. That af­fects GE’s utility business. They travel less,which hits its airline business. Even itshealth­care business is slow, he says, be­cause the elderly are not keen to adopt newinformation technology.

When de�ation can be good for youThere is a further e�ect: the more that soci­ety ages, the more it may unconsciouslyencourage de�ation�at least the gentlesort prevalent in Japan. People with sav­ings get more in real terms as prices fall.Robert Feldman, chief economist of Mor­gan Stanley MUFG, has recently shownthat older people have a tendency to toler­ate de�ation. He has also found that theJapanese electoral system favours older

voters, who tend to live in rural areas thatare over­represented in parliament. Thatgives them disproportionate in�uenceover economic policy.

Perhaps this is one explanation for thegovernment’s and the Bank of Japan’s(BOJ’s) failure to end Japan’s long run offalling prices. The BOJ itself appears to be­lieve that de�ation is not a monetary pro­blem but one of low productivity. It hasdoubts about the e�ectiveness of quantita­tive easing, which it pioneered and whichthe Federal Reserve has used to inject li­quidity into the American economy sincethe 2008 �nancial crisis. In October theBOJ took some steps to increase liquidity,but the main reason for that seemed to beto try to appease politicians who were con­cerned about its independence.

To help with �ghting de�ation, parlia­ment is mulling whether to set the bank anin�ation target above its current range of0­2%. However, Andrew Smithers, a Britisheconomist with long experience of Japan,argues that setting an impossible targetmay be no more productive than keepingthe existing one. If ageing has helped makede�ation endemic, tinkering with in�ationtargets will make little di�erence. 7

IF YOU travel by public transport, Japancan seem like one of the most networked

countries on Earth. When they are notasleep on your shoulder, many of the un­der­50s are feverishly thumbing their mo­bile phones. You would think they had ahuge circle of friends, but Yuji Genda, a la­bour economist at the University of Tokyo,says that many just keep on texting thesame few close friends and family. Main­taining such strong bonds with a few peo­ple is very di�erent from the Western wayof keeping up with lots of �Facebookfriends�, few of them close.

Such strong relationships are echoed inJapan’s tightly knit �rms, some of whichare clannish to their roots. Mitsubishi, forinstance, started life in 1870 running theships of the Tosa clan from an island insouthern Japan. Though it is now one ofthe world’s biggest trading companies, itstill displays signs spelling out the found­ing family’s core principles everywhere. Itsemployees are encouraged to drink Kirin

beer because its makers are part of the Mit­subishi family. The companies think thistribalism is a source of strength. Innova­tors generally bring dedication, fame andfortune to their �rms rather than strikingout on their own.

Like many tribes, however, companieshave a strict pecking order based on age.When Howard Stringer, the Welsh­bornboss of Sony, last year promoted four pro­mising Japanese middle managers to se­nior positions over the heads of theirbosses, the chosen ones were initially ner­vous about accepting.

There are also lots of rules. These areuseful for encouraging the attention to de­tail and relentless improvement that arethe hallmarks of Japan’s high­precisionmanufacturing, but they can be less help­ful in the more free­spirited knowledgeeconomy. Nor is clannishness best suitedto a depopulating country. To �nd newmarkets, Japan needs to have a vibrant ex­change of information with the outside

world, which it has not been good at lately.It also needs to attract talented workerswith adaptable skills.

The island mentality a�ects the pro­ducts Japanese �rms make. The NomuraResearch Institute (NRI), a consultancy,coined the term �the Galapagos e�ect� todescribe how mobile­phone companiessuch as Sharp developed brilliant 3G tech­nologies that are ubiquitous in Japan buthad no impact overseas, where the mobileecosystem is di�erent. With an almostcomic lack of irony, Sharp this year is intro­ducing an e­reader exclusively for the Japa­nese market which it has called Galapagos.

A few big �rms, such as Sony and Nis­san, have hired outside bosses, thoughusually under duress: both faced severecompetition from abroad. Sony’s MrStringer has had to wrestle with Japan’scorporate culture in trying to turn the com­pany round. Nissan went further thanmost by forging an alliance with Renault, aFrench carmaker, with which it shares its

Insiders and outsiders

Japan’s fabled corporate culture is ill­suited to a smaller workforce and a knowledge­based economy

6 A special report on Japan The Economist November 20th 2010

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chief executive, Carlos Ghosn. But Japanese �rms’ hiring practices re­

main inward­looking, which means theirworkforce may lack a global perspective.The big �rms take on as many students asthey can from top Japanese universities, ir­respective of their skills or outside inter­ests. They hire almost exclusively upongraduation, so studying abroad during therecruitment period is bad for applicants’job prospects. Even Japanese graduateswith PhDs from foreign universities de­spair of getting jobs at big Japanese �rmsbecause they will be seen as overquali�ed.By and large Japan remains a �one­shotsociety�: those who fail to get a good jobupon graduation can be frozen out for life.

Some believe that Japan’s insularitymay have caused it to miss one of the big­gest business opportunities of the past de­cade: it failed to realise that a lot of the val­ue had migrated from the electronicdevices that the country had excelled atmaking to the content to which they gaveaccess. Sony, for example, is seeking to dealwith the problem by integrating its huge�lm, music and gaming content into itssleek products.

NRI’s Fumikazu Kitagawa says to dealwith a shrinking population, Japanesecompanies will need to reach out to over­seas markets and perhaps to forge partner­ships with foreign �rms that make soft­ware to complement their devices. If it isnot forthcoming, says Jesper Koll, head ofresearch at JPMorgan in Japan, the futuremay be not so much Galapagos as EasterIsland, where at one stage in the 19th cen­tury the number of native Rapa Nui tribes­men shrank to 111. His message is stark:�Corporate culture is killing Japan.�

For better, for worseThe company song may have gone, but forthe moment loyalty, character­building in­duction rituals and rigid hierarchies re­main common for fast­track managerialemployees. Japanese workers introducethemselves by their company name �rstand their own name second, and are farmore likely to de�ne themselves by whomthey work for than by what they do. This istrue even in Japan’s most global compa­nies. �In the United States you are alwaysdating the company,� says one executive.�Our employees marry us.�

For decades this loyalty generated hugerewards for Japan, making workers dili­gent, committed and highly productive.Their rewards were jobs for life and pay ris­ing with age. The seniority­based pay sys­tem has receded as growth has slowed but

the older workers, especially the over­50s,who are growing in number, remain themost costly.

