This text first appeared as a section in The Wednesday Letter #296.
Things are happening in Japan. The Nikkei 225 index made a new all-time high today (chart). The country has a new prime minister, Sanae Takaichi, who also happens to be the first female prime minister and a conservative. She is described by some as Japan’s Donald Trump, and has stated that she will prioritize closer relations with the United States.
I spent a summer in Tokyo in 1989 and was enrolled in business and management classes at Sophia (Jochi) University. At the time, the 1980s Japanese bubble was in its final stages. It peaked at the end of that year and deflated in the early 1990s. There was at the time of my visit, and for years after, a lot of anxiety in the United States about Japan being the rising power that would supplant the US on the world stage. The Japanese were increasingly dominant not only in auto manufacturing but also in new technologies such as computers, semiconductors and robots. Instead, Japan entered a lost decade in the 1990s (which arguably became two lost decades in the 2000s), while the US economy and stock market raced higher.
Today the rising power threatening US supremacy is China. Now as then, there is a lot of anxiety in the United States about China supplanting the US on the world stage. There are some important differences however. First, relative to the US economy, China is much larger now than Japan was in 1990. Second, the emergence of several other countries from poverty means that China can trade with the rest of the world to a much larger extent than Japan did in the 1990s. Third and perhaps most important from a US perspective, Japan was and remains a strategic ally of the United States, whereas China is at best a competitor and adversary, and at worst a future enemy in a kinetic war.
It is possible that China’s rise will stall or decline in future decades, much as Japan’s stalled in the 1990s, but we cannot assume that it will. Chinese policymakers are shrewd and have studied the lessons of Japan and also of the Soviet Union to avoid the same loss of prestige and hegemony. We should assume until proven otherwise that China’s power and economy will continue to grow and that they will increasingly challenge US interests.
The revival of Japan’s stock market, economy and governance is therefore a welcome development from the point of view of the United States. Japan and China have been enemies in the past and eye each other today with wary suspicion. Further, Japan has close relations with Taiwan and will be compelled to defend Taiwan if China tries to forcibly take over the island. We can see the contours of deterrence forming in Northeast and Southeast Asia. The US and its main regional allies, Japan, the Philippines and South Korea, are all preparing for an eventual conflict. It is possible that, in the event of a shooting war, Vietnam and other countries would join the US side.
As of today, Japan’s armed forces are not very large but they are large enough to make Chinese strategists incorporate them in their calculus of a Taiwan invasion. Takaichi has vowed to increase defense spending, and will likely show a greater disposition to stand up to China, two shifts in policy that may bolster deterrence and help avoid a shooting war. It is worth noting that China has not congratulated Takaichi on her appointment as prime minister.
Meanwhile, the Japanese economy has several challenges to deal with. One is the government’s high level of indebtedness at 230% of GDP, the highest in the OECD. Another is the country’s fading demographics. Japan is getting older and its population is shrinking. This first chart below shows the median age in Japan, China and the US. Japan’s current median age is 49.8 years, vs 40.1 for China and 38.5 for the US. The median age is rising in all three countries, and fastest in China. In 2050, the median age will be 52.8 years in Japan, 52.1 in China and 41.9 in the US. The total Japanese population peaked in 2010 at 128 million. Since then, it has declined to 123 million and is expected to drop to 105 million by the year 2050.
Naturally, the combination of aging and a shrinking population will have a greater impact on the size of the working-age population. This is shown in the chart below. The population aged 15 to 64 peaked in 1995 at 87.6 million and has fallen to 72.3 million in 2025. It is expected to continue falling to 53.9 million in 2050. This is a decline of nearly 40% since the year 2000. Under a traditional economy, this precipitous fall would cause great concern. But under a new AI-driven economy that requires fewer workers, it is possible that Japan will avoid the employment difficulties that other economies will encounter.
Also critical for the economy is the rise of the dependency ratio, the ratio of dependents (children and the elderly) to workers. The dependency ratio will rise in Japan, China and the US (chart below), but Japan’s shows the most dramatic profile and most extreme climb between now and 2050. I have written elsewhere that China owed a large part of its economic boom to a halving of its dependency ratio between 1975 and 2010, but this trend has now been thrown in reverse. The dependency ratio in China is rising and has created headwinds for the Chinese economy.
Note in the chart below how the dependency ratio bottomed close to an economic peak in all three cases: in Japan around 1990, in the US around 2008 and in China around 2010. This is at the very least an interesting coincidence.
When we consider the three pillars of wealth creation per the populyst model, Innovation & Productivity, Demographics & Health and Governance & Society, Japan seems well positioned in all three. The country’s demographics have been a major concern but they may in fact yield unexpected advantages in an AI world.
