Is Greece Japan’s Future?

The Greek fiscal crisis has sent shockwaves through markets around the world. In just two years, Greece’s budget deficit jumped from 4% of GDP to 13%. Now other European Union countries seem under threat, and the EU and the International Monetary Fund are grappling 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% – much higher than in Greece, where the figure stands at around 110%. But, despite the grim parallel, Japan’s government does not seem to think that it needs to take the problem seriously. Last year’s general election brought regime change to Japan. Yukio Hatoyama’s Democratic Party of Japan (DPJ) thrashed the Liberal Democratic Party, which had governed almost continuously for a half-century. But Hatoyama’s government has ignored macroeconomic management by abolishing the policy board charged with discussing economic and fiscal policy. Instead, the government has focused on increasing spending to meet its grand electoral promises, including a huge amount for new grants to households and farmers. As a result, the ratio of tax revenue to total spending this fiscal year has fallen below 50% for the first time in Japan’s postwar 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 1990’s, the country’s so-called “lost decade.” At that time, Japan’s budget deficit soared after the country’s property bubble burst, causing economic stagnation. But JGBs are mostly purchased by domestic organizations and households. In other words, the private sector’s huge savings financed the government’s deficit, so that capital flight never occurred in the way it has in Greece, despite the desperate budget situation. But this 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. But in a mere three years, total JGBs will exceed this total. This suggests that taxpayer assets will no longer back government debt, at which point confidence in the JGB market is likely to shatter. Second, Japanese society is aging – 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 aging 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 age 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, which has been stable so far, will face serious trouble in the years ahead. After averting its eyes since coming to power, Japan’s new government has finally started discussing tax hikes. One possibility is an increase in the consumption tax, which currently stands at 5% – low in comparison with other industrialized countries. But tax hikes alone with not close Japan’s fiscal black hole. What is most needed is consistent and stable macroeconomic management. Such management is possible. Between 2001and 2006, Prime Minister Junichiro Koizumi aggressively tackled Japan’s fiscal problems. Koizumi sought smaller government and set clear numerical targets for fiscal consolidation, including a primary budget balance in 10 years. Surprisingly, 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 realized. But over the past three years, the prime minister changed each year, 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 solve the problem. Indeed, some economists fear that a fiscal crisis could erupt even after a tax hike is passed.Once that happens, the impact on neighboring countries – and on the world economy – will be huge compared to the current European problem. After all, Japan remains the world’s second largest economy, accounting for about one-third of Asia’s GDP, and 8% of global output, whereas the GDP share of Greece in the EU is about 3%. In some countries, lower military expenditures and interest rates has helped to improve a weak fiscal position. But in the case of Japan, military spending is already low, as are interest rates. This suggests that fiscal rescue will be extremely difficult if and when trouble starts – and underscores the urgent need for real political leadership now. Heizo Takenaka was Minister of Economics, Minister of Financial Reform, and Minister of Internal Affairs and Communications under Prime Minister Junichiro Koizumi; he is currently Director of the Global Security Research Institute at Keio University, Tokyo. Copyright: Project Syndicate, 2010.