This post started life as a response/reinterpretation of R. Douthat's "Incredible Shrinking Country" opinion on the NY Times (28th April) Op/Ed page... and yeah, I wasn't going to be very nice about it. Between the fact that his writing is mostly a reaction to N. Eberstadt's far better "Japan Shrinks" and the otherwise annoying lack of understanding by Douthat of most of the anciliary issues he mentions, I'm not going to bother linking to his Op/Ed piece. However...
...while demographics are related to the on-going economic problems in Japan, they aren't uniquely responsible for how poorly things are trending right now.
I'd also note that I see the demographic future here as an opportunity with challenges, which was Eberstadt's general thrust (setting aside off-topics like some of his "random facts" mentioned), rather than the doomsayer-scenarios that similar discussions of Italy and Russia often turn into.
The real problem, likely dominant politically for the rest of this decade, is that the generation born in or just around 1980 is now ~10 years into what was supposed to be their careers and yet a stunning number have found they are "capped off" from any meaningful career opportunities by the combination of a no-growth economy and a slug-in-the-pipeline effect of a vast number of unpromotable middle-aged desk occupiers just half a generation older than them. If that sounds rather like the situation faced by Americans coming into the workforce just after 1980, well, there are some similarities. What allowed the U.S. workforce to at least in part shake that off was the long, mostly steady, rise in the U.S. economy from ~1984 to the turn of the century (arguably a bit beyond that, even). New enterprises and expansion of existing businesses spread the demand for experienced employees and opened new pathways of advancement. Japan, today, sees little or nothing of that sort of opportunity. But given a chance, it could.
Here's the rub: Japan is faced with a pair of nasty problems that as a set run contrary to the solution of either problem.
Problem One: Any hope of shaking off the shackles of low growth has to come by creating a positive business environment, and we're currently going backwards on that, not forward. Roughly 30% of electric power generation capability is off-line or going to be allowed to restart on a very limited basis... those would be our nuclear power stations. Insufficient or unreliable electric power supply is doom to manufacturing and nearly as damning to any modern urban office activity. Starting up or even expanding an existing company is still a process of red-tape-wrestling frustration for anything more complex than a neighborhood ramen shop. While direct corporate taxation was somewhat reformed during the Koizumi administration, the combination of direct corporate taxation, indirect mandated expenses and a virtual penalty for making any worker a "regular" employee rather than a contract or temp worker remains burdensome. Add to that the fact that no real recovery of the job losses in contract and temp employment in the wake of last year's disaster panic has happened and you are looking at a real unemployment/underemployment for the born-around-1980 generation that remains absurdly higher than the official workforce unemployment rate (By some measures, over 20% vs under 5%). Having the domestic part of the economy rebound would help that a lot, but even with the need to rebuild from last year's disaster we are only seeing GDP growth in the low 2% range (Broken Window Fallacy, but it is a demand). Schemes of the current administration to raise the Consumption (Sales) Tax will prove even more damaging to domestic demand after a brief pre-implementation bubble. Lastly, as Export remains a prime driver in the Japanese economy (roughly 30% of all activity, until recently), there is the possibility of getting growth going by export... except... the en (Yen; JPY) is at an all-time high against pretty much every other currency in the world.
Problem Two: The short-term efforts needed to shore up electric power generation (barely) by massive imports of fossil fuels and the import needs for rebuilding both play hobb with Japan's balance of trade. Without the purchasing power of a super-strong JPY, the cost might likely be unaffordable. But the same super-strong JPY makes imports of a wide array of consumer demands cheaper than domestic-origin goods. In the short run that's a necessary evil; in the long run it may well permanently stunt the already-feeble production of goods for the domestic market. Since full-on Merchantilism and WTO membership are incompatible (for a good reason! cf. PRChina), there's no way to slam that door and little benefit even if there was a way.
Those are the horns we are stuck on: Need a weaker JPY to restore Export and preserve an opportunity for long-term domestic growth; Need a strong JPY to pay for rebuilding after the disaster and to paper over our fears and inablities in providing electric power.
