Forecasting Japan: A Slow-Burning Crisis
September 28, 2015
Japan is waking up. For two decades, the island nation has been relatively removed from both regional and global affairs. Now it is in the earliest stages of a push to re-establish itself as a leading power in the Pacific Rim, a role that will require Japan to make some significant internal adjustments. Over the past 150 years, Japan's political order has undergone three such overhauls. Each came as a reaction to profound changes in the international system: the entrance of European powers into East Asia, the rise of fascism in Europe and the beginning of the Cold War.
As the Cold War ended, Japan began to stagnate. Previously, Japan had managed to thrive by modeling its internal order to adapt to regional geopolitics. This time, however, no coherent order emerged in the Pacific Rim, so Tokyo maintained its Cold War status quo. Japan's maladapted holdover order quickly entered a 20-year slow-burning crisis that has come to be known as the "Lost Decades." It is this period of crisis that is now coming to an end.
No single force will bring about the end of the Lost Decades. Instead, a number of circumstances will coincide, ushering in a new Japanese order. Over the next 10 years, the status quo will change as Japan adapts to the rise of China and changing U.S. expectations for Pacific allies. Meanwhile, economic and demographic pressures will mount on Tokyo. However, the direct antecedents of Japan's coming break will be the contradictions that lie within its current stagnant order. Understanding this situation is the first step in forecasting the future of Japan.
Despite its strong economic performance in the 1970s and 1980s, Japan foundered in the immediate aftermath of the Cold War. A succession of asset bubbles and financial crises in the 1990s and 2000s further undermined the country's economic growth. But leaders had little incentive to make the necessary reforms to political institutions or foreign policy: Despite the sluggish economy, quality of life for voters was high and external threats were few. For the first time in its modern history, Japan did not know what to do, did not need to do much and therefore did nothing. The political and economic order designed for an earlier era persisted and became Japan's new status quo, gradually fraying at the edges, but stable enough to endure.
Japan's now-ailing Cold War configuration rests on two pillars: integrated business groups known as "keiretsu" and an autonomous, effective and powerful bureaucracy. Both of these interest groups have maintained strong ties with the Liberal Democratic Party, which has controlled the government for all but six of the past 60 years. The enduring power of the party rests on its ability to mobilize keiretsu employees in elections and its connections within the bureaucracy.
During the Cold War, Japan's political order leaned heavily on the support of the United States, which needed a strong Japan to serve as a key ally in the Pacific. To bolster Japan, the United States granted it a variety of benefits including open access to U.S. markets while allowing Tokyo to shelter its own market and implement policies to maintain artificially low-cost exports. The United States also shared defense and computing technology, fueling Japan's electronics and high-tech booms. When the Cold War began to wind down, the U.S. approach shifted from support to quiet containment.
The 1985 Plaza Accord embodied this shift. The landmark agreement between the United States, France, West Germany and Japan allowed the U.S. dollar to depreciate relative to the yen and deutsche mark to bring the United States out of recession by curbing U.S. inflation and making its exports more cost competitive. But the deal was a bad one for Japan. The rapid rise in the yen's value against the dollar between 1985 and 1987 undermined the low-cost export sector and sparked an enormous asset price bubble in Japan. When that bubble finally burst in 1990, it triggered a banking sector crisis that sent Japan's GDP growth tumbling from an average of 5-7 percent annually in the mid-1980s to near-zero percent by 1993, initiating the first of Japan's Lost Decades.
Fueled by newfound purchasing power, Japanese investment began to move overseas into developed markets. Many companies also moved operations to take advantage of low-cost labor in Thailand and China. Such offshoring has continued over the past few decades, undermining the domestic job market.
Since the 1990 banking crisis, Tokyo has made several attempts to revive economic growth through fiscal stimulus and structural reforms. All have failed; Japan's problems require much deeper structural reforms. Though leaders have tried to make these reforms, they have been constrained time and again by the alliance between business, bureaucracy and the Liberal Democratic Party.
