Long-term economic outlook for Japan, as impacted by COVID-19

1 Introduction

Japan’s economy faltered from 1992 until 2019 with a weak annual gross domestic product (GDP) growth rate of 0.9% while the economy from 1960 to 1991, in the previous 30-year period, grew at an annual rate of 5.8%. Failure to continue the golden period after WWII until the late 1980s is due to mainly structural problems of the economy and the Abenomics of aggressive monetary policy, flexible fiscal policy, and growth strategy, the so-called three “economic arrows,” did little to stimulate growth to such levels of over 5% annual growth rate [1,2,3].

In addition to the three decades of slowdown, the COVID-19 pandemic, starting in 2020, has worsened any prospect of escaping long-term stagnation. The pandemic has disrupted an already fragile economy, leading to a sharp decline in GDP in 2020 and challenging the effectiveness of existing and new economic policies aimed at recovery. The economic measures deployed in response to the pandemic, including multiple fiscal stimuli, reflect the severity of the downturn and in the absence of such stimuli packages, the situation would be even worse.

During the 1990s and 2000s, Japan’s government debt surged significantly as the government pursued expansive fiscal policies, including massive infrastructure projects, to stimulate the economy after the burst of the stock market bubble in December of 1989. In 1991, the central government debt was only 38.2% of GDP, but in 2022 the debt ballooned to 216.2% of GDP [4]. Such an increase in the ratio of debt to GDP raises the issue of the sustainability of Japan’s government debt [5]. In addition, the banking sector’s bad debt accumulation contributed to economic stagnation, with estimates suggesting taxpayers would need to cover financial system losses equivalent to 20% of GDP [6,7]. Failure of the Keynesian approach to stimulate the economy is due to many factors including the great recession in 2008, low consumer confidence, rising public debt, an inefficient corporate structure, labor market rigidities, and the demographic challenge of an aging society [1,8,9,10,11,12,13]. Studies show that long-term structural reforms are more crucial than short-term Keynesian policies for Japan’s long-term economic recovery [10,14].

In terms of health impacts, the long-term stagnation and COVID-19 pandemic exaggerated the situation, affecting the well-being of the Japanese society, and that stagnation could continue into the future, until 2030, losing another decade. Several surveys showed a deterioration of the mental health of Japanese people induced by the pandemic and the economic downturn [15,16]. Such public health issues play an important role in labor productivity and hence the long-term economic growth of Japan.

The objective of this article was to analyze the economic consequences of COVID-19 in Japan by examining historical GDP growth as well as government measures taken and future economic forecasts until 2030. We utilized a counterfactual analysis method to determine the economic losses under two different potential economic trajectories in the absence of COVID-19 and policy relative to what happened in 2020 to 2023 with the pandemic and the impact of policy changes and assuming a continued low growth rate of 0.7 and 1.0% for 2024 and 2025 as predicted by the International Monetary Fund (IMF) in its World Economic Outlook July 2024 report (Table 1) and 0.9% per year from 2026 until 2030 as per 1992 until 2019 stagnation period. This methodology allows for an understanding of the direct, but more importantly, the opportunity costs incurred by the Japanese economy during this period.

This article is structured as follows. The first section provides a detailed examination of the immediate effects of the pandemic in Japan, analyzing fiscal responses made by the government to curb the economic decline, including adaptations to “soft” lockdowns and political transitions. The subsequent section employs a counterfactual approach to assess the long-term economic effects, exploring both pessimistic and optimistic growth scenarios absent the pandemic’s disruption. Finally, the last section summarizes the broader implications for economic growth prospects with further considerations given to four key challenges the Japanese economy will face.

2 COVID-19: Impacts on the Japanese economy in 2020 and 2021

Under the Abe administration, the average annual GDP growth rate from its inauguration to December 2019, before COVID-19, was 0.9%, calculated as an annual compound rate of real GDP changes from 2012 to 2019. However, because of COVID-19, the growth rate turned negative, with the IMF showing a 4.5% reduction in GDP for 2020 in its January 2023 World Economic Outlook Report [17]. In the same report, the IMF predicted a slow growth of 1.1% in GDP for 2023–2024.

Unlike other countries around the world, where harsh lockdowns were imposed, Japan implemented “soft,” voluntary or “interventional” lockdowns, such as personally decided or government-recommended stay-at-home measures, in April–May 2020, January–March 2021, and April–June 2021, in which restrictions of different levels were put in place [18,19,20].

In early 2020, with hopes of a positive 2–3% economic growth as exports kept on growing, public sector investment spending rising, and a booming tourism industry had brought the unemployment rate to its lowest level since 1993 (2.4% in 2018–2019) but rising again to 2.8% in 2020–2021 [21]. The sudden economic shutdown caused by COVID-19 cancelled or reversed any gains and aspirations that Abenomics created to end the period of great stagnation. Moreover, the economy would have collapsed further had there not been two economic relief packages, one in April 2020 and one in late May 2020 of ¥117 trillion (US$871 billion) each, from the Abe administration, totaling ¥234 trillion (US$1.74 trillion) [22]. After serving as the longest Prime Minister of Japan, PM Shinzo Abe resigned on 28 August 2020.

