3 Economic Challenges Facing Japan in 2025

In the 1980s, Japan was on track to become the world’s leading economy. Its rapid industrial expansion and global exports positioned it as a rising superpower. But that momentum collapsed with the bursting of a massive asset bubble in 1990, ushering in decades of economic stagnation, deflation, and sluggish growth. This era, once known as the “Lost Decade,” is now better understood as a structural stagnation lasting more than 30 years.

Meanwhile, the Bank of Japan (BOJ) and the Japanese government have implemented a range of measures to stimulate the economy. For instance, the BOJ was the first central bank ever to implement quantitative easing, a monetary policy of asset-buying, which sought to drive long interest rates to near-zero levels. The second Shinzo Abe administration, which took office in 2012, introduced the three programs of “Abenomics” to try to revive the economy. These were an aggressively expansionary monetary policy, increased government spending, and changes to regulations to increase trade and growth.

As of mid-2025, Japan is contending with three key economic challenges: sustaining a fragile recovery, reducing its overreliance on China amid geopolitical and supply chain disruptions, and confronting the long-term consequences of its demographic crisis. Let’s explore each more in-depth.

Key Takeaways

• Since 1990, the Japanese economy has suffered from economic stagnation, and COVID-19 has worsened the situation.
• Japan has yet to fully recover from the economic damage inflicted by the COVID-19 pandemic.
• Rising global tensions and supply chain disruptions have forced Japan to rethink its investment relationship with China.
• A shrinking population and rising elderly dependency are straining Japan’s labor market and social security systems.

Sustaining a Fragile Recovery

Japan’s economic rebound from the pandemic-induced contraction has been modest and uneven. Real GDP has grown in fits and starts since the sharp 2020 collapse, and as of Q1 2025, it remains just below pre-pandemic trend levels. While consumer spending and tourism have improved thanks to the return of international visitors and relaxed travel restrictions, underlying structural weaknesses persist.

Fiscal stimulus continues to play a central role. Prime Minister Fumio Kishida’s government approved a ¥114 trillion (~$700 billion) budget for fiscal 2025, prioritizing energy subsidies, wage support, and digital infrastructure. However, global headwinds—such as geopolitical instability, rising interest rates abroad, and inflation in imported energy—are dampening consumer and business confidence.

Japan remains especially vulnerable to energy price shocks, as it imports nearly all its fossil fuels. Although inflation has ticked up from historic lows—headline CPI was 3.6% year-over-year as of April 2025—this remains modest compared to global peers. The BOJ, under new leadership since 2023, continues its cautious tightening of policy but maintains a dovish stance to support fragile demand.

Rethinking China Dependence

For decades, Japan’s manufacturing and export sectors benefited from China’s vast labor force and growing consumer market. However, the landscape is shifting rapidly.

Rising labor costs in China—now significantly higher than in Vietnam, India, and the Philippines—have eroded its competitiveness. Meanwhile, escalating tensions over Taiwan, regional military drills, and export controls on key technologies have pushed Japanese firms to diversify production away from China.

Recent government initiatives, including subsidies to reshore manufacturing and deepen trade ties with ASEAN countries and India, reflect this strategic pivot. Companies like Panasonic and Toyota have announced major investments in Southeast Asia to mitigate geopolitical risk and enhance supply chain resilience.

Note

Japan’s debt, at over 200% its GDP, means it has twice as much public debt as its GDP. This makes Japan one of the most indebted developed countries in the world.

Confronting Demographic Decline

Japan’s most entrenched economic challenge remains its demographic trajectory. With a fertility rate of just 1.15 in 2024 and the total number of annual births (686,000) in 2024 dropping below 700,000 for the first time, the country faces acute labor shortages and mounting social security costs. In 2024, Japan’s population declined for the 18th consecutive year.

The dependency ratio—the proportion of retirees to working-age citizens—continues to worsen. In fiscal 2025, the government has plans to cover a roughly ¥558 billion increase in Social Security expenditures for its aging population. Meanwhile, Japan continues to be among the world’s developed countries most reliant on debt; as of 2023, Japan’s public debt remains the highest in the developed world, at approximately 263% of GDP.

Efforts to address this issue include expanded support for working parents, modest increases in immigration, and digital transformation policies aimed at boosting productivity. However, these remain long-term fixes, and the demographic drag on growth is expected to persist for years, which may continue to drag on the country’s drag on needing to secure debt.

What Led To Japan’s “Lost Decades” Of Economic Stagnation?

Japan’s “lost decades” trace back to the spectacular collapse of twin property‑and‑equity bubbles in 1990, which wiped out trillions in household and corporate wealth almost overnight. Banks were saddled with bad loans, credit tightened, and consumer confidence cratered. Policymakers responded slowly, allowing deflationary expectations to take hold.

What Are The Main Pillars Of Japan’s Abenomics Strategy?

Launched in late 2012, Abenomics rested on “three arrows”: ultra‑easy BOJ policy to weaken the yen and lift inflation expectations, large‑scale fiscal stimulus for public investment, and structural reforms to spur private‑sector dynamism.

How Has The Bank Of Japan’s Monetary Policy Evolved Since 2020?

The BOJ doubled down on yield‑curve control and asset purchases during the pandemic, then began a cautious exit in 2023‑24 as global rates climbed. As of June 2025, it now allows the 10‑year JGB yield to fluctuate in a wider band while pledging emergency purchases if market stress returns.

The Bottom Line

Japan enters the second half of the 2020s at a crossroads. While cyclical challenges like inflation and global instability weigh on short-term growth, the real test lies in its ability to address structural issues—especially demographic decline and economic overdependence on China.

Policy efforts have shown some progress, but transformative change will require political will, innovation, and openness to immigration and reform. Without bold steps, Japan risks another decade of stagnation in an increasingly competitive global economy.