Government data last month showed that Japan’s economy shrank in the first three months of 2018 due to weaker export growth, business investment and private consumption. The annualized contraction of 0.6 percent put a stop to the nation’s longest growth streak since the 1980s, demonstrating that the economy is still in need of key structural reforms.

Despite having accomplished growth over the past eight quarters — it was the first contraction since the final quarter of 2015 — the January-March figures show the difficulty of achieving continued growth and escaping over two decades of stagnation without implementing fundamental changes to its economy.

An example is wages. While the government’s aggressive monetary easing and fiscal stimulus measures have helped lift the economy out of deflation, the Bank of Japan’s stated goal of a 2 percent annual inflation will prove difficult without implementing policies that promote wage growth.

For two decades, Japanese salaries have been static and wage hikes remained stagnant in more recent years even as a number of corporations enjoy record profits. Understandably, Japanese workers are hesitant to open their purse strings wider if they are not seeing an increase in the amounts they are getting paid.

A separate structural challenge facing Japan’s economy is its demographic crisis. In 2017, Japan’s population shrunk by 227,000, marking seven straight years of decrease.

To put things in perspective, over the past 20 years Japan’s working age population has shrunk by more than 11 million people, and the overall population of 126.70 million is projected to fall below 100 million in 2053 and to 88.08 million by 2065. This has left Japan as the country with the world’s most aging population with over 25 percent of the population 65 years or older. As the population ages, there are less working-age people to support the tax base needed for the social welfare system.

To help fill its shortage of workers, Japan will need to make further changes to its immigration policy, in particular its policies on foreign workers. Reports over the past week of the government planning to ease restrictions on unskilled workers to mitigate labor shortages in nursing, shipbuilding, lodging, construction and agriculture are timely. Yet, further changes to the foreign worker and immigration laws will be necessary in the coming years to confront the challenges stemming from the shrinking and graying population.

Labor reform is another key area that is belatedly receiving the attention of policymakers. Japan has long needed to expand its labor force by developing more family-friendly work policies, providing incentives for older employees to remain working, reducing wage disparities between permanent employees and nonregular contract workers, and creating a more flexible and welcoming environment for immigrant laborers.

Efforts toward labor reform in Japan must also help empower women through equal pay for equal work policies, removing outdated labor market obstacles, creating more child care facilities to allow mothers to return to the workforce after giving birth and increasing opportunities for women to fill senior management positions in Japanese corporations.

Although not without controversy nor detractors, the labor reform bill that Prime Minster Shinzo Abe’s ruling coalition pushed through the Lower House on May 31 is a step toward certain needed changes, among them creating a more flexible work style, raising wages for irregular workers and implementing measures aimed at reducing overwork.

Other necessary changes for getting the economy back to sustainable growth are opening the agricultural, energy and environmental sectors as well as the deregulation of the overly restricted health care industry. The government would also benefit from providing incentives to promote local and foreign entrepreneurship as well as overhauling outdated corporate governance.

Finally, Japan must begin to tackle perhaps the biggest long-term challenge to its economy — making headway against its eye-watering public debt-to-GDP ratio of over 240 percent.

Although Japan is one of the most developed and creditworthy countries in the world, it is also the most indebted — more than Greece, and some analysts believe that Japan may never pay off the entire amount. Despite the fact that the risk of Japan defaulting is unlikely given that its bond liabilities are owned by its own citizens and because it can maintain low interest rates to keep repayment values manageable, the ballooning public debt poses as an unsustainable burden in the long term — particularly if interest rates rise.

To address this problem, Japan will need to adopt a series of measures, among them the unattractive option of increasing the consumption tax rate. Prime Minister Shinzo Abe is right to call for raising the rate to 10 percent in October of next year as scheduled. However, this hard medicine is likely to amount to a meager down payment as analysts estimate that this measure will only reduce the deficit by 2 percent of GDP. Indeed, many argue that Tokyo will need to increase the rate to 15 percent to achieve a balance between fiscal sustainability and economic growth.

In the years to come, administrations following Abe’s will need to implement fiscal strategies that focus on reducing the national debt so that the country may be better positioned to accommodate future economic shocks and rainy days.

Japan’s path back to a healthy economic footing must involve taking painful steps that will require the attention and effort of succeeding generations. It will also demand a sustained, multifront battle against special interests. Yet, over the long term, these changes offer hope for revitalizing Japan and putting it on course toward fiscal sustainability even as its population continues to contract and age.

Ted Gover is associate director of the Tribal Administration Program at Claremont Graduate University.

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