Japanese Prime Minister Junichiro Koizumi, for example, pushed strongly for reform from 2003 to 2006. He attempted to break Japan's Cold War-era order to clear the way for necessary change. His efforts largely failed, as have those of other reformers, and Japan has remained stagnant. Because the country has failed to alter its fundamental order, Japan essentially has not grown since 1994. The country has managed to maintain high levels of overall employment, but a growing share of these jobs are part time. In the 1990s, part-time workers represented less than 20 percent of the workforce, but by 2014, this number had risen to nearly 38 percent. Meanwhile, Japan's sovereign debt has grown substantially since 1994 as Tokyo has borrowed to maintain the bureaucracy, sustain infrastructure investment, cover social services and healthcare costs and service past debts.
But the crisis of Japan's post-Cold War model is relatively mild. Despite two decades without growth, Japan is still the world's third-largest economy and maintains one of the highest GDPs per capita among major economies. Meanwhile, a consistently strong yen has meant rising purchasing power. Japan also has one of the world's highest research and development expenditure-to-GDP ratios and remains one of the world’s most innovative high-tech economies.
Battered, Not Broken
Recognizing that the Lost Decades have not led to an earthshaking national crisis is key to forecasting the next step for Japan. The country will only shift if it is forced to do so. If not, the status quo will persist more or less intact, albeit fraying at the edges, for the foreseeable future.
Two factors undergird the stability of the current order: high living standards and a stable regional position. The Japanese government, first and foremost, needs to guarantee that quality of life remains steady or improves. Tokyo will need to keep Japan's GDP constant, or at least declining slow enough to dovetail with its population decline, over the next several decades. The government will also need to find a way to pay the costs associated with the country's growing elderly population. Both will mean improving worker productivity to offset a shrinking workforce while helping Japanese industries remain globally competitive and effectively taxing overseas economic activity. Extracting government revenue from Japanese businesses abroad, which have used offshoring to keep themselves globally competitive, will be possible with some political wrangling. It will also be a crucial move, since the government will need to bolster domestic spending. Social security and healthcare costs now account for over 35 percent of government expenditures. At the moment, however, only 26 percent of the population is over 65. By 2040, the elderly will make up 36 percent of population. The government will likely manage this by exploiting its close ties with the leading keiretsu.
Tokyo will also push for incremental labor reforms and technological advances to improve worker productivity. To be politically viable, these reforms will only need to be gradual enough to avoid substantially increasing unemployment (currently just 3.4 percent) or underemployment in the near term. This will be tricky. For the next 5-10 years, Japan will see population aging and workforce shrinkage slow. Between 2015 and 2025, Japan's workforce will shrink by 5.5 million-5.6 million, down from its loss of 7.7 million-8.3 million workers between 2005 and 2015. Steadier population levels will raise the pressure on the government to maintain employment.
After 2025, and especially after 2045, extreme working age and overall population declines could force more fundamental changes in the structure of Japan's economy. By 2060, Japan's total population will fall by around 25 percent, while the working-age population will fall by around 50 percent. This will almost certainly have profound implications for the country's economy. Still, the population shifts will be gradual and it will take some time before their full effects are felt. Without changes in Japan's external environment, the Japanese government could make incremental policy adjustments that address the impact of population decline on quality of life over the next three to five decades, at least enough to stave off a catastrophic change in the foundations of the current order.
Section 2: Summary
Japan's current political order is a holdover from the Cold War, when the country was buoyed by U.S. strategy in the Pacific. But when that configuration changed dramatically after the fall of the Soviet Union, Japan continued to cling to the old system – it had no other option. Tokyo is now looking ahead to a future of demographic decline and increased government spending. While Japan will likely be able to manage these issues, the country's slow-burning internal crisis will begin to interact with broader regional shifts in the next 5-10 years, the most important of which is the ongoing transformation of China. The external changes in Japan's region will ultimately cause the country's internal political order to undergo an epochal shift of its own.
Through the Cold War and beyond, Japan has been able to pursue a foreign policy centered on economic competition and cooperation rather than defense and security. External allies like the United States protected both the home islands and Japanese economic interests overseas. But things are changing, and Japan's mercantilist foreign policy will soon be insufficient to meet its strategic needs.
China, of course, is the new factor. Since the end of the Cold War, Japan's neighbor has transformed from an isolated and impoverished pariah state into the world's second-biggest economy and Asia's largest. China has been the demographic center of East Asia for millennia and, for most of its history, it was also the regional hegemon. However, in the middle of the 19th century, internal and external pressures drove China into one of its periodic cycles of political fragmentation, social upheaval and introversion. Although China reunified in 1949, the preceding century of chaos had left its economy in tatters, preventing China from translating its demographic heft into regional economic, political or military dominance throughout the 20th century. Now Beijing is building on its economic strength to accrue diplomatic influence and military power, and it has begun to pose a serious challenge to the U.S.-led Pacific alliance structure of the Cold War era.