The new PM, Yoshihide Suga, who took over from PM Abe in the midst of the 2020 COVID-19 pandemic, stated that he would follow Abenomics, and from among the three arrows of the Abe administration’s monetary policy, fiscal policy, and growth strategy, PM Suga focused on the growth strategy, especially regulatory reforms that increase growth potential [23]. On 8 December 2020, the Suga administration announced a ¥73.6 trillion (US$708 billion, projected scale) economic stimulus package to aid the ailing economy from the pandemic, with investment targeting green technology and digital innovation [24].

In early October 2021, PM Suga was replaced by a new PM, Fumio Kishida, due to poor public support of PM Suga’s response to the fifth wave of the pandemic [25]. Under Kishida’s administration, the Cabinet decided on 19 November 2021, to spend ¥19.8 trillion in the third quarter for launching a “New Form of Capitalism” to open up a future society to put the economy back on a self-sustaining growth path [26]. In addition, the government decided on 26 April 2022 to spend ¥6.2 trillion for “Comprehensive emergency measures such as crude oil prices and rising prices” under COVID-19 [27].

Japan’s massive new stimulus package amounting to 56 trillion yen for the 2021 year, which included direct financial aid to businesses and households impacted by the pandemic [26,28]. In October 2022, another major economic package was unveiled by Prime Minister Fumio Kishida, targeting the rising cost of living and the recovery from the pandemic’s economic impacts. This ¥39 trillion package (including [27]) had subsidies to reduce the costs of energy, aid small to medium businesses, and support families with children, among other initiatives [29]. In June 2023, a draft policy framework of PM Kishida indicated an end to the crisis-mode stimulus spending [30].

In summary, the Abenomics period from 2013 onwards, even with its three arrows, did not achieve significant economic growth that is distinguishably different from the earlier great stagnation period. However, during 2020, a total of three economic relief packages were implemented totaling almost US$3 trillion (¥403 trillion), the equivalent of approximately 60% of GDP for that year.

3 Models analyzing the impact of COVID on Japan’s long-term economic growth

To predict the economic impact of COVID-19 on Japan, various models have been employed, including artificial neural networks [31], dynamic conditional correlation multivariate GARCH models [32], deep learning models [33], state-space modeling combined with the susceptible-infected-recovered (SIR) model [34], and an input-output table analysis [35]. These models, as expected, showed a negative impact, be it social, health and economic, from the COVID-19 pandemic. Chudik et al. performed a counterfactual economic analysis using a threshold-augmented dynamic multi-country model, showing long-lasting decline in world output, with advanced economies having more severe impacts from COVID-19 relative to emerging nations [36].

In the next section, we follow a simple counterfactual approach that was also employed by Cutler and Summers [37] to estimate economic losses for the US economy. They estimated economic losses at US$7.6 trillion from 2020 until 2030 using only one scenario of projections that the Congressional Budget Office conducted on July 2, 2020.^[1]

4 Possible economic losses in Japan over the next decade

In this section, an attempt is made to estimate how COVID-19 has impacted the Japanese economy thus far, and to project its impact on GDP in the medium- to long-term. Economic losses were estimated from 2020 to 2030 based on the yearly projected GDP path in the presence of COVID-19 less the GDP path without the presence of the COVID-19 pandemic to account for the counterfactual.

The scenario in the presence of COVID-19 assumes a continued low future average growth rate for the period 2020 to 2023 as per the IMF actual growth rates and those predicted for 2024 and 2025, after which the economy stabilizes at 0.9% per year until 2030, as per the historical average during the Abenomics period. Basically, an assumption that COVID-19 and the events aftermath, such as the Russia-Ukraine War, supply chain issues, and inflationary pressures, will keep the economy until the end of the decade stagnated at a low growth path (Table 1). This path is called the IMF.LG. Given the latest July 2024 IMF Report, the 0.9% annual growth rate assumption can be considered as optimistic since from 2020 to 2025 the Japanese economy is expected to grow only by 0.3% on average annually (Table 1). Thus, the estimated economic losses in this article can be considered as an underestimation since it assumes under the pandemic the economy will grow at 0.9% annually on average in the future.

To model the scenario without the presence of COVID-19, for the counterfactual (CFL), we simulated two different scenarios. The first counterfactual scenario (CFL.LG) is for GDP to grow at 0.9% per annum, as has been the case under the Abenomics period from 2013–2019 and during the “Great Stagnation” period from 1992–2019. This counterfactual path will give a low estimate of the economic losses since the assumed future path is similar with the assumed path in the presence of the pandemic making the opportunity cost to be low. The second counterfactual scenario (CFL.HG) assumes that the GDP growth path from 2019 to 2030 rises towards a steady state growth rate of 3.6% following the AR1 model (Supplementary Methods, Table S1). This scenario reflects the possibility that Abenomics, as well as the Suga/Kishida administration policies, in the absence of the pandemic and other economic shocks that occurred during the four years 2021–2024, would eventually have a positive impact on the economy (CFL.HG).

