How should an advanced nation like Japan with low growth potential, an aging population and a shrinking workforce, go about lowering national debt to manageable levels? Beacon Reports put that question to economist Motoshige Itoh, an inner-circle member of the panel advising Abe’s cabinet on economic strategy. The Tokyo University professor sits alongside the Prime Minister and the Bank of Japan’s Governor Kuroda as members of the Council on Economic and Fiscal Policy.
Professor Itoh told Beacon Reports it is best to act pragmatically rather than let pessimism govern Japan’s economic policy. His voice takes a middle ground in the ongoing debate that pits the Ministry of Finance favoring fiscal austerity at one extreme against other voices who want the nation to adopt a no holds barred ‘go for growth’ strategy at the other — Abe has yet to decide his own thoughts on the matter.
The economic policy advisor said that Japan’s problems are more complicated than those of other countries. Its gross debt to GDP ratio at over 200% is already the largest in the developed world. It continues to run large deficits equivalent to about 6% of GDP. In addition, the nation faces a long-term challenge to care for its rapidly aging population.
Rather than react in a knee-jerk way, the professor recommends tailoring short-term macroeconomic policy to reflect current economic conditions. Those might differ from strategies better suited to the long term. “What we should do over the next 5 years may be different from policies needed after 2020, because the aging issue is more of a ten or twenty year problem,” Professor Itoh said.
He suggested that systemic low growth, also known as secular stagnation, be ignored when setting short-term macroeconomic policy. Former US Treasury Secretary Lawrence Summers hypothesized a nation’s trend rate of growth can be below that originally predicted when its economy suffers sequential shocks. This, Professor Itoh said, is exactly what happened when a long period of deflation followed the bursting of Japan’s financial bubble. “If Larry is right, then taking some stimulus measures to end deflation might cause Japan’s economy to return to a higher growth rate,” he theorized.
While it is still too early to predict the outcome, the professor said that it is wrong to determine macroeconomic policy based on a lower real rate of growth than the 2% target set by the Cabinet. Encouragingly, Japan grew at a 3.9% annualized rate over the period January – March.
The pressing agenda is to shrink the size of the primary deficit, equal to the budget deficit minus debt interest expenses. The primary deficit has halved over the past five years, down from 6.6% to 3.3%. Higher tax revenues resulting from increased corporate profits and the hike in last year’s consumption tax were cited as causes.
The professor hoped that the primary deficit would further shrink from 3.3% to 0% by the end of 2020. This might be achieved through tax reforms, increased corporate tax revenues (obtained from higher nominal growth) and by slowing the rate of expansion of government expenditures. “That’s exactly the scenario of our budget reform,” he said. Details of the new reforms are scheduled to be announced later this month.
Social entitlements needed to be reined in, but there was no immediate need for draconian cost cutting. “We should have substantial cutting of expenditures on the one hand, but not too much to kill the economy,” he advised.
Pension reform would be simple to implement under the macroeconomic indexing mechanism already agreed to by the Cabinet, once the politically difficult decision to make the reform was taken. Under this mechanism, the rate of future pension growth will be limited to a fraction of the inflation rate. For example, if the future rate is 2%, pension benefits would cap at .9%.
Medical reform would be needed to keep costs in check, especially after 2025 when baby boomers turn age 75 and older. Medical reform is made complicated by the need to make 1,000 or 2,000 individual reforms. By making preventative healthcare more available, Professor Itoh believed that future demand for public health services could be reduced. Already Japan spends on average about the same percentage of GDP on medical care as do other OECD nations.
The planned rise in the consumption tax to 10% in April 2017 would likely suffice through 2020. There was, he said, the capacity to lift the tax rate to European levels if the need arose.
Professor Itoh said that fiscal measures alone would not suffice to stabilize government finances in the long run. Eventually mild inflation would be needed. “It is becoming an important issue because everybody knows mild inflation is a big help to reduce the debt to GDP ratio,” he said noting, “The debt is so large that even if the government achieves a 2 – 3% budget surplus as a percentage of GDP each year, it would take 30 or 40 years just to halve the debt to GDP ratio.”
To achieve mild inflation, real interest rates might need to turn negative, “perhaps to minus 1% for a while,” he thought. How negative depended on market conditions.
According to the professor, ‘bad’ macroeconomic policy in the past has created current market distortions. To fix this, he recommended that the government transfer publicly owned and managed activities (it has many) to the private sector through concessions, private sector partnerships and through private finance initiatives. For instance, the management of government owned airports could be outsourced to private firms.
Benefits were already accruing from measures to bring private sector competition to previously uncompetitive industries like the energy sector. “The reforms we are making will provide a huge additional investment by the corporate sector,” he said. These he hoped would cut the size of the national budget.
Other reforms appeared to be moving in the right direction. Corporate governance, adoption of the stewardship code, measures that encourage Japanese firms to deliver value to shareholders and so forth have been introduced. Labor reform is another matter: “It’s a pity to have just two tiers,” he said, referring to the two classes of workers that exist in Japan – one ‘regular’ and another ‘irregular’. He believed, “There should be 10, perhaps 100 tiers to cater to the many different types of work situations.” It was, he said, the direction the government wanted to move in.
Japan’s substantial economic problems were never going to be easy to solve. A democratically elected government cannot dictate legislative reforms. Its purpose is to create an environment conducive for real reforms to be made by individuals and businesses. “We have to keep doing the reforms. But reforms are not magic. The important thing is that you have to do what you can do at this moment. If macroeconomic performance moves in the wrong direction, that means the reforms are not being implemented quickly enough. Then, we have to adjust the system,” said Professor Itoh.
Beacon Reports reveals Japan through the lens of thought leaders. Subscribe free!