The Japanese economy has gone through important transitions during the postwar period such as the gradual slowdown in economic growth and the steady increase in the share of people aged above 65 years old among the adult population. In this paper we construct a parsimonious neoclassical growth model to quantitatively assess the impact of population aging and various government policies on output growth in Japan over the 1975-2015 period.
We consider several interactions between government policies and population aging. First, labor income tax has been rising steadily as the social security burden of the working age population has increased. Next, population aging tends to decrease employment and increase hours worked per worker in exchange; the workweek reduction policy introduced in the late 1980s is crucial to account for the decline in hours worked per worker during this period. Finally, the composition of fiscal spending has shifted from public investment to medical expenditure as the demand for health care services has risen.
Our main findings are that:
i) the increase in the aged-population share can account for most of the decline in employment and reduced output by 8% from its potential level
ii) workweek shortening policy led to a 20% reduction in output from its potential level by reducing hours worked over the 1988-1992 period
iii) labor income tax led to an 11% reduction in output from its potential level by discouraging hours worked
iv) the shift in the composition of government spending may have caused a slowdown in productivity growth and hence a reduction in the potential output level itself
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