Don't Sleep on Japan's Economic Transformation

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If you do business or invest overseas take note of the transformation in Japan that is unfolding right now. After years of struggling with little growth and the threat of deflation, Japan is transitioning to a higher-inflation environment, which brings new challenges but also opportunities.

Inflation doesn’t sound like a hopeful thing. But for Japan, it is something of a relief. Before prices started perking up recently, its economy had suffered through close to three lost decades. Japan’s postwar boom came to a halt in the early ’90s. Growth, prices and the stock market started dropping.

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The central bank eventually pushed interest rates below 0% in a radical bid to revive the growth engine. That did little in the near term, but gradually, the yen weakened enough to help Japan’s prolific exports. Japan emerged from the pandemic growing, not at a breakneck pace, but faster than it had grown in a very long time. Prices rose and the central bank was finally able to raise interest rates above 0%. Savers no longer get punished for putting away cash. Workers are seeing pay rises. The stock market is up.

Still, this is just an opening to reboot the economy, not a guaranteed trend. Japan faces immense demographic challenges. Its population is shrinking by about 0.5% per year and is set to fall from 124 million now to 100 million by 2050. Japan has been offsetting this decline by bringing more women into the workforce and keeping people working for longer, plus allowing some immigration — long a taboo.

The declining workforce makes productivity gains an absolute must. Here, Japan is seeing some early success. But it will need to invest a lot in areas like robots and AI if it hopes to offset its demographic woes with a far more productive economy.

Funds to consider if you want to invest in Japan

Some funds to consider if you want to invest in Japan, from the editors of Kiplinger Personal Finance: Fidelity Japan (FJPNX). T. Rowe Price Japan (PRJPX). WisdomTree Japan Hedged Equity (DXJ) and Japan Hedged SmallCap Equity (DXJS).

Japan’s economic fate matters a great deal to the U.S. Among trade partners, it’s America’s fourth-largest export market. It’s also a key source of outside capital for the U.S., as both a buyer of Treasury debt and an investor in American business. Four decades ago, that seemed like a threat. Now, with the rise of China, it’s critical for us to have friendly creditors and investors, not to mention amicable trade partners.

Japan should be able to get along with President-elect Donald Trump. He is promising sweeping tariffs, but he had good relations with Tokyo in his first term. However, look for Trump to press Japan on defense spending. He will want to bolster ties with friends in the Pacific to counter China, but he also probably wants to see Japan contribute more money, taking some of the burden off U.S. taxpayers.

This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.

Rodrigo Sermeño covers the financial services, housing, small business, and cryptocurrency industries for The Kiplinger Letter. Before joining Kiplinger in 2014, he worked for several think tanks and non-profit organizations in Washington, D.C., including the New America Foundation, the Streit Council, and the Arca Foundation. Rodrigo graduated from George Mason University with a bachelor's degree in international affairs. He also holds a master's in public policy from George Mason University's Schar School of Policy and Government.