Shinzo Abe

What Japan's Abenomics is missing: Immigrants

November 14, 2013: 5:00 AM ET

Japan may be able to battle years of deflation under its master plan to bolster the economy, but it won't reverse its declining population.

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Japan Prime Minister Shinzo Abe

FORTUNE -- The U.S. and the rest of the world have been watching Japan closely. Nearly a year ago, Prime Minister Shinzo Abe launched what has been dubbed "Abenomics," an aggressive plan to revive its economy from a two-decades long slump; the hope is that if Japan turns around, it could, for the first in a long time, lift the global economy.

On Thursday, Japan's economy slowed sharply in the three-month period ended September, as demand from emerging markets fell and consumption at home weakened. The country's gross domestic product, the broadest measure of goods and services produced in the economy, grew at an annualized rate of 1.9%, compared with 4.3% and 3.8%, respectively, during the previous two quarters, the government said.

"Japan cannot rely on exports. We have to pursue domestic demand-led growth," said Finance Minister Taro Aso during a parliamentary session last week. "We didn't expect economic woes in Europe to last for so long, while China's economy has also slowed down to a growth rate of 7% from 8%."

Japan's weaker data on Thursday doesn't suggest Abenomics isn't working, but it does highlight what's missing in Japan's master plan: immigration reform.

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In a report released last week, Standard & Poor's global chief economist Paul Sheard said Japan could accelerate the pace of economic growth by letting more foreign workers in. Japan's population has been declining for years. It was at 128.9 million people in 2010 and is set to fall below the 100 million mark in 2048, but Japan has been reluctant to allow more foreigners in and there's hardly any mention of such plans under Abenomics.

To be sure, Japan has made bold moves to end deflation. Years of falling prices have kept wages stagnant or declining, but more and more investors are now convinced that could soon turn around. According to an October survey of 1,000 Japanese retail investors by Goldman Sachs Asset Management, more than half of respondents (56%) said they expect deflation to end soon and prices to start rising moderately, while 21% worry about the risks of too much inflation.

Japan's problems run deeper. Its birth rate, currently 1.39 children per woman, has sunk to record lows. Years of stagnant wages have made Japanese men less attractive to potential partners, and couples have delayed getting married and having children because of economic uncertainties. What's more, the costs and burden of parenthood are high, as there's also a big shortage of public day care centers, especially in cities.

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All this translates to a huge shortage of working-age people. Under Abenomics, policymakers hope the country would grow an average of 2% a year over the next decade, compared with an average of 0.8% a year over the previous decade. If that's really going to happen, Japan will need to tackle its declining workforce, Sheard says.

Japan has been trying to raise its birth rate, but even if it successfully did that tomorrow, it will take at least a generation before it solves its demographic problems. A shortcut cure would be immigration reform, Sheard says.

Immigrants grow the population, plus they are more likely to have more children. And allowing more foreigners in could also encourage more women to stay in their careers -- a problem that's plagued Japan for years as women struggle to pursue a career while raising a family. Sheard says a smart immigration policy would ease labor restrictions over childcare facilities, helping to make it easier for working women.

Others have supported this idea, but it remains a deeply touchy topic for Japanese politicians who have opposed bringing in more foreign workers. But depending how Japan's economy fares over the next several years, that idea may not be so far-fetched.

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