The weight of older workers in the la­bour force, and the cultural aversion�atleast until the 2008 recession�to �ringthem has several tricky implications. Theunlucky middle­aged employees who arelaid o� are, in e�ect, thrown on the scrap­heap. Depressingly, it is possible to �nd for­mer salarymen with good English work­ing as security guards.

Just as serious are the consequences forthe young. Companies with large numbersof elderly employees have responded to ashrinking domestic market and sti� pricecompetition in foreign markets by cuttingexpenditure on hiring and training youn­ger workers. Companies are increasinglytaking on �irregular� workers, meaningthose without full­time contracts, who areeasy to hire and �re. They now make upone­third of the labour force, up from 18%in 1984, and among women the share ismore than half (see chart 4). Average payfor irregulars falls far short of that for �reg­ular� employees, even if they are doing ex­actly the same job. Irregulars also get farless on­the­job training than their contract­ed counterparts. This exacerbates the skillsgap in the Japanese economy and weakensits overall level of competitiveness.

One encouraging sign, according to To­kyo University’s Mr Genda, is that youngpeople with irregular jobs are �nding iteasier to stay on longer at the companiesthat hire them. But until they are treatedthe same as regular employees, they will

remain a poorly motivated underclass.Faced with a declining workforce, the

government has realised that its �rst priori­ty must be to make better use of the coun­try’s capable existing workers. It is settingup more crèches to bring women back intothe labour force, and indeed the propor­tion of women working is increasing asthat of men is declining.

Bamboo ceilingEven so, according to the World EconomicForum the gap between male and femaleparticipation in the workforce in Japan re­mains larger than in any other developedcountry. Women’s wages lag one­third be­hind men’s, partly because they take irreg­ular jobs, partly because they stop work­ing to start families, and also becausewomen are not given the same opportuni­ties as men to follow managerial careers.Instead they are pigeonholed into less se­nior clerical jobs, which bosses used to re­gard as little more than matchmaking ser­vices to provide overworked husbandswith loyal wives.

The passing of the 1986 equal­employ­ment­opportunity legislation removedmost legal barriers to women in the work­place, but discrimination remains ram­pant. An executive at one of Japan’s lead­ing trading behemoths explained that thewomen who applied in this year’s mana­gerial hiring round were far more able thanthe men, yet only 20% of them were of­fered jobs because women were not con­sidered well suited for the industrial em­ployment the �rm o�ered.

Such attitudes go all the way up to theboardroom. Only a tiny fraction of thecountry’s high­�ying managers are wom­en. One of them, Sakie Fukushima, ofKorn/Ferry International, an executive­search �rm, says there are only 16 senior fe­male executives working in Japan’s top 100companies. The glass ceiling in Japan isknown as the bamboo ceiling, and is evenharder to break.

There is a similar bias against olderworkers staying on after the o�cial retire­ment age. Japan has very high rates of em­ployment among people aged 60­64 com­pared even with America. It generally didnot encourage workers to retire before 60,as happened in continental Europe. Butafter 65 employment drops o� sharply.

Atsushi Seike of Keio University saysthis is partly because pensioners are sub­jected to an earnings test, so they get fewerbene�ts if they continue working. Manda­tory restrictions at many �rms force manyworkers to take lower­paid jobs after 60,

4Regular guys

Source: Ministry of Internal Affairs and Communications

Japanese employment by sex and age, 2009, %

0 20 40 60 80 100

15-24

25-34

35-44

45-54

55-64

65+

15-24

25-34

35-44

45-54

55-64

65+

0 20 40 60 80 100

Non-regular staff

Males

Females

Regular staff

The Economist November 20th 2010 A special report on Japan 7

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1

though from 2013 it will be illegal to forceanyone to retire before 65. This will make iteven more necessary to scrap the senior­ity­based pay system, because keepingolder workers on will be prohibitively ex­pensive. Mr Seike thinks that small andmedium­sized �rms, which tend not tohave mandatory retirement ages, may begood places for older people to continueworking. In fact some such �rms have trou­

ble �nding younger workers.Another way of bumping up the num­

ber of workers is to employ more immi­grants, though this is a cultural mine�eld inJapan. Pro­immigration policies are partic­ularly opposed by young people fearingcompetition from newcomers, says Keii­chiro Asao, an opposition politician whosupports letting in more foreigners. Thegovernment wants to introduce an Ameri­

can­style green­card scheme, but it seemsimplausible that it would allow in enoughforeign workers to make up for the demo­graphic shortfall, even if they all learnedJapanese: by some estimates that wouldrequire about 600,000 immigrants a year.Hiring highly skilled workers, like the Indi­an and Chinese graduates who �ock toAmerica, might be a better bet because itwould introduce fresh ideas.

The number of foreigners living legallyin Japan has more than doubled in 20years, but only from 1m to just over 2m.Most of these are Chinese and Korean, andthey are not always made welcome. More­over, these countries’ own populations areageing, so they may not be in the businessof exporting people for much longer.

The number of foreigners who havecompleted their studies in Japan is pitifullylow compared with other advanced econ­omies: 0.7% of the total, compared with29% in Australia, 16% in Britain and 13% inAmerica, according to the Ministry ofEconomy, Trade and Industry (METI).Clearly the universities are not providing abreeding ground for bright foreign gradu­ates who choose to stay. 7

Hands up those who want a decent job

THE oldest company in the world is Kon­go Gumi, a construction �rm based in

Osaka. It started building Buddhist shrinesin 578AD, and was still run by a man sur­named Kongo 40 generations later. Thenext four �rms by age are also Japanese.According to Yasuchika Hasegawa, chiefexecutive of Takeda Pharmaceuticals(founded in 1781), more than 20,000 Japa­nese �rms are at least 100 years old.

This has many merits in a world wheremost �rms come and go. No one wants tosee Japan’s industrial heirlooms vanish.But too many businesses are surviving be­cause credit costs nothing, and bankerscare little whether their borrowers arepro�table or not. That has two damagingconsequences: it ossi�es corporate culture,and it drags down productivity.

According to Mr Feldman at MorganStanley MUFG, since the 1990s productivi­ty has been rising by an average of around1% a year. That is not too bad by rich­worldstandards, but the trend is downwards,and if it drops much further GDP will turn

negative because of the country’s demo­graphic drag.