Each counterfactual path of GDP was compared with the actual and future assumed scenario (2024–2030) under COVID-19. One counterfactual path CFL.LG takes on a pessimistic approach, while CFL.HG is an optimistic scenario. The GDP data were obtained from the World Bank and was in constant local currency (see Supplementary information: Data sources and definitions). Figure 1 shows the historical path of real GDP annual growth rate since 1961 and projections to 2030. The green counterfactual path without COVID-19 assumes the economy will grow faster after 2019 and approach a steady-state growth rate (SSGR) of 3.6% without any other shock (CFL.HG). Under this scenario, the economic losses are highest due to the opportunity cost of losing out on high growth under the counterfactual (IMF.LG – CFL.HG). They are estimated at US$4.8 trillion (present value) (Table S2). Figure 1 also shows (blue line) the SSGR of the Japanese economy with or without COVID-19 remaining at the “Great Stagnation” long-run growth rate of 0.9%. The only difference in growth rates under this scenario was the 2020 COVID-19 economic lockdown shock and the small economic recovery during the 2021–2025 period. The least losses in this case are US$1.1 trillion. The reason is that the opportunity cost had low growth as opposed to high growth under the counterfactual.

Figure 1

Historical path of real GDP in Japan since 1961 and projections to 2030 using IMF.LG (red until 2025 and blue afterwards) and as the counterfactual marginal growth (CFL.LG, blue line from 2019) and high growth for the counterfactual (CFL.HG, green line from 2019). The red line indicates actual growth rates from 2020 to 2023 and for the year 2024 and 2025 as projected from the July 2024 IMF Report.

5 Concluding remarks

In this article, we offer a brief overview of the impact of COVID-19 on the Japanese economy under the Abenomics model at a time when its three-arrows policy may have begun to have had a positive impact. Using a simple counterfactual-based model and IMF data, we estimated the economic costs or losses to the Japanese economy caused by the pandemic. Table 1 shows that the IMF was hoping for a V-shaped recovery when forecasting COVID-19 impact in 2020 and 2021 with the policy support and availability of vaccines like an AR1 adjustment growth model. In fact, Pujol [38] had estimated a 16.8% loss in GDP for Japan for 2020–2025, translating to about US$0.7 trillion, estimates that relied on a V-shaped recovery. However, in 2022, the IMF gave up on the V-shaped recovery and downgraded growth until 2025 due to factors such as: “War Sets Back the Global Recovery” [39], a “Gloomy and More Uncertainty” [40], “Inflation Peaking amid Low Growth” [17] and “The global economy in a sticky spot” [41]. The COVID-19 pandemic has had an impact that is just as large as the 2008–2009 great recession and will have an economic cost of at least US$1.1 trillion (¥160 trillion) over this decade, i.e., 2020 to 2030 (or 30% of 2019’s GDP), showing continued stagnation, with or without the pandemic. However, if without COVID-19 there was growth, economic losses could reach US$4.8 trillion.

Based on the model’s results and the observed historical stagnation, Japan faces several key challenges in accelerating economic growth from 2024 to 2030 and beyond. First, the post-COVID-19 pandemic effects, such as supply chain disruptions and inflationary pressures, will continue to pose significant risks to the Japanese economy [42,43,44,45,46]. Second, Japan’s aging population presents a long-term challenge, impacting labor force participation and productivity gains [1,47]. Promoting automation and technological innovation can somewhat counterbalance the declining working-age population [48,49,50,51]. Third, the need for fiscal sustainability is necessary to foster growth as discussed previously. Japan’s high public debt levels, reaching 216% of the GDP in 2022, exacerbated by extensive fiscal stimulus during the pandemic, could lead to the crowding out of the private sector through higher real interest rates, which would lead to further escalation of the public debt to GDP ratio [52,53,54,55,56]. Research suggests that when debt-to-GDP ratios exceed 90–95%, there can be a negative effect on economic activity [57,58]. Finally, global geopolitical uncertainties and large-scale shocks, such as the Russia-Ukraine war, natural disasters from the intensification of climate change, earthquakes and tsunami shocks, and nuclear threats could create a future economic instability in Japan and elsewhere [59,60,61].

Hence, the Japanese government faces numerous challenges to increase its economic growth from 2024 to 2030. Addressing demographic shifts, enhancing digital innovation, promoting sustainable development, and ensuring sustainability of public debt with macroeconomic stability are key areas that require strategic interventions. In closing, the COVID-19 pandemic not only wiped out any small gains made with Abenomics’ three arrows, but potentially extended the period of “Great Stagnation” for another decade.