But China's newfound power rests on a shaky foundation. Beijing faces mounting social, economic and political strain at home. A number of factors have contributed to China's current crisis. Internally, there are profound economic imbalances and intense regional tensions. China is also uniquely dependent on overseas supplies of energy and raw materials to sustain its industrial plants, and for the next decade, it will be heavily reliant on foreign consumption of Chinese-manufactured goods. Historically, China enjoyed a surplus of domestic natural resources relative to its economic needs. This allowed generations of Chinese leaders, most notably Mao Zedong, to close the country off in times of internal turmoil. Because China is now reliant on imported inputs, the country has little choice but to press outward to protect its overseas assets, interests and personnel and to ensure the security of crucial sea lines of communication.
Consequently, the next 5-10 years will be a period of extraordinary strain for China. The Communist Party of China will continue its attempt to transition to a new economic model grounded in robust domestic consumption, high value-added manufacturing and service industries. The process will require Beijing to substantially change core aspects of its existing political and economic model, and the Chinese government will need to implement all of these disruptive changes amid a sustained slowdown in low-end manufacturing and housing construction. The government has long relied on these two sectors to maintain economic growth and employment. At the same time, the country will need to metabolize the staggering levels of local government and corporate debt accrued over decades of rapid investment-led growth and extensive capital misallocation.
Beijing's task is not impossible, but it will need to perfectly coordinate several complex maneuvers to achieve success. To manage these shifts, the government will dramatically centralize power, essentially becoming a dictatorship – a process that is already underway. China's new order might also entail promoting nationalism as a means of maintaining social cohesion, likely at Japan's expense. China shares its sea lines of communication with Japan, and the Chinese military has already become increasingly proactive in defending its territories. For Japan, this is a fearsome prospect.
Shifting U.S. Strategies
China's rise will coincide with a change in the United States' strategic posture in the Pacific Rim. Since it became the leading superpower at the end of World War II, the United States has enforced its position by securing global sea-lanes, maintaining a permanent U.S. military presence along key regional fault lines, and on occasion, directly intervening to maintain the balance of power. The United States wants to prevent the emergence of a rival regional hegemon anywhere in the world.
Washington's strategic imperatives in the Pacific will not change, but its methods will. The United States will transition gradually in the coming years toward indirect and less costly ways of enforcing its writ. This will mean devolving responsibility to regional partners such as the Philippines, Australia, Taiwan, South Korea and Japan.
The United States' shift is already beginning to push its allies in East Asia to become much more proactive in defending their security interests. Japan is at the forefront of this movement. In late 2012, Japanese Prime Minister Shinzo Abe launched an initiative to revive Japan's regional economic, diplomatic and military standing. Since that time, Japan has made strides in regional diplomacy and military expansion and normalization. Still, to be successful, Japan will need to dramatically expand its efforts.
Throughout history, economic power and military power have been intertwined. In the 20th century, industrialization, combined with the technological limitations of ballistics, placed a premium on volume. However, since the final years of the 20th century, the quality of weaponry has become more important than the quantity. Vast fleets of large military vessels traveling long distances will continue to decline in significance, while precision-guided weapons platforms supported by space-based guidance systems will become increasingly important.
Meeting Japan's Military Needs
To play a role in 21st-century Pacific regional security, Japan will need to cultivate and sustain a cutting-edge domestic computing industry. To do this, Tokyo could start by increasing spending and public-private partnerships in defense research and development. It could also increase cooperation, intelligence sharing and technological connections with the United States. But Japan will also need to form a broader fabric of innovation and experimentation in computing technologies upon which the state can draw in times of need.
Although Japan has long excelled at advanced manufacturing and is still at the forefront of robotics, the country has struggled to gain a comparable footing in Internet-based computing. Japan's enduring Cold War order — an order defined by the close relationship between the government and major business groups, the keiretsu — is part of the problem. Keiretsu have hampered the efforts of successive Japanese leaders to open Japan to greater outside competition and investment, a factor that will need to change if the country is to encourage innovation in computing. Tokyo will also need to foster Silicon Valley-style tech startups, cultivate entrepreneurship and educate its workforce in the relevant disciplines.