Productivity is poorest in service indus­tries, source of 70% of Japan’s output, butan o�cial at METI describes it as �veryweak across the board�. In the domesticmarket, where two­thirds of output is gen­erated, production per worker in manufac­turing is adversely a�ected by too muchcompetition. That is because companiesrefuse to consolidate, clinging onto a wideportfolio of businesses, so industries aresaturated and pro�t margins are poor.

In carmaking, for instance, Japan hasToyota, Honda, Nissan, Suzuki, Mitsubishi,Daihatsu, Mazda and Subaru. South Koreamainly has Hyundai. As a result, saysMETI, the market per car company in Ja­pan, with a population 2.5 times that ofSouth Korea, is only two­thirds the size ofits neighbour’s. Moreover, the slowdownin the global car market since 2008 has leftJapan with huge overcapacity.

In the service industries, meanwhile,the problem is too little competition rather

than too much. Few foreign �rms are activein Japan. Myriad construction �rms arekept alive by lashings of political pork. Thecountry has 350,000 wholesalers, many ofwhom just sell to each other, and mostmake only just enough to keep going.Many of the 1m retail out�ts serve as taxdodges for pensioners who sell a few itemsof stationery or snacks from their frontroom. They rarely go bust because theyhave no overheads, and stop only whenthe owners are too old to carry on.

Both manufacturing and services su�erfrom head­in­the­sand attitudes in the �­nance industry. Banks are sitting on hugeamounts of money because of the highstock of savings, but they mostly put it intoultra­safe Japanese government bonds. Asenior executive at Bank of Tokyo Mitsub­ishi UFj (MUFG), Japan’s largest bank, de­scribes this as a �public mission� to helpsustain public �nances. After lending mis­haps in Latin America in the 1970s his bankhas an abiding desire to be cautious.�We’ve existed for 130 years. Prudence has

Corporate euthanasia

To boost productivity at home, Japan needs to kill o� some of its old, unpro�table companies

8 A special report on Japan The Economist November 20th 2010

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really helped us to become a survivor.�The upshot, however, is a disturbing

lack of risk capital�not to mention vision.Bankers say their customers have little ap­petite for loans, but a third of those in thesystem are made by government entities,which may crowd out the private sector.One­quarter of the nation’s household as­sets sit in the postal system, which hasbeen beset by on­o� privatisation plans.

According to Naomi Fink of the bank­ing arm of MUFG, much of the liquidityavailable is in the form of inter­company

loans, meaning that big �rms keep theirsuppliers a�oat. That seems to be the mis­sion of the �nance industry as a whole: tokeep everyone a�oat. It is not hard to dowhen money is so cheap. But given thelack of growth in the Japanese economyover the past 20 years, it suggests thatmany companies are on life support.

Japan’s big banks could make moremoney if they were su�ciently bold andoutward­looking to enter foreign creditmarkets and fund the expansion of Japa­nese �rms abroad, where there are many

more growth opportunities. Hiroshi Wata­nabe, head of the Japan Bank for Interna­tional Co­operation (JBIC), the govern­ment agency that increasingly fundsoverseas projects, laments that �the mega­banks are still very cautious about lendingin foreign currencies. They feel comfort­able getting money in yen but they don’tknow how to raise it abroad.�

Naoto Kan’s new government appearsto have grasped the importance of produc­tivity. It has introduced a ten­year strategythat seems to be aiming for the best of all

SATOSHI OGISO was 32 in 1993 when hetook on the task of building what

Toyota, his employer, vaguely thought ofas the car of the future. The deadline wasthe start of the 21st century. In America atthat time car designers were sketchinggas­guzzlers or sport­utility vehicles. ButMr Ogiso’s team, mostly in their early 30s,wanted to create something that would�do the Earth good�, as he puts it. Withintwo years they had come up with Toyota’shybrid technology, in which a batterypowers the car for short distances and apetrol engine kicks in at higher speeds, re­charging the battery. Within four yearsthey had their �rst Prius on the road.

Now there are 2m of them and Toyotahas a prototype plug­in version that canbe charged at home, like other electric ve­hicles, but has a petrol engine for long dis­tances. In Toyota’s more distant vision, thehome (built, of course, by Toyota’s hous­ing division) will be solar­powered,which will cut emissions even further.And at night, when demand is low, thehome may even be plugged into the hy­brid car, which will have recharged its bat­tery from the engine.

This is the kind of thing you would ex­pect from Japanese manufacturing, withits focus on craftsmanship, or monozukuri.Mr Ogiso’s project exempli�es some ofthe strongest traits: teamwork, in­housedevelopment and a desire to earn gloryfor the company. What was di�erent wasthe engineers’ ages. All young, they weregiven the freedom to follow their in­stincts, with no middle managers to sec­ond­guess them. �The senior engineers

could not understand the hybrid engi­neering,� chuckles Mr Ogiso.

The tradition of in­house innovationruns deep in Japan, and some of the re­sulting products may help the country toadapt to an ageing society. Bill Hall at Syn­ovate, a market­research company, reelso� a list of new products that are alreadyavailable, or will be soon: the Toto intelli­gent toilet that can detect the level of sugarin urine; Panasonic’s robotic bed thatturns into a wheelchair; Toyota’s battery­powered individual three­wheeler, withbuilt­in sensors to avoid collisions.

But it is not so easy for people whowant to strike out on their own. YoshiyukiSankai’s company, Cyberdyne, makes ro­botic suits that interact with damaged ner­vous systems to enable people to walk, forexample. This year a man who had beenstuck in rehabilitation for nine years aftera car accident started to walk again afterputting on a Cyberdyne suit. Mr Sankaibelieves that there would be many moresuch innovations in Japan if the countrywere to set up business parks near univer­sities to stimulate entrepreneurship.There are hardly any.

