Japan wrestles with world's biggest debt

PUBLISHED : Wednesday, 30 June, 2010, 12:00am
UPDATED : Wednesday, 30 June, 2010, 12:00am

Belatedly, Japan's leading politicians are waking from their coma and realising that the country's economy is in a massive mess, hit by a triple whammy of low growth, heavy debts and an ageing population.

The increasing talk in the run-up to next month's upper-house elections is by how much and when to raise the 5 per cent consumption tax. The good news is that there is a sort of Japanese-style consensus forming about the inevitability of doubling the tax. The bad news is that 10 per cent is not going to be sufficient to close the government deficit or get on top of the debts.

The worse news is that the tax will have to go to at least 20 per cent and maybe as high as 37 per cent if Japan wants to escape the debt trap, according to economists who have looked closely at the government's own figures.

The worst news of all is that Japan's leading politicians are still living in a make-believe world of their own, uncontaminated by hard economic facts and figures.

Only one party is advocating an early rise, to 8 per cent by 2012, in the consumption tax. Another party has a 2020 time horizon for the tax to go to 10 per cent. Prime Minister Naoto Kan, having raised the spectre of a Greek-style failure if Japan does not get to grips with its deficits and debts, has now backed away from setting a firm timetable for tackling them through a consumption tax increase.

To be fair, Kan has suggested a national debate over tax issues, but he needs to go further and launch a grand debate on the economy and society and how Japan can get out of the deep hole that its politicians and bureaucrats have dug.

For years, dirty deals between bureaucrats and politicians, with the active compliance of construction companies, allowed massive spending on ugly but election-sweetening projects, like town halls, bridges, Shinkansen lines. Now the bill is coming due when Japan can least afford it.

The outlined facts are well enough known. Japan's total government debts are the highest the world has ever seen, at 219 per cent of gross domestic product, according to the International Monetary Fund. They have continued to rise as the economy has responded only sluggishly to government stimulus spending, and will rise more steeply as the rapidly ageing population puts extra demands on health and welfare payments without a corresponding increase in income from taxes paid by a declining workforce.

Social security costs are rising by 1 trillion yen (HK$87 billion) a year. They already account for 27.3 trillion yen or 30 per cent of the budget.

Despite Kan's clarion call for action, the Japanese elite continues to live in an unreal world. The media yesterday gave prominence to the fact that the Group of 20 leaders in Toronto had given Japan 'wiggle room' by allowing it until 2013 to reduce its debts. But it is not the G20 that Japan needs to worry about, but its own debt levels and its own leaders' inability to promote economic growth.

So far, Japan has been sheltered from the chill winds of international debt markets because more than 90 per cent of government bonds are held by Japanese at very low interest rates. This is good for the government short-term, but there is a long-term price to be paid in that the big pension funds cannot earn enough to pay for the proper retirement of the increasingly elderly population. It does not help that the stock market is at about a quarter of its 1989 record-high level.

But the politicians are continuing to believe in magic. The former ruling Liberal Democratic Party is 'targeting' that Japan's growth will be 4 per cent a year over the next three years. Kan's Democratic Party of Japan forecasts 3 per cent a year until 2020.

They're kidding themselves, say all respectable economists, pointing out that for the past 10 years, even a modest 2 per cent growth has been unachievable.

Ministry of Finance officials, meanwhile, are beginning to say that a 20 per cent consumption tax is looming as 'inevitable'.

One of the most respected economists in Japan, Robert Alan Feldman of Morgan Stanley MUFG, has just issued a critique of the government's fiscal strategy, in which he accuses planners of sloppy economics.

The first of his damning five points is that 'the basic calculations include an implicit assumption that there will be unspecified sources of demand other than fiscal spending and external demand to close the output gap over the next five years'.

Devastatingly, he adds the fiscal management strategy 'advocates a tax-and-spend strategy to close the fiscal gap. However, reasonable parameter values in a simple Keynesian model of the economy imply that the tax-and-spend approach would require tax-spending rises of 16 percentage points of [gross domestic product] in order to close even the 4 per cent fiscal gap that the framework calculates. This is the equivalent to raising the consumption tax rate from 5 per cent today to 37 per cent'.

And that would devastate the economy. All is not lost - quite. Japan has forgotten that economic growth can essentially be raised in two ways - by a rise in population or growth in productivity. Restructuring and liberalisation of the economy would yield productivity gains, though at the cost of unemployment, and key government allies have dug their heels in against restructuring. Allowing foreign workers in would be another solution, but faces fierce popular opposition.

Kan essentially has only one way out. The honest prime minister has to be honest with his people about the problems, put the issues and choices before them and stimulate a popular debate.

Kevin Rafferty is author of Inside Japan's Powerhouses, a study of Japan Inc and internationalisation


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