The Impact of Aging Population on Debt Dynamics and the Differences Between Developed and Emerging Markets

Japan’s experience as one of the first countries to have an aging population offers a glimpse of what’s to come for other countries on the same path. See what an older population could mean in terms of social policy, productivity, immigration reform, medical costs and more.

----- Transcript -----

Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Robert Feldman: And I'm Robert Feldman, Senior Advisor at Morgan Stanley MUFG Securities.

Seth Carpenter: And on this special episode of the podcast, we will talk about longevity, and what the rest of the world can learn from Japan. It’s Tuesday, February 6th, at 8 a. m. in New York.

Robert Feldman: And it's 10 p. m. in Tokyo.

Seth Carpenter: Over the past year, I am guessing that lots of listeners to this podcast have heard many, many stories about new anti obesity drugs, cutting edge cancer treatments. And so today, we're going to address what is perhaps a bigger theme at play here.

Now, the micro human side of things is clearly huge, clearly important. But Robert and I are macroeconomists, and so we're going to think about what the potential for longer human lifespans is. For the economics. So as life spans increase, we're probably going to see micro and macro ramifications for demographics, consumer habits, the healthcare system, government spending, and long-term financial planning.

And so, it follows that investors may want to consider these ramifications across a wide range of sectors. So, Robert, I wanted to talk to you in particular because you've been following this theme in your research on Japan -- which is perhaps at the earliest stage of this with the fastest aging population across developed economies.

So, start us off. Perhaps share some more about the demographic challenges that Japan is facing and what's unique about their experience.

Robert Feldman: Thanks, Seth. First, let me start by saying that Japan is not so much unique as it is early. For example, in the 1960s, Japan's total fertility rate averaged about two children per woman. But it hasn't been above two since 1975. Now it's about 1.34. Population as a whole peaked in 2010 and now is down by about 2.4 per cent.

What about government spending on pensions and healthcare? Well, those went from about 16 per cent of GDP in 1994 to about 27 per cent now. So the speed of these increases is extremely fast. That said, Japan has one very unusual feature. Labor force participation rates have climbed quite sharply, especially for women. So, more people are working and they're working longer.

But at the same time, Japan has actually been pretty successful in holding down costs of many longevity related spending categories. Japan has a nationalized healthcare system. So, the government has lots of power over drug prices, which it has held down. It’s shortened hospital stays. They're still too long -- but it has shortened them. It has also raised retirement ages and has a very clever pension indexing system.

Seth Carpenter: All right, so if I can sum this up then, Robert. Japanese workers are working longer, the Japan economy is spending less on health care. So, does this mean that we can just say Japan has solved most or all of the challenges associated with longer lifespans?

Robert Feldman: Well, it’s not exactly reduced spending on healthcare. It just hasn't gone up as much as it might have.

Seth Carpenter: Okay, that's a good distinction.

Robert Feldman: Yes. Anyway, Japan has not solved all the problems, not by a long shot. So, for example, productivity growth is very important for holding debt costs down. But productivity growth -- and I like the simplest measure, just real output per worker -- has been anemic in Japan.

So, when productivity growth is low and aging is fast, it's kind of hard to pay the cost of longevity; even if labor force growth is high and Japan has been able to suppress ageing costs. That's the wrinkle here.

Seth Carpenter: Okay. So then, if we shifted to think about the fiscal perspective on things. The debt side of things. Is the longer-lived nature of the population; is that going to end up being something like a debt time bomb?

Robert Feldman: Well, I don’t think so. At least not yet. And there are two factors behind my view. One is the potential for productivity growth to accelerate a lot. And the other is some special things about Japan's debt dynamics. Let me start with growth. There is huge room here for productivity growth here in Japan. We still has a lot of labor that's underused. The labor force is very well educated, and it's very disciplined. Therefore, it can be re-skilled for more productive jobs. There's also a lot more room for cost reduction in social spending categories, especially by using IT and AI. In addition, healthier people are more productive workers.

On the debt dynamic side, the national debt is about 250 percent of GDP. Very high. But Japan owns 1.23 trillion dollars of foreign exchange reserves. So, Japan is borrowing a lot at very, very low short-term rates, and very low long-term rates as well. They're below one per cent. That said it’s earning high foreign interest rates on its external assets. In addition, about half the national debt is owned by the central bank. And so when the central bank, the Bank of Japan, collects coupons from the government, it pays them right back to the government in its year end profit.

Seth Carpenter: Okay, so that helps put things into perspective. So, if we're looking forward, do you have any concrete measures that you think Japan as a society, the Japanese government might undertake? And what some of those potential outcomes might be?

Robert Feldman: Well, I'm expecting incremental change that Japan is very good at. Social policy is hard to make. There's a lot of politics involved. Even in the prime minister's policy speech the other day, he mentioned a number of things. There will be changes. For example, ways to keep costs down but also to improve productivity. There will some changes in retirement ages. There will be some flexible labor market rules. This is important because ideas move with people; and when people move more, then productivity should go up. There will be continued easing of the immigration rules for highly skilled workers. Japan now has about 2 million foreign workers and the number will probably keep going up. Medical costs reforms are also very important. For example, it’s important for Japan to allow non doctors to do some things that heretofore only doctors have been permitted to do. Faster deployment of new technologies in high import sectors like energy and agriculture -- this should save us a lot of money in terms of not buying imports that we don't need once technology is deployed domestically. Now, can I ask you some questions?

Seth Carpenter: Of course.

Robert Feldman: Okay. So. From where you sit as a global economist, what aspects of Japan's experience do you think are particularly relevant to other economies?

Seth Carpenter: I would say the part where you were touching on the debt dynamics is particularly salient, right? We know that in the COVID era, lots of countries sort of ran up a really large increase in their national debt. And so, trying to figure out what sort of debt dynamics are sustainable over the long run I think are critical. And I think the factors that you point out in terms of an aging population, sort of, have to be considered in that context.

I think more broadly, the idea of an aging population is pretty widespread. It is not universal, obviously. But we know, for example, that in China, the population growth is coming down. We know that for a long time in Europe, there has been this aging of the population and a fall in fertility rates. So, I think a lot of the same phenomena are relevant. And like you said at the beginning: it's not that Japan is unique, it's that Japan is early.

Robert Feldman: I have another question for you is, and also on this longevity theme -- about the difference between developed and emerging markets. What are the notable differences between those two groups of countries?

Seth Carpenter: Yeah, I mean, I think we can make some generalizations. It is more often the case that slowing population growth, falling fertility rates, aging population is more of a developed market economy than an emerging market economy phenomenon. So, I think in that regard, it's important. I will say, however, that there are some exceptions to every rule.

And I mentioned China that, you know, maybe straddles those two worlds -- developed versus emerging market. And they’re also seeing this slowing in their population growth. But I think within that, what's also interesting is we are seeing more and more pressures on migration. Immigration could be part of the solution. I think you highlighted this about Japan. And therein lies, at times, some of the geopolitical tensions between developed market economies and emerging market economies. But I think, at the same time, it could be part of the solution to any of the challenges posed by longevity.

Seth Carpenter: But, I have to say, we probably need to wrap it up there.

Robert, for me, it is always a pleasure to get to talk to you and hear some of your wisdom.

Robert Feldman: Thank you, Seth. This is great. Always happy to talk with you. And if you want to have me back, I'll be there.

Seth Carpenter: That's fantastic. And for the listeners, thank you for listening. If you enjoy thoughts on the market, please leave us a review on Apple podcasts and share the podcast with a friend or colleague today.