Some conclude there is almost a cultur­al aversion to entrepreneurship in Japan.Banks are reluctant to provide credit tostart­ups. Venture capital is scarce. Manysay it re�ects the communal nature of Jap­anese society, developed in the rice pad­dies and re�ected in the time­worn adage,�the nail that sticks up will be hammereddown.� Yoshito Hori, a venture capitalistwho founded Globis, a fast­growing busi­ness school in Japan, explains that �themore successful you are, the more carefulyou have to be of how you project your­self, because of the envy.�

But young Japanese are also unwillingto take the risks associated with starting abusiness. Yoshikazu Tanaka, the 33­year­old boss of Gree, a mobile­gaming com­pany whose listing made him reputedlythe youngest billionaire in Asia, believesthis is because many are too complacent.�About 99% of young Japanese thinkeverything is just �ne. They are wrong. Ja­pan is like a frog being boiled alive, but sofar the water is only warm.�

Japan has a strong innovativestreak, but needs to use it betterRecharging the batteries

What will they do for an encore?

The Economist November 20th 2010 A special report on Japan 9

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worlds�a strong economy, strong public �­nances, a strong welfare system�but itspriority is growth. �We need to revive anenergetic Japan,� Mr Kan said at his inau­gural news conference in June.

The growth targets�3% a year in nomi­nal, 2% in real terms by 2020�may bebased more on hope than experience, butthe diagnosis of the industrial problems isrefreshingly clear­eyed. METI says Japan’sdependence on the car industry, whichgenerated half of all GDP growth from2000­07, is unsustainable. It also points toJapan’s uncompetitive tax system. Big�rms pay around twice as much as theirSouth Korean rivals in absolute terms, yettax revenues are notoriously weak. Thegovernment plans to lower corporate taxrates in order to boost competitiveness.

But is its solution the right one? It be­lieves it must actively support industrieswith strong global growth potential, suchas clean energy, because everyone else isdoing it. But by �picking winners�, it risks ahuge misallocation of resources if it makesthe wrong choice.

At least there is broad agreement be­tween the government and Japanese busi­ness about which industries deserve themost support. Japanese car �rms and bat­tery­technology companies are already

well placed to create low­energy products:CO2 emissions per unit of GDP are halfthose in America, and brands like the hy­brid Prius have become household names.�We were behind in the IT revolution. Thegreen revolution is a competition we can­not lose,� says the METI o�cial.

Japan insideThe government also wants to developmedium­sized �rms with very high­techproducts that form the basis of future de­vices. Like �Intel inside�, the logo the chipcompany puts on computers, productscould carry a �Japan inside� badge of qual­ity, METI muses.

Given Japan’s broad manufacturingbase, one big opportunity could be to de­velop cross­industry partnerships involv­ing, say, water, nuclear power or railwaysthat tap into the need for infrastructure de­velopment in emerging markets. Mr Wata­nabe of JBIC points to the example of har­nessing solar or wind power with batteryrecharging. It is not the same type of con­nectivity that produced Facebook andTwitter, but it would have its uses.

Boosting productivity, however, is notjust about �nding the industrial darlings oftomorrow. It is also about weeding out to­day’s second­raters so that pro�table new

businesses can spring up instead. To makethat happen, Japan needs to do more toopen up to foreign competition by forgingfree­trade agreements (FTAs). Japan has ahandful with smaller economies like Mex­ico, Chile and Singapore, and has an eco­nomic partnership with the Association ofSouth­East Asian Nations. Meanwhile itsambitious rival, South Korea, has signedFTAs with the European Union and others,and is restarting talks with America. Nego­tiation of such treaties has been held up byJapan’s powerful farm lobby�eventhough farming accounts for just 2% ofGDP. Everyone else is paying a huge op­portunity cost to protect those farmers.

What Japan needs most of all is a hugeboost to its domestic economy, which isstill its greatest source of demand. Thereare many ideas for achieving this, such asreviving its housing industry by getting itto build properties suitable for an ageingpopulation, and bee�ng up its health­caresector. The �nance industry too should be�nding ways to encourage the elderly to dosomething constructive with some of their¥1,500 trillion savings hoard. But thatwould require improvements in Japan’ssocial­security system, which delivers in­adequate pensions and o�ers weak safetynets for those who lose their jobs. 7

TWO decades of post­bubble economicstagnation, together with an ageing

population, have led to what the Japanesecall the waniguchi (crocodile’s mouth) ef­fect: total public expenditure has soaredwhereas tax revenues have dropped. Thefastest­rising expenditure item in the bud­get is social security (covering pensions,medical insurance, welfare and employ­ment programmes), which has risen from¥11.5 trillion in 1990 to a forecast ¥27.2 tril­lion this year. Some 70% of all social­secu­rity payments now go to those over 65.

Japan’s social­security bene�ts are stillless generous than those of many Euro­pean countries, but the scope to increasethem is limited by the size of the nationaldebt. Already pension payments are ab­sorbing a growing share of the total social­security bill. In 2006 they accounted for13% of national income, almost double thelevel of 1990, and their share is due to rise

further (see chart 5, next page).A reform of the public­pension system

in 2004 provided for a small rise in contri­butions each year until 2017, when theywill be �xed at 18.3% of income. It also com­mitted the government to increasing itssubsidy to the basic pension and drew up aframework for indexing pensions basedon the number of contributors and on lifeexpectancy. The idea was to reduce overallbene�ts and stabilise the system for 100years. But the OECD says that for people onlow pay the projected pension, at 47% ofprevious earnings, is much lower than therich­country average of 72%.

Japan’s private pensions complementthe public ones, covering 45% of the work­force, though years of meagre investmentreturns, especially after the 2008 �nancialcrisis, have hit them badly. Several big lifeinsurers have gone bust. What is more, themandatory retirement age and the age

from which employees can start drawingcorporate pensions will rise to 65 in 2013,just when lots of people born in the mid­dle of the baby boom start to take theirleave. Given that sudden rush, the cost ofpensions may start to look unsustainable.

Worse still, the longer that people live,the fewer workers there will be to supportthem. When public pensions were intro­duced in the 1960s there were 11workers forevery pensioner. Now there are 2.6, com­pared with an OECD average of four. In asign of growing disillusionment with thepension system, almost 40% of the self­employed fail to pay contributions.

On top of the pension problem, health­care costs will rise inexorably, mainly be­cause of technology. McKinsey estimatesthat total health­care expenses will almostdouble between 2005 and 2020, makingthem increasingly una�ordable, not leastbecause of the rising number of elderly

Social insecurity

Japan’s social­security bill is getting out of hand

10 A special report on Japan The Economist November 20th 2010

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people. The quality of care may well godown. Already, says McKinsey’s LudwigKanzler, emergency wards turn away pa­tients because they are understa�ed.