Maintaining and widening its technological edge against regional rivals will require Japan to make significant changes to its domestic job market, changes the country has avoided thus far because of the mildness of its current economic stagnation. Tokyo will need to address the stark rise in underemployment Japan has seen in recent years. The total portion of Japanese employed in part-time jobs rose from 29 percent of the workforce to nearly 38 percent between 2002 and 2014. The offshoring of Japanese manufacturing activity over the past two decades has only added to the country's employment problem. Anecdotal evidence indicates that over the past 20 years, many major Japanese electronics and advanced manufacturing companies that once dominated Japan's economy (and accounted for a sizable chunk of domestic employment) have downsized their domestic workforces, at least in manufacturing, while expanding their share of overseas employees.
The Japanese economy will not necessarily have to grow for Japan to buffer against China and play a leading regional role, but it will need to become much more dynamic. This will mean channeling the nation's dwindling working-age population into cutting-edge industries, something that will also be critical to maintaining domestic political order as the shrinking workforce bears the burden of caring for an aging population. How Japan responds to external pressures, and whether its response is adequate, will be determined largely on the basis of what happens to its economy over the next 5-10 years, the period in which Japanese Prime Minister Shinzo Abe's reforms will play out.
Section 3 : Summary
As the strategic situation in the Pacific changes, Japan will be forced to adapt. Tokyo will need to pull the Japanese economy out of stagnation and cultivate a dynamic set of new industries while luring back businesses that have gone overseas. Current Japanese Prime Minister Shinzo Abe has an ambitious plan to do just that – but the strategy has so far foundered, and in the long term it will likely fail.
"Abenomics" aims to revive Japan's economy through three measures: monetary easing to devalue the yen, fiscal stimulus, and structural reforms. By devaluing the yen, the prime minister hopes to revive consumer spending by reversing consumer expectations of continually falling prices after years of stagnant-to-negative inflation. A weaker yen would also make Japanese exports more globally competitive and increase the value of overseas corporate earnings repatriated to Japan. Fiscal stimulus will include direct government investment into infrastructure development, defense and other sectors. The measures would also include corporate tax cuts and reforms aimed at stemming the flow of investment overseas while attracting greater foreign investment.
The last set of initiatives, structural reforms, aim to improve worker productivity by loosening the regulation of full-time workers, deregulating protected sectors such as agriculture and power to increase competition domestically, and expanding international free trade agreements, including the Trans-Pacific Partnership. In addition to the "three arrows," the Abe administration is trying to encourage the autonomy and competitiveness of Japan's different regions and cultivate a startup culture.
Abenomics is still in its early stages. The next two years will be critical in determining whether Abe's plan will succeed. But there are numerous factors that will constrain Abenomics and could derail the program completely.
The Japanese economy's most serious problem for the next decade will be high and rising underemployment. For 20 years, this has been the key driver behind declining average household consumption and a drag on consumer spending. Weak consumer spending, combined with expected population decline, limits the Japanese government's ability to boost corporate investment at home.
Each of the arrows has aspects meant to raise employment. Monetary easing seeks to boost the value of Japanese corporate earnings overseas to raise earnings for major conglomerates and free up bandwidth for them to invest domestically if they choose to do so. As part of fiscal stimulus, Abe aims for corporate tax cuts to create stronger incentives for these conglomerates to invest capital domestically rather than put it into savings or reinvest it abroad. Finally, structural reforms seek to ensure that when companies invest domestically, they are free to do so in ways that will maximize productivity and profitability, even if it means cutting back on long-standing workforce privileges.
Insufficient, Unpopular Measures
This strategy will fail for a number of reasons. The simplest is that Abenomics will not compel Japanese companies to sufficiently expand domestic investment. Companies went abroad to avoid the extremely high cost of manufacturing in Japan, much of it due to high labor costs. China is both a key market for the products produced by these companies and has a strong production base with low labor costs.