Lacking any sign of ロナルド・レーガン reborn as a Japanese politician, the odds of having a "Morning in Japan" moment seem pretty long. Bringing down the bunch of DPJ (Democratic Party of Japan) amateurs and Finance Ministry draftees that make up our current government would be a very fine start, however. There are a few folks left in the LDP (Liberal Democratic Party; the old guard now in opposition) that could do some good, and there is hope that the YP (lit. "Everyone's Party" but commonly rendered as Your Party) may someday grow into a proper limited-government party that could take on most of the issues in Problem One, above. Neither are really ready, but either are head-and-shoulders more able than the current crew. For that to happen, it will be necessary to hang on the current administration all the blame they deserve and for the electorate of Japan to realize how horrible the situation actually is. Faced with a sense of "we can't be broke; I still have cheques!" upper middle class, that's going to take some educating... but it is possible. One can undermine all the DPJ ploys of offering grants to families with children by making general prosperity and less burdensome government the promise; financially secure citizens make commitments that the fearful do not.
It is time to show some serious fortitude and either fish or cut bait about the national electricity supply: Either go through an upheaval in the Utility sector that turns the regulators of the nuclear industry into bulldogs (rather than the lap dogs they are currently seen to be) and then go all-in on building *lots* of the newest model and safest nuclear power stations... yes that would be the order required; the Japanese public is prone to panic and nuclear power after Fukushima Daiichi is pretty much top of the panic scale... Or dive in with whole heart into the brave new world of Natural Gas as a generator fuel of choice and spend the money now while the JPY is so strong to lock in opportunities in any of the many places where shale gas production is remaking the world energy market. Don't let various Carbon-reduction schemes further injure the economy, or go spending or encouraging any deeper moves into any of the new "green" tech power generation ideas unless they make stand-alone economic good sense right now. Both of those are luxuries, and until Japan is back on the course of wealth (if then), they need be ignored.
Realize a strong JPY is needed this week or month, but not necessarily much after that. This is a risky one... Devalue. The fact so far is that the BoJ (Nippon Ginkou; Bank of Japan) has been persistently engaged in monetary expansion trying to stem the JPY rise for years as well as bail out the Government's awful budget choices and has done rather little of any use in the process. Changing the course of a currency isn't a nice thing to do (cf. the intentional destruction of the value of the US$) and only the most powerful central banks (cf. US Federal Reserve System) can hope to get away with doing it without severe reprisals. That said, as cited in the article linked above, the current government bond situation in Japan is totally dependent on unsustainably low interest rates (~1% on a 10-year note) and a move by bonds to a historically low twice that much would destroy the government's finances... and analysts are seeing a devaluation risk in order to get out from under that sword. How much? Try a JPY40 devaluation vs. the US$. Wham. Welcome back to the "natural" ~115Y/$ trading range of the last two decades. Fair question, though: Can they get away with it? Triggering a full-on currency war helps no one in the end. If a race for the floor doesn't happen, then there is still the reputation damage with foreigners holding the currency (that would be PRChina, for one). It has to happen all at once, too, or foreign exchage speculation can undermine much of the hoped-for gain. Debasing the currency has lots of other risks internally too. But something needs to happen and "easing" isn't getting the job done.
There is certainly more to each of these items, above, and I encourage discussion in the comments about them.
There are certainly other things that will have to play out as well. Like Europe and the USA, Japan has an absurd Higher Education bubble that while not the burden on taxpayers and loan-demanding students that those cases are, is a spectacular expense that generates remarkably little benefit in applicable workforce skills. The conundrum of rising medical demand and yet not enough students willing to train to be doctors is also in the mix. If you have thoughts on what else is in play, do feel free to discuss that as well.
But, to wrap up the hypothesis, I offer you this: A Japan of declining population is a wonderful opportunity to make a better lifestyle and to remove some of the pressure our overcrowded civilization has placed on our limited land. If that meant a hundred years from now Japan is a rich population of 50 million people with the financial means to restore much of what has been changed to support 120 million, *and* rich enough to engage in the luxury of chosing appropriate technologies rather than only necessary ones, that would be fine... Or we might see a hundred year swing of the demographic pendulum back toward 80~90 million as the population regains confidence that there will be enough wealth and opportunity for generations of people to thrive... But we aren't going to get there if we can't get a handle on economic growth sufficent to generate the wealth that either offering requires.
The problem of the economy and the social conditions it creates is the place our focus need be directed. The rest, as they say, will follow.