The government has been able to fundits growing �scal gap by raising debt in thedomestic market. Through banks and pen­sion schemes, the Japanese hold 95% of thecountry’s huge public­sector debt. Andhousehold and corporate savings stillcomfortably exceed the level of debt, keep­ing the national balance­sheet solvent.

Piggybanks in perilBut the more the Japanese age, the morethey will dip into this savings pot. Accord­ing to the life­cycle theory of savings, peo­ple build up assets in their working yearsand spend them in retirement. The savingrate, once above 20% of disposable in­come, has dropped to about 2% and mayturn negative�which would increasedoubts about the sustainability of Japan’s

debt �nancing. For now this decline is o�­set by the strong rise in corporate savings,which is why Japan continues to run acomfortable current­account surplus. Theworry is that the more companies and or­dinary savers fret about the future of Ja­

pan’s economy, the more likely they are toinvest their money overseas. For a com­pany that may take the form of setting upfactories in Thailand, for example, and notrepatriating the pro�ts. Personal savers arealready seeking higher returns in marketssuch as Brazil’s.

In that scenario Japan would have toborrow abroad. Its current­account sur­plus would vanish and it might su�er thesame sort of turbulence as Greece did earli­er this year. That is something it would go along way to avoid. So more likely, econo­mists say, it will progressively push up theconsumption tax, cut back on social ser­vices and possibly even in�ate away itsdebts. It would, in e�ect, partially defaultnot on its debts but on its obligations tosociety. �The most serious inconvenienttruth in Japan is that the government will�reluctantly�have to cut social spending,�says Masaaki Kanno, chief economist ofJPMorgan in Japan. 7

5Not cheap, not cheerful

Source: Ministry of Finance

Japan’s social-security benefits, ¥trn

0

40

80

120

160

0

10

20

30

40

1990 95 2000 06 11 15 25

Pensions

Medical care and welfareAs %of GDP

F O R E C A S T

WALK into the inn in the Hokkaido vil­lage of Akanko, and everything from

the welcoming cry of �irasshaimase� tothe taciturn old man grilling chicken on the�re seems quintessentially Japanese. Until,that is, you hear all the customers speakingMandarin. The Chinese have �ocked tothis area since it provided some of the set­tings for a 2008 Chinese blockbuster com­edy, �If You Are The One�.

The local Japanese were shocked whenthe early arrivals used the onsen, or spas, todo the unthinkable: they washed theirdirty clothes in the hot tubs. There is stillsome tut­tutting about Chinese customs�the elbows on the table, the lack of famil­iarity with �ushing loos�but if it were notfor these visitors, the tourist trade in thearea would be half­dead. Before the Chi­nese �y out of Sapporo, Hokkaido’s capi­tal, they splurge on items like medicinesand rice cookers. Tourism o�cials call itthe �Hokkaido boom�.

Japan is a country with immaculate ser­vice, good food, beautiful countryside andexcellent beaches. As the domestic popula­tion shrinks and regional economies suf­fer, it makes sense to encourage increasing­ly a�uent visitors from other parts of Asia.The Japan Tourism Agency (JTA) has at last

understood this. It has set a goal of attract­ing 10m tourists this year, a big leap fromlast year’s �gure of 6.8m. To make this pos­sible it has relaxed its stringent visa re­quirements, which used to allow in onlythe wealthiest Chinese. Figures up to Sep­tember showed a 56% rise in tourist arriv­als from China, a degree of success that hascaught the Japanese o�­guard.

However, in late September the JTA’splans went awry when the arrest of a Chi­nese trawlerman, �shing in what Japanconsiders its own waters, triggered theworst diplomatic incident between thetwo countries in half a decade. China loud­ly reasserted its rights to the disputed is­lands, administered by Japan, which theJapanese call the Senkaku Islands butwhich in China are known as the DiaoyuIslands. China cancelled diplomatic andcultural exchanges. When Japanese o�­cials discovered that imports of rare earthsfrom China, vital for some of Japan’s tech­nologies, were being held up, the �sher­man was abruptly sent home. But not be­fore all but �ve of 61 Chinese tour groupsthat had booked to visit a spa near MountFuji had cancelled their reservations.

Japan still carries a lot of old diplomaticbaggage in Asia. It has festering territorial

disputes not only with China but also withSouth and North Korea, Taiwan and Rus­sia. Japanese history books sometimes dis­agree with those of its neighbours, and Ja­pan’s apologies for its treatment of themduring the second world war have notfully allayed their suspicions. Many in Ja­pan seem to believe that the war startedwith Pearl Harbour and ended with atom­ic bombs being dropped on Hiroshimaand Nagasaki. But for many Chinese, hos­tilities started in 1931 with Japan’s invasionof Manchuria, and for South Korea 100years ago with its annexation by Japan.

Uncle Sam’s umbrellaJapan was able to turn its back on Asia formost of the post­war period because of astrong security alliance with America thathas now been going for 50 years. In itsneighbours’ eyes, that helped avert the riskof resurgent Japanese militarism. It alsomeant that Japan was able to keep its de­fence spending at less than 1% of GDP, en­abling it to concentrate more resources onbecoming an industrial power. But Asia’srise since the end of the cold war has com­plicated Japan’s external relations.

When the Democratic Party of Japan(DPJ) swept to power in 2009, ending 54

Friends and neighbours

Nearby economies are booming, but Japan’s foreign relations are getting more complicated

The Economist November 20th 2010 A special report on Japan 11

2 years of virtual one­party rule, one of itsmost controversial policy platforms was toestablish a friendship with China that bal­anced the close post­war relationship withAmerica�one of the hallmarks of the Lib­eral Democratic Party’s rule. The DPJ’sleaders dispatched hundreds of its MPs topay court to Beijing. In a sign of its eco­nomic ambitions, the government later ap­pointed a former captain of industry as itsambassador to China.

But the strategy was quickly blown o�course, initially by a row with America.This was caused by a rash promise madeby the DPJ’s �rst prime minister, Yukio Ha­toyama, to the people of the island of Oki­nawa to scrap an agreement to moveAmerica’s Futenma marine base from acrowded town to a more remote part of theisland. Many locals resent the Americanbases, so they welcomed Mr Hatoyama’spledge to reduce the burden on the island.But he failed to �nd a better alternative, sowhen last May he was forced to proceedwith the move more or less as planned, itcost him his job. All this meant that foreignpolicy in the DPJ’s �rst year in o�ce fo­cused mainly on the strained relationshipwith America. Pro­American countries inAsia, such as South Korea, reacted ner­vously to the potential threat to a securityalliance that has helped preserve peace inthe region for decades and acts as a coun­terweight to a strong China.

