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The fiscal 2005 “Annual Report on the Japanese Economy and Public Finances” pays attention to the impact on the economy of two inevitable demographic changes: the expected shrinkage of the population (the first such shrinkage since World War II) and the retirement in large numbers of baby boomers born immediately after World War II.

The recently released report takes up the effects of these demographic changes for the first time. It’s about time — in view of the fact that Japan’s population is due to start shrinking in 2007. The report also declares an end to the postbubble economy, stating that the Japanese economy has virtually rid itself of three drags on economic growth — excessive labor, production capacity and debt (bad loans held by banks).

The baby boomers — Japanese born between 1947 and 1949 — total 6.8 million, accounting for 5.3 percent of the population. Meanwhile, people aged 15 to 64, who are regarded as the core of the nation’s labor force, has been declining since 1995.

Naturally, the retirement of baby boomers will cause a significant dent in the nation’s labor force not only quantitatively but also qualitatively, if experience and skills are taken into consideration. The report stresses the need for younger generations to inherit the experience and skills accumulated by the baby boomers, especially in the field of research and development and manufacturing.

To prevent a decline in per capita income at the time of a shrinking labor force, the white paper stresses the need to increase productivity, especially through development of value-added new technologies and management skills that can quickly put such technologies to effective use. This is reasonable thinking. But the white paper should have considered concrete ways to help achieve this goal, including measures the government can take to support enterprises.

The retirement of baby boomers will increase payouts of retirement allowances and corporate pensions, thus leading to a squeeze in capital investment and corporate profits. But the white paper says the retirement of baby boomers will eventually lead to lower personnel costs for enterprises, making it easier for them to hire young workers.

While retired baby boomers are expected to spend their money on durable appliances and travel, thus contributing to increased consumption, the graying of the population is expected to increase total medical costs for the nation. This will bring great financial pressures to bear at a time when the labor force, as well as the total population, is shrinking amid a declining national fertility rate.

In view of this, the white paper says that curbing spending in social security is indispensable, and calls for the realization of smaller government. That is understandable in view of the nation’s massive debt-load, worth 700 trillion yen or 1.6 times the nation’s gross domestic product. But merely calling for smaller government may cause uneasiness among people. What if smaller government eventually means deterioration in medical, education and other public services?

The government must strive to offer people, in detailed and concrete terms, various options for bearing future social security burdens and receiving benefits. To cope with increasing social security costs, an increase in the consumption-tax rate should be one of the strongest options. But the white paper fails to delve into either the consumption-tax or the pension issue.

Understandably, as a way of realizing smaller government, the white paper calls for transferring various services from the government to the private sector. For example, it points to using money from the private sector for public works, and to letting both public-sector entities and private companies compete in bids for services traditionally provided by the public sector. This kind of approach may be useful, but the white paper does not touch on the issue of surplus public servants in depth.

Although the white paper declares an end to the postbubble economy, local banks are still saddled with a large amount of bad loans, and exports are not vigorous enough. It is true that the percentage of bad loans held by major banks has dropped to a normal level since fiscal 2001. But if the same rigorous standard applied to such loans held by major banks is applied to local banks, the management of local banks would appear headed for trouble. Meanwhile, the policy of maintaining an abnormally low “zero” interest rate continues.

The government’s July report on the economy says that information technology-related inventories have increased for the first time in six months. And, as the white paper says, a mild deflation is continuing. Too much optimism in the Japanese economy is not warranted.

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