Last week John Campbell summarized his thoughts on why aging and population decline are not a big problem for Japan. I thought the points he made about the labor shortage and savings shortage aren't biting and might produce changes via market mechanisms once they do were important to consider, but wrote back (off-line) a sort of rebuttal, arguing that there are still reasons to worry. At his suggestion, I have reproduced those rebuttal points below in hopes of stimulating more dialogue on this forum.

While aging may not be constraining Japanese economic growth via the supply side (labor, capital), it is clearly constraining growth via the demand side. One reason Japan still has surplus savings, despite the sharp decline in savings since 1990, is that few people want to invest in a shrinking market. Businesses that sell less every year don't need new factories.
Individuals who expect the number of households to decline and (some) housing to be abandoned hesitate to invest in housing. So it's not just consumption demand that is dented by a shrinking population but also investment demand. If Japan increased immigration or had more babies, these additional people would add more demand, as well as more supply. I am not sure that I am reassured that the labor shortages and capital shortages are slow to appear because demand is shrinking faster than supply.

There are also two mechanisms through which a falling population slows productivity growth, which is also critical to Japan's ability to grow fast enough to service its debt and cover social insurance costs.
First, I worry that a lack of investment in new capital stock because of shrinking demand will constrain Japanese productivity. Even if it's not a shortage of savings that does this, a shortage of demand might lead to a steady aging of the average Japanese factory / home / infrastructure.
In fact, it already has. Britain grew slowly for much of the postwar because its capital stock was older than that of its competitors. Might this not happen to Japan? Second, an aging population will consume less goods and more services, and the opportunities for productivity gains are greater in goods production than in services. More and more Japanese will work as elder care workers, but there will be limits in the degree to which these workers can be more productive. Same for other service workers providing for the needs of the elderly. Japanese overall productivity growth has depended heavily on world-beating levels in autos and electronics. As these industries become a smaller part of the economy, won't the ability of the economy to grow be hampered?

Finally, while I take your points about how the Japanese have limited their vulnerability to a pay-as-you-go aging crisis by limiting pension and health spending obligations, I worry that the PACE of aging, on top of the need to pay back Japan's massive debt, will nevertheless strain the ability to maintain the economic vitality of the working population. If Japan were going into this aging crunch with a low level debt, no problem. But it is going to have to finance the baby boom bulge while also turning the corner on its debt trajectory. Can it do this without imposing taxes on work and capital that drive people to emigrate or move money abroad?

And one more point. Japan's secret weapon for escaping from its debt problem is its ability to inflate it away because all of the debt is domestic and denominated in yen. But I worry that rapid aging is deflationary (because of shrinking demand), making it hard to jump-start inflation (as we've seen!). And aging is going to create a politically powerful constituency of older voters living off fixed-income interest on savings that will vote against any politician who hints at pulling the inflation lever. Won't someone have to revise the BOJ law to retake control of monetary policy so that politicians can force the BOJ to shift away from their deflationary bias? And what politician is going to do that with 35 million older voters watching their every move. The older voters are going to insist that Japan refrain from inflating away the debt but will instead try to force the government to live up to the full value of its commitments by extracting more money from working age Japanese. I see much more inter-generational conflict ahead than you do, over issues like this.

Nice to have this opportunity to put these rebuttal points on paper (or email). I am sure you have rebuttals yourself and would enjoy the chance to hear your reactions, if you have time.

Cheers!

Len