Naoto Kan’s government has reaf­�rmed its support for the alliance withAmerica. But the Senkaku incident re­newed fears within the Japanese govern­ment that China’s rise�and especially itsmassive military spending�is a threat toJapan. DPJ politicians in the party’s �real­ist� faction think that China must be madeto understand that it cannot rattle its sabrewith impunity. Others in the DPJ �rmly be­lieve in Japan’s paci�st constitution. Oth­ers still insist that Japan can become in­creasingly independent of America’ssecurity umbrella, perhaps by building upits own forces, but at the same time remaindoveish towards China.

Seiji Maehara, the new foreign ministerin Mr Kan’s government, is on the party’srealist wing. He is convinced that if eco­nomic relations between the two coun­tries were to cool it would be bad for bothof them. But he adds: �I’m neither a shal­low­minded rightist nor a nationalist. I’m arealist who believes in a win­win relation­ship with China.�

That is where the relationship withAmerica comes in. There was relief in To­kyo when Hillary Clinton, the secretary of

state, a�rmed that the Senkaku Islandswere covered by America’s security treatywith Japan. Yet the Kan administrationmay not be able to hold up its side of theFutenma bargain with America. Okina­wans still staunchly oppose relocation.

Japan, in a volatile neighbourhood, istrying to hedge its bets. Yet it is not fully se­cure in its relationship with either east orwest. It needs America’s security backing,but its industrial future increasingly de­pends on East Asia. In theory, the regionshould provide it with boundless opportu­nities to o�set the decline in its population.METI estimates that within �ve years therewill be more high earners living in otherparts of Asia than in Japan itself. China isso big that just the increase in the numberof cars sold there last year was roughly thesame as the entire Japanese car market.

The business caseBut if the opportunities are huge, so are thechallenges, and they are not just dip­lomatic. According to METI’s statistics, Ja­pan’s sales of intermediate goods to Chinahave tripled in the past decade, but SouthKorea’s have increased by a factor of 11.Over the same period Japan’s exports of�nished goods to America and Europehave risen by a mere 10%, whereas SouthKorea’s have increased 6.5 times and Chi­na’s 5.9 times. Japan still has a large tradesurplus with South Korea, partly because itsells specialist high­tech components forcompanies such as Samsung to put into itsown devices. South Korea is so bothered

by this that its o�cials keep trying to lurethe component­makers away with prom­ises of lower tax rates.

Japanese �rms that have expanded intoChina have sometimes failed to grasp howdi�erent it is. They have a lot to o�er theirneighbour, including an emphasis on qual­ity, trusted products and a strong serviceculture. They were among the earliest in­vestors in China after the two countriesnormalised their relations in 1972. Shang­hai­based Yasuo Onishi of JETRO, Japan’sexport­promotion agency, notes that Japa­nese carmakers, for example, enjoy strongbrand recognition, even though some oftheir cars are too expensive for middle­class Chinese. (The Prius, however, is con­sidered not fancy enough for China’s rich.)

Chinese executives complain that Japa­nese businessmen too often come to lec­ture them rather than to listen, and thatthey tend not to promote Chinese manag­ers. There are some honorable exceptions.After a series of strikes this year at compa­nies supplying goods to Toyota andHonda, Komatsu, a maker of heavy ma­chinery, pledged to replace all the Japanesemanagers at its 16 sites in China with Chi­nese bosses by 2012.

Shiseido, a cosmetics­maker, has en­joyed a sevenfold increase in sales to Chi­na since 2000, says Shinzo Maeda, its chiefexecutive. It has created brands exclusivelyfor the Chinese market and promotes localtalent, albeit with strict Japanese rules onhow to serve customers.

Such companies have a long history inChina and are likely to stay the course. Butthey are still vulnerable to strains in the re­lationship. After Junichiro Koizumi, primeminister from 2001 to 2006, enraged theChinese by making repeated visits to To­kyo’s Yasukuni shrine, which honourssome war criminals along with fallen sol­diers, it was the business lobby that helpedpersuade his successor, Shinzo Abe, tobreak bread with the leaders in Beijing.

More tourism within the region mayhelp ease some of the misgivings. Culturealso plays a role: many young people inAsia were brought up on Japan’s J­pop mu­sic scene and manga comics. The Japanese,for their part, are wowed by South Korea’sgirl bands and soap operas.

But there is another thing that some ofthese Asian countries have in common.South Korea is already getting older fast,and even China’s working­age populationis forecast to start declining from 2015. If Ja­pan can �nd a way of dealing with an age­ing and falling population, its neighbourswill be all ears. 7Japan �rst

12 A special report on Japan The Economist November 20th 2010

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AT 84, Masuyo Hirano happily describesherself as in �the spring of my life.�

The sprightly woman lives in a nursinghome with 50 other pensioners. But she isnot idle. She votes. She does acupuncture.She and her friends sing karaoke, their del­icate hands wrapped around the micro­phone. She dexterously weaves slippersfrom multicoloured ribbons that take daysto �nish, and hands them out to visitorslike sweets.

There are two reasons for her happi­ness. The �rst is that she has made satisfac­tory arrangements for the remainder ofher long life. In a country where 28m peo­ple are over 65 and many millions livealone, are bedridden or su�er from de­mentia, she has found herself a place thatis a model of public­private care and willlook after her until she dies. She has nochildren, and will not need to ask her rela­tives to do anything further for her.

The second reason she is happy is thatshe knows what will happen to her re­mains after her death. The Yashioen nurs­ing home in Saitama, a district north of To­kyo, o�ers her a burial club in which sheand her friends will be placed in the sametomb together, which the nursing homepromises to tend. This sort of service islikely to become more popular in Japan aselderly people have fewer children tomourn them. Many Japanese in their lateryears are tormented by the prospect of ly­ing in a lonely and forgotten tomb. �I’vetalked this over at length with my neph­ews and nieces,� she says. �I don’t want tobe a burden on them.�

When Ms Hirano was born in 1926, herparents’ generation was not expected to

live beyond 50. Today her age is nothingexceptional; life expectancy for women is86 and for men 80. Japan has known fordecades that it was getting older. Its grow­ing life expectancy, now the longest in theworld, was a cause for celebration as farback as 1962, when a special report by TheEconomist described it as possibly �one ofthe most exciting and extraordinary sud­den forward leaps in the entire economichistory of the world�. The fruits of this suc­cess are now known as �hyper­ageing�: noother country has grown so old so rapidly.The median age is approaching 50. That issurpassed only by Monaco, a Mediterra­nean retreat for wealthy pensioners.