To date, Abe's policies (particularly monetary easing) have done as much damage to ordinary Japanese consumers as they have helped, simply because they have raised prices. The main reason that this damage has not politically crippled the administration is that low energy prices have given consumers a boost. Large corporations with overseas operations have benefited from a weak yen, but ordinary Japanese consumers and small businesses with domestic operations have only experienced rising costs. Base-pay hikes at major Japanese companies will help boost consumer spending in the second half of 2015, as will the recovery from last year's consumption tax hike, but given Japan's employment situation it is unlikely that these wage hikes will make a significant, lasting difference in consumption levels. At the same time, demographic decline will drive down the number of potential consumers more quickly each year.
Abenomics will also likely fail to boost domestic investment by Japan's industrial conglomerates. One solution would be to bring in investment from non-Japanese companies overseas. This would require the deep deregulation of long-protected industries, a relaxation of labor controls and the uprooting of deep cultural norms. It would also require Japan's accession to the Trans-Pacific Partnership and the rapid development of a Japanese Silicon Valley. Together, such radical moves could be enough to draw substantial investment away from the United States, Europe, South Korea and China in just over a decade. Such a scenario, however, would need measures much broader by far than anything Abenomics has considered. It would mean a revolutionary break with the post-World War II order and truly profound adjustments. Such changes would encounter substantial opposition from the industrial keiretsu (Japan's powerful integrated business groups) and key electoral constituencies. More likely, overseas investment into Japan will remain around current negligible levels: $2.3 billion in 2013 compared with $135 billion in outbound investment.
Laying aside the need for more ambitious measures, several short-term factors could undermine even the basic reforms that Abe wants to roll out. The Bank of Japan is currently purchasing bonds at a high rate. It is unclear how much longer this can continue before the market tightens to the point of dysfunction. If the Bank of Japan is forced to pull back before inflation reaches the 2 percent target, Japan could experience a return to deflation. If the Bank of Japan's rapid purchase of debt leads to a debt default or some other catastrophic event, it could well trigger the fundamental break in Japan's current order that Stratfor anticipates. However, a default is unlikely.
But more pressing than these financial considerations is the potential erosion of public support for Abenomics and for the administration itself. Without a surge in corporate investment and a hike in full-time jobs to counterbalance it, Abenomics will have primarily negative effects on the population's quality of life. The initiatives would reduce the value of savings, raise the cost of living, contribute to perceptions of rising inequality and leave the workforce vulnerable to layoffs. The last of these will most acutely harm the very corporate employees that form the backbone of the Liberal Democratic Party's "organized vote." The electorate is already uneasy about the prime minister's reforms and many voters have continued to support the Liberal Democratic Party only because the opposition is hopelessly fragmented. Their negative perceptions will only grow given the outlook for corporate investment and consumer spending. Thus, Abenomics in its current form probably will not last beyond 2017.
Section 4: Summary
In the coming years, Japan will transition out of its slow-burning state of crisis as it seeks to make a radical break with its current, decaying Cold War political order. The transformation will take place against the backdrop of significant demographic changes. Since 2005, Japan has seen its 65-and-over population grow by more than 33 percent, faster than any past or future forecast rate. Over the next decade, this rate of aging will slow substantially, as will the decline in Japan's working-age population. These trends will persist until around 2040, when most of those born in the country's 1968-1976 baby boom will have entered retirement. Then, between 2035 and 2045, the rate of the working-age population's decline will pick up slightly, increasing pressure on the system. By 2060, the situation will become dire. Even under constant fertility conditions, Japan's population will fall to around 86 million; if fertility declines, population levels will drop further still to 79 million. As a result, Tokyo will likely be increasingly confronted with internal issues related to economic and social management in the years after 2040.
In the next five years, Japan's break from the post-Cold War period will begin. Tokyo will start to dismantle key elements of its current political order and the reforms that have made that order more democratically accountable. The process will require substantial changes in the relationships between the Liberal Democratic Party, civil service and keiretsu, and Tokyo will have to find some way to curb or eliminate the electoral strength of economically non-competitive public utilities while offsetting the growing power of the over-65 voting population. Meanwhile, the Japanese government will need to make reforms to improve the productivity, efficiency and competitiveness of Japanese businesses. Only these changes will ensure that Japan can cope with the acute population aging and workforce shrinkage it will face in the decades after 2020 while guaranteeing the country's national security.
