75 HEIZO TAKENAKA FORMER JAPANESE MINISTER OF ECONOMICS UNDER PRIME MINISTER JUNICHIRO KOIZUMI
Japan as number three C
hina has now offi cially supplanted Japan as the world’s second largest economy. The question for Japan is whether or not the country will continue to tumble down
the list of the world’s great economies, or whether its politicians will return to a path of reform that can revive growth. That the ruling Democratic Party of Japan now seems trapped in a power struggle between Prime Minister Naoto Kan and party power broker Ichiro Ozawa suggests that serious economic reform is not at the top of the DPJ agenda. In the 1980’s, Japan’s annual GDP growth averaged 4.5
percent; since the early 1990’s, the economy has been virtually stagnant, averaging barely 1 percent annual growth. In the 1990’s, Japan’s government, grossly misjudging the sources of the economy’s diffi culties, vastly increased government expenditures on public works, but ignored supply-side adjustments. This policy created new vested interests, and thus a new
political environment, as construction companies and other benefi ciaries of government contracts began donating heavily to the ruling Liberal Democratic Party. This kept the LDP’s coffers brimming, but posed the risk of a serious fi nancial crisis in the late 1990’s.
Political instability It was in these circumstances that Prime Minister Junichiro Koizumi took offi ce in April 2001. Under Mr Koizumi’s leadership, insolvent banks were made whole again. At the start of Mr Koizumi’s government, 8.4 percent of bank loans in Japan were non-performing. By the end of his tenure, the rate was down to 1.5 percent, restoring the country’s potential for growth. Indeed, this was one reason why Japan was so little affected by the “Lehman Shock” that incited the global fi nancial crisis. But macroeconomic reform came to a screeching halt after
Mr Koizumi stepped down in 2006. A series of short-term prime ministers began a pattern of huge government outlays. Not surprisingly, the economy deteriorated. Frustrated by the long-ruling LDP’s poor political and
economic management, voters opted last year for change at the top. But the pattern of economic mismanagement, far from being reversed, has only become worse. Huge spending increases were directed at farmers and
households. As a result, the share of tax revenue to total spending this fi scal year slipped below 50 percent, something unseen in Japan’s entire post-war history.
Problematic bonds Despite the parlous fi scal position, for now the market for Japanese government bonds (JGBs) remains stable. But this is because government bonds are purchased mostly by domestic organizations and households. In another words, the government’s negative saving is fi nanced by the private sector’s positive savings.
WITHOUT A STRATEGY FOR GROWTH, WHICH INCLUDES EFFORTS TO REDUCE GOVERNMENT EXPENDITURES AND A POLICY TO STOP DEFLATION, JAPAN’S ECONOMY WILL REMAIN IN THE DOLDRUMS
But that private-sector safety net of savings is fraying.
Japanese households hold savings of about ¥1.1 trillion (around MOP0.1 trillion) in net monetary assets. In about three years, however, the amount of JGBs will exceed the total assets of Japanese households. Government debt will no longer be backed up by taxpayers’ assets. Confi dence in the JGB market will likely decline. Moreover, as Japan’s society ages, the household savings
rate will decrease dramatically. This will make it diffi cult, if not impossible, for the domestic private sector to fi nance the budget defi cit indefi nitely. And new demands for fi scal expenditures are expected to
grow as the country ages. In about fi ve years, all baby boomers will be over 65, but pressure on government expenditures for pensions and health care is expected to start sooner, around 2013.
No growth strategy Japan’s new government, led by Prime Minister Naoto Kan, started discussing a consumption-tax hike to offset the growth in spending. But a consumption-tax hike is no panacea, particularly given the government’s lack of a growth strategy. Although a tax increase will undoubtedly be needed, it is the wrong priority at the moment – and could prove counter- productive if it causes the economy to decline dramatically. Indeed, Mr Koizumi’s government demonstrated the best
way to tackle fi scal consolidation. Mr Koizumi decided that a primary budget balance should be restored in 10 years. And he came close to being successful, as the primary defi cit of ¥28 trillion in 2002 was reduced to just ¥6 trillion in 2007. Had this effort been continued for two more years, a primary surplus could have been realized. Without a strategy for growth, which includes efforts to
reduce government expenditures and a policy to stop defl ation, Japan’s economy will remain in the doldrums. But Mr Kan still seems unwilling to focus on growth. Instead, like so many other leaders before him, he proclaims his desire to fi nd a “third way.” But, as history has shown, no third way exists. Mr Kan continues to believe that a large government, with
growing social-welfare expenditures, is the way to get the economy moving. This should not be surprising. He used to be involved in civic movements and groups – like environmental organizations – that take little heed of the need for economic growth. Increasing the tax burden seems almost a natural part of
such a mindset, as does ignorance of the need for increased economic competition. Without that, and a renewed focus on growth, Japan will continue to climb down the global ladder of success. Indeed, any Japanese who thinks that complacency is an
option should look to Argentina. A hundred years ago, Argentina was arguably the world’s second wealthiest economy. Now, thanks to bad policies, and even worse politicians, it ranks among the world’s also-rans.
OCTOBER 2010
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