Some of the stories about Japan’s en­during centenarians need to be taken witha pinch of salt. This summer Tokyo’s sup­posedly oldest man, 111­year­old SogenKato, turned out to be a heap of bones cov­ered in newspapers dating from 1978. Hisdaughter, now 81, had been collecting hispension for decades. That event turned upa few similar cases. But for all the �miss­ing� centenarians, there are still reckonedto be about 40,000 bona �de ones. Somany have reached the age of 100 that thesilver sake cups they are customarilyawarded have been reduced in size.

The darker side of that heartening pic­ture of longevity is Japan’s shrinking birthrate, which at 1.4 per woman is the second­lowest in the rich world, after South Ko­rea’s. From the start of the Meiji period in1868 Japan’s population rose for about 70years. During that time Japan cast o� itsisolationist feudal system, opened its bor­ders and started its headlong rush to indus­trialisation. Then, in the 1950s, fertility

started to plummet. Since the 1980s, whenthe birth rate fell below 1.5 children perwoman, Japan has, in e�ect, had a one­child policy�though, unlike in China, itwas self­imposed.

It came as a shock to demographerswhen the 2005 census showed that thenumber of deaths exceeded that of birthsfor the �rst time: the population had start­ed to shrink two years ahead of schedule.The 2010 census results are currently beingprocessed and preliminary results are duein February 2011.

Go on, have another oneSince the mid­1970s, when it became clearthat the number of births was resolutelydeclining, Japanese governments havemade e�orts to encourage people to havemore babies. But for all that they have in­creased child bene�ts and provided day­care centres in the past 30 years, the birthrate has remained stubbornly low. Onereason is that in Japan, unlike in the West,marriage is still more or less a prerequisitefor having children. Only 2% of births takeplace out of wedlock. And weddings cost alot of money. The more elaborate sort mayinvolve renting a chocolate­box �church�and hiring or buying at least three bridalout�ts. The average cost of a Japanese wed­ding is about ¥3.2m ($40,000).

Having gone to all that trouble, marriedcouples do, in fact, have an average ofslightly more than two children, just abovewhat is needed for births to exceed deaths.The trouble is that fewer and fewer peopleget married. Women wait ever longer andincreasingly do not bother at all. Accordingto the NIPSSR, six out of ten women in

The dearth of births

Why are so few young Japanese willing to procreate?

The Economist November 20th 2010 A special report on Japan 13

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IN THE Hokkaido town of Yubari, the gen­eral hospital was one of the earliest casu­

alties of the municipality’s bankruptcy.The building was so big that the heatingbill alone ate up a lot of the budget, and thegrowing number of elderly patients put itunder increasing strain. So in 2006 Tomo­hiko Murakami, a pioneering Hokkaidodoctor, decided to turn it into a blueprintfor health­care reform. His blunt messagewas that the money had run out, so atti­tudes had to change.

He closed down two­thirds of the hos­pital, cut the number of ambulances inhalf and told his elderly patients theyshould walk to hospital because it wasgood for them. They grumbled, but itcaused no obvious deterioration in theirhealth, he says. They had to use their owninitiative rather than relying on the gov­ernment to look after them. It was the

same when half­empty schools merged.What he calls the �Yubari model� mayhold a lesson for the country. �It may takebankruptcy to change attitudes in Japan,but that would be a good thing,� he says.

Similar change is creeping into otherpockets of Japan too. Doctors praise thepreventive health care in mountainous Na­gano prefecture, which has the highest lifeexpectancy and the lowest health­carecosts in Japan. In one Nagano village, Shi­mojo, where almost a third of the citizensare pensioners, some of the elderly havestarted providing child care so that youngwomen can work. The birth rate is rising.

Talk of radical change is becoming in­creasingly common among Japan’s busi­nessmen and academics. People seem tobe almost yearning for a proper crisis toshock the country out of its state of lethar­gy, ingrained after 20 years of economic

stagnation and almost 15 years of declinein the working­age population. But as yetthere are not enough Dr Murakamis tohelp along the painful but necessary pro­cess of reform.

The sooner the betterIn dealing with its demographic troubles,Japan will need a cultural revolution to im­prove productivity, boost its labour forcewith more women, older people and im­migrants, promote a more vibrant domes­tic economy and make the most of boom­ing markets overseas. And even if itmanages to do all these things, it may stillhave to go through a period of managedeconomic decline when its famously com­fortable living standards start to fall, as hasbeen happening in places like Yubari.

Boosting productivity will require bigchanges in its business practices. They may

Bring on the cultural revolution

To stop the genteel decline, Japan needs radical measures

their mid­ to late 20s, which used to be thepeak child­bearing age, are still unwed. In1970 the �gure was two out of ten. And al­most half the men between 30 and 34 wereunmarried in 2005, more than three timesas many as 30 years ago.

But the cost of weddings may be theleast of the reasons why the Japanese areincreasingly putting o� marriage or avoid­ing it altogether. One weightier one is thatemployment rates among women have in­creased but private companies implicitlydiscourage mothers from returning to theirold jobs. Toshiaki Tachibanaki, an econo­mist who has written on inequalityamong Japanese women, �nds that about80% of female civil servants return to theirold jobs after having children because theyget reasonable maternity bene�ts and helpwith child care. But in private companiesthey are typically less well looked after,and only about a third go back to work.

So most women are forced to take low­paid irregular or part­time jobs after hav­ing children. NIPSSR �gures show that thevast majority of working women aged35­49 have jobs of that kind, earning¥500,000­1.5m a year. Most men in thesame age group work in regular jobs (withfringe bene�ts) and are paid ¥3m­6m.