Over the next two years, Tokyo will focus on achieving Japanese Prime Minister Shinzo Abe's "virtuous circle." Each of Abe's proposed economic reforms aim to address the root causes of underemployment, with the hope that higher employment will drive up domestic consumption, thereby boosting the economy and raising employment levels even further. This cycle will need to be in place before the Bank of Japan pulls back on monetary easing or the central government is forced to improve its fiscal position by raising the national sales tax or increasing corporate taxes. The bank's current rate of bond purchasing is unsustainable, and Stratfor expects that the Bank of Japan will cut back on its bond purchases, perhaps significantly, before 2017.
While the prime minister's "Abenomics" measures will make some progress before 2017, the administration's efforts are not extreme enough to put Japan back on the path toward sustainable growth within the next two years. The weak economies of both China and Europe – key destinations for Japanese exports – will make this outcome even more unlikely. Therefore, when the Bank of Japan inevitably pulls back on its bond purchases, Japanese companies with extensive overseas operations will see repatriated funds decline in value, which will reduce their incentive to invest domestically. The cost of Japanese goods will also rise yet again, eroding the country's competitiveness with China and South Korea.
The drawdown in bond purchases and declining investment will lead to fiscal deficits for the Japanese government, putting pressure on Tokyo to raise taxes on either companies or individuals. Whichever Tokyo chooses, by the start of 2017, it will once again find itself facing a dilemma after a short period of economic growth.
But Abenomics will not implode. The Japanese government will likely find a way to avoid defaulting on its sovereign debt and the Bank of Japan will manage to implement a modest amount of monetary stimulus without undermining the country's sovereign debt markets. Inflation may hit 2 percent, wages may rise and Japan will likely succeed in attracting some foreign investment into long-protected sectors and new industries. Abenomics is fundamentally sound and economically rational, but its economic benefits in the long term will be preceded by hardship for individuals. In 2016, as Japan's growth picks up, these side effects will become slightly less glaring, but if the Bank of Japan pulls back on bonds and the government raises taxes, they will resurface.
Life will not substantially deteriorate for ordinary Japanese people, but events will hurt the prime minister and his administration at the polls. Abe survived the December 2014 elections because of an incoherent opposition, but Japan's fragmented playing field will not last forever. By 2017, dissatisfaction among older voters, especially those with ties to the agriculture lobby or to other keiretsu, as well as middle-aged and older small business owners, will begin to undermine Abe's electoral position.
A Quiet Revolution
The fate of the Abe administration will have relatively little bearing on whether the core policies of Abenomics persist. Over the next five years, two trends will emerge, the first being the rise of a new generation of bureaucrats dedicated to the reforms necessary to ensure Japan's long-term security. At the same time, an older population averse to those reforms, especially military normalization, will come to dominate the electoral system. Since avoiding reform is not an option, the government will move away from a system of electoral democracy.
China's Continued Rise
Over the next five years, the regional security situation will become increasingly volatile; economic dislocation and political turmoil within China will combine with China's expanding military power. Urged on by the United States, Japan will become more proactive not only in its own maritime patrolling and reconnaissance activity but also in deepening cooperation with Southeast Asian partners. The sheer quantity of vessels and aircraft deployed in the region will raise the risk of short, sharp crises. Such incidents will ultimately serve to bolster popular support within Japan for a defense posture against Chinese aggression.
Greater volatility in the Pacific will fuel the rise of the new generation of activist bureaucrats and keiretsu leaders by underscoring the need for reform. By 2020, these rising civil servants and business leaders will have made significant headway in consolidating their influence within key ministries. Meanwhile, Japan will seek to capitalize on the increased integration of the Association of Southeast Asian Nations to expand Japanese influence in Southeast Asia and nearby India. Japan will pursue these goals with an eye toward containing Beijing, but they will yield benefits independent of China.
Forecast After 2020
Japan will enter the 2020s in a relatively strong position. Despite growing opposition from an electorate dominated by older voters, the government will be more successful than previous administrations in implementing reform. Breaking up the agricultural and other lobbies in the late 2010s will expedite the process. As the generation born before World War II leaves politics and tensions with China grow, nationalist sentiments in Japan will surge, allowing the government to more actively mobilize support for defense reforms.
The reform measures initiated under Abenomics will slowly come into force after 2020 but will fall short of generating sustained annual GDP growth above 1-2 percent. Demographics will undergird this poor performance: Between 2015 and 2020, Japan's workforce will shrink by 3.3 million, or about 4 percent, increasing the pressure on the economy's productive capacity. Reform measures, however, will help ensure relatively stable GDP, improved efficiency and productivity as well as constant quality of life. This will provide a workable basis for the government's efforts to revamp the country's regional and global image and extend its political, military and economic reach.
