Japanification of the US Economy
Why US investors need to worry about long-term immigration trends
Written by Tom Yeung, CFA | CDFA Investment Advisor & Fund Manager, Jurnex Financial Advisors |
In 1981, The Harvard Business Review wrote a lengthy article extolling the successes of the Japanese economy. Post-WW-II Japan had become the envy of the world, producing goods and services that rivaled its western counterparts. By the year 2000, however, the Japanese miracle had ground to a halt, according to a study by McKinsey. And twenty years later, the country still hasn’t regained its position as a top world innovator. What happened, and why do US investors need to worry about Japanification of the US economy?
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What Japan got right
Japan became a leader in mass-produced technology and innovation through the 1970s through the 1990s. Sony released the first mass-market transistor radio in 1957 and the Walkman in 1979. And in 1989, Nintendo introduced the Game Boy to the world’s delight.
Innovation happened on the industrial front as well. Kawasaki modernized the steel-making industry in the 1960s, while Toyota Industries perfected the air-jet loom during the 1980s. Japan moved from a devasted post-war era to becoming one of the world’s leading economies. And this happened in just two generations.
These changes did not go unnoticed by the stock market. Between 1960 and 1990, the Nikkei 225 index rose from 875 to 38,915, a 44x increase. Gains averaged 13.4% per year, far faster than most countries ever saw.
How did the Japanese economic miracle happen?
Experts point to several factors that laid the groundwork for post-WW-II Japanese industrialization
- US Government. The influx of US investment after the war (thanks to the Marshall plan) helped kickstart a fledging industrial economy.
- Japanese Government. The Japanese government can also take credit: economic interventionism, enforced property rights, and a comprehensive education system all helped to modernize the Japanese economy.
- Corporations. Fierce competition between large companies sparked a competitive race to quality, allowing figures such as W. Edwards Deming to make their mark on Japanese production.
Where did Japan go wrong?
In the 1990s, however, the economic miracle began to break down. The property market crash of 1990 certainly didn’t help. But other factors also plunged Japan into one of the most prolonged bouts of economic stagnation in modern history.
According to a McKinsey study published in 2015, the Japanese economy truly started having problems in the year 2000. That’s when the economy began to take a two-track path.
Companies in foreign export industries, such as high-tech steel and automobiles, remained strong. However, weaker domestic companies began to lag. Productivity began to wane as “zombie companies,” propped up by bank loans, started taking an increasing share of economic wealth.
By 2011, the malaise of local zombie companies had also put pressure on high-performing export companies. Funding became tighter, and profitable corporations had to compete with loss-making companies at home. By 2020, the Total Factor Productivity (TFP) of Japan had declined to just a 0.79% growth rate, compared to 0.95% in Germany and 1.02% in the US, according to the Brookings Institute, a think tank.
Demographics helped cause Japanification
The key reason for Japanese stagnation came from a shift in the labor markets. In 1980, the median age in Japan was just 32.5 years old. By the year 2000, this number had ballooned to 41.2 years. And today? The average age is now a geriatric 48.8 years old.
For comparison, the US median age is currently just 37.7 years.
The quickly aging population took the Japanese economy by surprise. While demographers knew that Japan would age due to low birthrates, few foresaw how fast things would happen.
The key surprise? Virtually nonexistent immigration.
Geographic and cultural isolation
As an archipelago, Japan has historically remained isolated from the rest of the world. And the separation isn’t just physical. It’s cultural too.
Over the decades, Japan made it extraordinarily difficult for migrants to move there. Despite having an aging population, Japan awarded citizenship to just 15,812 people in the year 2000. And in 2015? That figure had collapsed to 9,469 approvals.
According to the Economist, Japanese immigration officials have traditionally made naturalization extraordinarily cumbersome, in an almost xenophobic fashion.
Demographics begin to bite
Rapidly aging demographics have turned the Japanese economy into one focused on dependent-care. The OECD now estimates that the old-age dependency ratio in Japan is now over 50%.
With a smaller working base, labor productivity gets channeled towards caring for the retired, elbowing out longer-term investment.
Deflation a symptom, not a cause
Many experts have long pointed to deflation as a cause of the Japanese economic malaise. Yet deflation is usually a symptom of a shrinking economy, not the cause of one. A study by the World Economic Forum found that over the decade of the 2000s, the population growth rate and inflation correlate positively across 24 advanced economies
From the data, researchers Derek Anderson, Dennis Botman, Ben Hunt concluded that aging caused substantial deflationary pressures, mainly from declining growth and falling land prices.
How to Invest in a Low-Return Environment
Will the US experience Japanification?
The US economy has flashed warning signs over the past decade.
- Low Bond Yields. Despite efforts by the US Federal Reserve to increase inflation expectations to its target of 2%, rates remain stubbornly low.
- Two-Tier Growth. Economic growth in US urban areas has outpaced growth in rural ones.
- Aging Population. America’s birthrate of 1.7 births per woman is lower than the 2.1 birth ratio required to maintain population size.
These factors sound like bad bad news for the US economy: low rates tend to signal lower future returns since invested capital can’t grow as quickly.
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Immigration helping the US stay competitive
For now, however, the US has maintained its working-age population and competitive edge in high tech industries thanks to immigration. In 2017, the US awarded 108,101 H-1B visas and 86,300 H-2B visas for foreign workers. A further 716,000 people became naturalized US citizens that year.
In other words, the US naturalizes around 30 times more people than Japan does on a per-capita basis.
However, US immigration has taken a turn for the worse. According to León Rodríguez, the director of US Citizenship and Immigration Services (USCIS) from 2014-2017, immigration has become far more difficult under subsequent administrations. Today, USCIS case processing time is 46% higher than in 2016. Additional application hurdles have made it harder for any would-be applicant to gain US citizenship. These days, every employer-sponsored green card applicant “must now appear for an in-person interview, even though there’s no practical justification for such interviews except in a small group of cases that appear to have higher potential to undermine public safety or the integrity of the immigration system.”
Will the US experience Japanification too?
Immigration policies compound another problem: the US is still a greying country. By 2040, experts estimate the old-age dependency ratio will increase from 28% today to 37%.
Nowhere else is this so clearly shown as in Social Security. According to Barron’s, an investment publication, the Social Security Trust Fund could run out of money as early as 2035.
And that’s bad news for retirees. With fewer working-age people to sustain the Social Security taxes, benefits must get cut, or Social Security tax rates must rise. Either outcome would further sap the economy of resources.
The warning bells for Japanification are sounding. Politicians on both sides are fretting about immigration policies. And investors are getting taken along for the ride.
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Conclusion: Japan offers a cautionary tale
Despite relatively high productivity by Japanese workers, the Japanese economy has stagnated as its population has aged. From an investment standpoint, Japan has also lagged. Since 2000, the Nikkei 225 has increased by just 15%, while the US S&P 500 increased by 115%.
Will the US face a similar problem? Without an increase in natural birthrates, the US will remain dependent on immigration to keep a healthy-sized working-age population.
As the US population ages, there’s a knee-jerk reaction to limit immigration. In the short-run, these limits might conserve resources for existing citizens. But the long-run effects of restricting immigration can be devastating. If the US wants to avoid long-term Japanification of its economy, its politicians must maintain clear immigration policies that favor admitting productive people, while helping existing working-age Americans remain productive.
The US faces a complex balance between immigration and job re-training. Get it wrong, and we risk a generation of Japanification. But if we get that balance right, we’ll not only avoid Japanification, but also thrive as a nation. Good luck investing!
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