Will Japan go the way of Greece?

May 28, 2010
EURO CRISIS

By Heizo Takenaka

THE Greek fiscal crisis has sent shock waves through markets around the world. In just two years, Greece's budget deficit jumped from 4 per cent of its gross domestic product (GDP) to 13 per cent. Now other European Union countries seem under threat, and the European Union and the International Monetary Fund are trying to stem the crisis before another nation trembles.

But the problem of excessive government debt is not confined to the EU. Indeed, Japan's debt-to-GDP ratio is around 170 per cent - much higher than Greece's 110 per cent. But despite the grim parallel, the Japanese government does not seem to think that it needs to take the problem seriously.

Last year's general election brought regime change to Japan. Mr Yukio Hatoyama's Democratic Party of Japan (DPJ) thrashed the Liberal Democratic Party, which had governed the country almost continuously for 50 years. But the Hatoyama government has ignored macroeconomic management and has abolished the policy board charged with discussing economic and fiscal policy.

Instead, the government has focused on increasing spending to meet its electoral promises, including a huge amount of new grants to households and farmers. As a result, the ratio of tax revenue to total spending this fiscal year has fallen below 50 per cent for the first time in Japan's post-war history. If the government continues on this path, many expect next year's budget deficit to widen further.
Despite the weakness of Japan's fiscal position, the market for Japanese government bonds (JGBs) remains stable, at least for now. Japan had a similar experience in the 1990s, the country's so-called 'lost decade'. Japan's budget deficit soared after the country's property bubble burst, causing economic stagnation.

But JGBs were mostly purchased by domestic organisations and households. In other words, the private sector's huge savings financed the government's deficit, so there was no capital flight from Japan, as there has been in Greece, despite the desperate budget situation.

But the situation has deteriorated recently, for two reasons. First, the total volume of JGBs has become extremely high relative to households' net monetary assets, which stand at roughly ¥1,100 trillion (S$17 trillion). In a mere three years, total JGBs will exceed this total. This suggests that taxpayer assets will no longer be able to back government debt, at which point confidence in JGBs is likely to shatter.

Second, Japanese society is ageing - fast. As a result, the country's household savings rate will decrease dramatically, making it increasingly difficult for the private sector to finance budget deficits. Moreover, an ageing population implies further pressure on fiscal expenditure, owing to higher pension and health-care costs, with all of Japan's baby boomers set to reach the age of 65 in about five years. The increase in social-welfare costs is expected to start around 2013, three years from now.

Given these factors, the JGB market will face serious trouble in the years ahead. After averting its eyes since coming to power, Japan's new government has finally started talking of tax hikes. One possibility is an increase in the consumption tax, which currently stands at 5 per cent - low in comparison with other industrialised countries.

But tax hikes alone will not close Japan's fiscal black hole. What is most needed is consistent and stable macroeconomic management.
Such management is possible. Between 2001 and 2006, then-Prime Minister Junichiro Koizumi aggressively tackled Japan's fiscal problems. Mr Koizumi sought smaller government and set clear numerical targets for fiscal consolidation, including a balanced budget in 10 years.

Surprisingly, Mr Koizumi was almost successful. Japan's primary deficit of ¥28 trillion in 2002 was reduced to only �6 trillion by 2007. If this effort had been continued for two more years, a primary budget surplus could have been realised. But Japan had three prime ministers in three years, and a populist trend in fiscal expenditure took hold.

What is needed most now is for the DPJ government to restore comprehensive economic management. A tax hike is only part of that. Without a strategy for growth, an effort to reduce government spending, and a policy to stop deflation, a tax hike will not be enough. Indeed, some economists fear a fiscal crisis could erupt even after a tax hike is passed.

Once that happens, the impact on the world economy will be huge. After all, Japan remains the world's second largest economy, accounting for about one-third of Asia's GDP, and 8 per cent of global output.

In some countries, lower military expenditures and interest rates have helped to improve a weak fiscal position. But in Japan's case, military spending is already low, as are interest rates. This suggests that fiscal rescue will be extremely difficult if and when trouble starts - underscoring the urgent need for political leadership now.

The writer was a minister under former prime minister Junichiro Koizumi. His portfolios included economics, financial reform and internal affairs and communications. He is currently director of the Global Security Research Institute at Keio University, Tokyo.

PROJECT SYNDICATE



[The norm seems to be for government to be short-sighted and to make populist policies to win elections and stay in power all the while mortgaging the future of the country. The democratic process seems to promote such short-sightedness, and encourage populist vote-buying. There should be a recognition that there are longer term issues that governments need to address, and that short terms goals or policies may be at odds with long-term security and well-being. And the democratic (or other political processes) should be tweaked or revised to address long term views.]