From 2020 to 2030, Japan's working-age population (ages 20-64) will fall by around 4.8 million to 5.6 million. This drop will be well below the decline of 7.7 million-8.3 million people from 2010 to 2020, but it will be substantial nonetheless. To maintain a constant GDP, Japan will need to ensure average annual productivity growth of at least 2 percent. Doing so will require securing labor reforms. It will also depend on the Japanese government's ability to stimulate higher value-added services (such as financial services) and computer technologies industries at home.
Fixing employment problems will be critical for supporting Japan's growing elderly population. Compared with the years between 2010 and 2020, when the country's over-65 population grew by 7.5 million, the rate of population aging will slow considerably in the 2020s. Still, the absolute burden of caring for Japan's elderly population will only grow. By 2030, people over 65 will account for 32 percent of Japan's population, as opposed to 56 percent of the population at working age.
Tokyo will make tangible progress throughout the 2020s in cementing reforms and encouraging the kinds of industries needed to improve the overall productivity of Japan's economy. But the Chinese and European economies will remain weak through the early 2020s, and Japan's internal changes are unlikely to generate enough taxable income to reverse Tokyo’s reliance on deficit spending. Japan probably will not default on its debt, given the high rate of domestic ownership, but the amount of debt will grow, as will debt servicing costs.
Japan's relations with China will be in flux between 2020 and 2030. Even as China's economy slows between 2015 and 2018 and the Chinese government struggles with rising unemployment and social dislocation at home, the United States, Japan and their partners in broader Asia will pull closer together to balance against the perceived Chinese threat.
Beijing will continue to invest in its military and maritime expansion, and the world will continue to expect an imminent Chinese economic recovery. This will fuel integration efforts by the United States and Japan. But before 2025, the limits to China's economic trajectory and military capabilities compared with those of the U.S.- and Japan-led coalition will have become unmistakably clear. This will coincide with the unleashing of long-suppressed social and political energies within China, a process that could reach a climax before the scheduled 2022 generational leadership transition. The extreme centralization of political power before 2020 will have thoroughly undermined the system of checks and balances within the Communist Party of China and will make for a tumultuous transition process.
Up to 2025, Japan's neighbors will continue to view it as the leading counterbalance to China. Before long, however, internal political turmoil and continued economic dislocation within China will start to put the breaks on this dynamic. Stratfor expects China's ongoing economic slowdown to bottom out sometime around 2020. Throughout the early 2020s, China will be engaged in a process of restructuring and rebuilding its economy, a process that will weigh on annual GDP growth through the late 2020s. It will not be until the end of the decade that China's painful restructuring comes to fruition and domestic consumption by the urban middle class emerges as a genuine driver of national economic growth. As a result, China will exist in a state of economic dysfunction between the leadership transition of 2022 and perhaps as late as 2029-2030, likely increasing regional economic fragmentation.
The United States will realize the state China is in and will begin to slowly adjust the U.S. position in the region. Washington will move to prevent a complete Chinese political and economic collapse, fearing that such an outcome would cause extraordinary disruption across East Asia and provide an ascendant Japan a chance to move beyond the United States. To prevent its displacement, the United States will move to constrain Japan while avoiding open displays of friction with the Japanese.
Thus, Japan will find itself in the second half of the 2020s caught between a recovering China and a United States more amenable to assist in that recovery. This strategic bind, combined with Japan's deepening demographic decline, could well pave the way for another period of relative introversion in the 2030s.
The rates of workforce decline and population aging will both remain moderate in the 2030s before picking up precipitously in the 2040s. Efforts to boost fertility rates in the late 2010s and 2020s may help counteract the effects of working-age and population decline after 2040, but by and large, their effects on Japan's workforce will not be felt in the 2030s. If fertility does improve, Japan's workforce (by 2040, only 52 percent of the population) could find itself even more financially strained than in the previous decade. By 2060, Japan's workforce will have declined by 50 percent since 2015, while the country's total population could fall by as much as 25 percent. With this in mind, the years after 2040 are likely to be increasingly dominated by internal economic and social management-related issues.