It does not help that unemployment ishigh and incomes are low among the

young�especially among young men,who increasingly give up even looking forjobs. One of Japan’s most prominent soci­ologists, Masahiro Yamada of Chuo Uni­versity, thinks that most young Japanesewomen still want to be housewives, butare struggling to �nd a breadwinner whoearns enough to support them. He pointsout that half the young people of primemarrying age�20­34�still live with theirparents. In the 1990s he coined the term�parasite singles� to describe them. Theyseemed to be getting a good deal, savingmoney on rent and spending it on foreigntravel and luxury goods instead. If theywanted privacy, they could always go toone of Japan’s ubiquitous love hotels.

Leave me aloneSince then the �parasites� have got older,and a lot of them are living with their par­ents not because they want to but becausethey cannot a�ord to live independently.They are moving towards middle age buthave remained single, working for low payor unemployed. Some have even becomewhat Mr Yamada calls �pension parasites�,living on their parents’ pensions.

Part of the problem may be that youngmen, who during Japan’s free­wheelingboom era rarely saw their workaholic fa­thers, do not want to fall into the same trap.

Some of them have become �grass­eatingmen� who prefer clothes and cosmetics tocars and avoid life in the fast lane. Othersresort to hikikomori, locking themselves intheir bedrooms and refusing to talk to any­one, even the parents who deliver food tothem. Many of them have watched theirmothers divorce their fathers on retire­ment. Those men are cruelly known as�dead wet leaves�, whose wives have trou­ble sweeping them out of the home. TheJapanese are also learning from personalexperience that looking after elderly par­ents can be more costly and time­consum­ing than looking after children. That maybe another factor in their calculations.

Florian Coulmas of the German Insti­tute for Japanese Studies in Tokyo, whohas made a special study of population is­sues in Japan, has no easy explanations forthe low birth rate, but describes it as the�bitter fruit of success� in Japanese demog­raphy. �A growing percentage of the popu­lation, both married and never married,without children has no vested interest insociety, with hitherto unknown conse­quences for its self­image and sense of pur­pose,� he writes. And even if policymakersmanaged to reverse those choices and per­suade the Japanese to have many morechildren, the bene�ts to the workforcewould not be felt for 20 years. 7

14 A special report on Japan The Economist November 20th 2010

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have served the country well when itspopulation was young and growing, butnow it needs to dismantle its rigid cor­porate hierarchies to allow new peopleand ideas to emerge. It needs to bust the ta­boo on hiring, or working with, foreigners,and it needs to continue streamlining itshydra­headed industrial giants. As HeangChhor, head of McKinsey in Japan, puts it,business has little choice but to focus ongenerating more pro�t with fewer re­sources. �This is a country where the mind­set is all about input. In Japan what is ex­pected of you is always to try harder, to putin more hours. They don’t value output.�

The workforce will have to becomemore diverse, too, to ensure both that tal­ent is recruited wherever it can be found,and that the products being made are at­tractive to foreign markets. That means hir­ing people who know something aboutthe world, not just those who have spentyears in crammer schools to get into Ja­pan’s best universities and biggest �rms.

The government, meanwhile, needs too�er incentives for its citizens to consumemore as they get older. The housing stock,for instance, could be adjusted to suitfrailer tastes. Medical tourism could helpturn Japan into a haven for rich Asians�ifonly more doctors spoke English andhealth­ministry bureaucrats relaxed theirstringent regulations. And reforms in �­nancial services and social security mightpersuade the elderly to release some of the¥1,500 trillion of household savings, help­ing to rebalance not just Japan’s economybut the world’s.

There are structural obstacles that makethese things harder to do. Throughout itsmodern history Japan has relied on its bu­reaucrats, in their bunker­like compoundKasumigaseki, the �fortress of fog�, toguide it. Yet Japan’s population issues spanso many ministries that they cannot be

tackled with fortress thinking. Politiciansneed to take the lead and rally society be­hind them.

That is why the victory of the Demo­cratic Party of Japan (DPJ) in last year’selection should be a reason for hope. Theparty vowed to diminish the power of thebureaucrats. It also aimed to lessen someof the inequalities that had emerged dur­ing the two �lost� decades under the Liber­al Democratic Party (LDP).

Yet it has barely begun to face up to thedemographic challenge, even though thatis likely to exacerbate those inequalitiesamong the young as well as the old. Whenit was in opposition, it shot down the LDP’ssensible plan to make the elderly pay a bitmore for medical services to re�ect theirgreater use of them. When it discusses age­ing, the DPJ mostly points to the opportu­nities of creating products and services forthe elderly, but rarely considers the threatto Japan’s already shrinking villages andtowns. It seems to have given little thoughtto merging those villages, towns or evensome of the 47 prefectures to rationalisepublic services.

If in doubt, do nothingThe political establishment has no grandplan for what to do with unused schools,or how to make the health­care systemmore e�ective by encouraging preventionrather than cure. And strengthening thepublic �nances to deal with an ageing pop­ulation remains politically fraught. Ideassuch as raising the consumption tax�at 5%the lowest in the rich world�meet withstrong opposition.

There is a daunting list of things to bedone, and Japan, like its elderly citizens,

tends not to be keen on change. Its defaultmode is to stick with things as they are un­til they become intolerable. For example,as in Yubari, overstretched social servicesmight have to get close to collapse beforeaction is taken.

The conservative camp, which includesmany elderly people, argues that the coun­try should simply learn to live with less.Economic growth does not matter, it con­tends, if the population is shrinking, aslong as GDP per person is su�cient for acomfortable life. Some hark back to the 150years after 1700, the last time when Japan’spopulation and economic growth stagnat­ed. Many cherry trees were planted to keeppeople on low incomes happy, and popu­lar theatre �ourished. At that time Japanwas in voluntary isolation from the out­side world. But the regime became su�o­cating and unsustainable, and ended withthe Meiji Restoration of 1868.

A similar hairshirt approach to popula­tion decline today would rob the younggeneration of economic opportunities,and would be a huge waste of Japan’s po­tential economic bene�t to the world atlarge. Given Japan’s already high publicdebt, it would also be hard to sustain; pub­lic services might still end up in tatters.

Many Japanese feel that the countrywill gather the courage to tackle the demo­graphic threat only when living standardsand social services fall in the cities, wheremost young and middle­aged voters live.For the moment, such places still feel toobusy and comfortable to be ready for pro­found change. But as Japan’s city­dwellingpoliticians look at their greying hair in themirror, tomorrow’s crisis may be staringthem in the face. 7

Tomorrow’s world?