The potential growth rate in Japan is low due to a shrinking population as well as slow capital accumulation. Without acceleration in productivity growth, a shrinking labor force will cause the GDP to contract, although GDP per capita is likely to continue to rise, according to Capital Economics.

In the report by Capital Economics, increasing the participation of the young, women and the elderly in the workforce, reducing regulation and increasing regional integration will help increase the potential growth rate.

Capital Economics says the onus to achieve the potential growth rate lies with the government. It published its New Growth Strategy in June 2010 but has been steered off course by last year’s disaster and subsequent reconstruction efforts. This looks like it will delay rather than speed up the strategy’s implementation.

The most obvious solution to reverse a shrinking population is to allow higher immigration, but this remains politically unpopular and there are added difficulties such as culture and language, says Capital Economics.

An influx of young immigrants would have the added benefit of increasing the government’s tax take and would distribute evenly the financial burden of looking after an aging population, reports Capital Economics.

Employment can be boosted in other ways too, such as through increasing participation of women in the labor force and encouraging workers to work beyond the statutory retirement age of 60, which many already do, says Capital Economics.

Also Capital Economics notes that there is considerable scope for changing the tax structure to support growth by shifting the burden from corporate taxes to consumer taxes. Businesses pay one of the highest rates of corporate tax in the developed world, discouraging investment and innovation.

Capital Economics adds that the central bank has an important role to play in ensuring that monetary and financial conditions remain accommodative, but supporting lending to growth sectors is unlikely to do much to boost growth as there is little evidence that the economy is being held back by a lack of credit.

Capital Economics points out that the real problem is the reluctance to invest, which is hardly surprising given businesses face a shrinking domestic market, an appreciating yen and expected higher future tax burden.