Today I wish to move across the other side of the world and examine the economy of the land of the rising sun Nippon or Japan. It exhibits many of the themes and issues highlighted by this blog but let me present one of them in a new form. One of the links between Japan and Italy my subject of yesterday is high levels of public debt relative to economic output although Japan makes even Italy seem an amateur at the game as its gross ratio is expected to reach 247% this year. Putting it another way Japan’s national debt at the end of June was 1,008,628,100,000,000 Yen as we record another sign of inflation which is that counting in quadrillions is now necessary.
Tax rises forever?
This brings with a consequence which is tax rises. In a coincidence of timing the Value Added Tax rate in Italy rose from 21% to 22% overnight just before the Japanese Prime Minister Shinzo Abe announced that its sales tax would rise from 5% to 8% on the first of April. Assuming that this is not some sort of April the 1st ploy or joke there is a clear underlying theme that some 5 years after the credit crunch began taxes are still rising. That leaves me with today’s question which is when will the tax rises stop?
Japan’s fiscal position
This is somewhat dreadful as what is very dangerous if you have a high level of national debt is to run large annual fiscal deficits as well! However Japan is running annual fiscal deficits of around 10% of its economic output. Indeed earlier this year what has been named Abenomics actually boosted the deficit with a stimulus package of around 1.4% of GDP. The supporters of such a move argue that it will be paid for by increased economic growth which if true would be a genuine change of direction for Japan.
A sign of a problem in this area is a recalculation of the numbers. Like the Euro area Japan has chosen to focus on the primary balance because it is smaller. This is driven by another function of the size of the debt which is that the cost of financing it is at 22 trillion Yen some 24% of all public spending.
What has driven this?
One underlying factor has been demographics. Japan has a low birth rate such that in spite of its reputation for longevity its population is shrinking and is indeed in danger of quite substantial falls over the next few decades. Also whilst increased longevity much preferable to the reverse situation it does pose questions as to how it is to be finances as health and care costs rise substantially with age. According to the International Monetary Fund (IMF) the impact so far has been as follows.
public and private spending on healthcare and long-term care (HC/LTC) more than doubled during the last two decades, reaching 9.4 percent of GDP in 2010.
The IMF also offered a forecast of the future.
Extrapolating past trends, HC/LTC spending would increase by as much as 5 percentage points of GDP during 2010–30
The previous Governor of the Bank of Japan was very concerned about this area and made something of a ground-breaking speech on the subject back on the 30th of May 2012. The emphasis is mine.
In the meantime, Japan’s economic growth gradually slowed during the past two decades mainly for two reasons. In the former half of the period, the Japanese economy was hobbled by the crippling effect of the burst of the bubble. In the latter half, the rapid population aging hampered the Japanese economy through a variety of channels.
This turned out to have a deeper implication which as I shall explain in a moment poses concerns for many other nations.
Among G-7 countries, the Japanese GDP growth rate per working-age population –– an indicator least affected by demographic changes in the short run –– was the highest. By contrast, the Japanese per capita GDP growth rate was almost the same as the average, and the Japanese GDP growth rate, which is subject to the decreases in the total population, was below average.
Putting this another way the Japanese economy actually did well but found that although it was swimming powefully it was dragging a heavy anchor,such that weaker swimmers overtook it.
Along the way I note that Governor Shirakawa seems to share my disappointment with economic textbooks or what has become known as economics 101.
Neoclassical growth theories normally do not distinguish the overall population from the working-age population due to analytical simplicity.
No wonder he ended up getting the order of the boot!
Is this our future too?
Whilst Japan has perhaps the worst demographic pattern of the world’s major nations others have issues in this area. For example net emigration is adding to an existing problem for Portugal and Spain is beginning to feel the effects of such an influence too. Indeed the peripheral nations in the Euro area find that aging western populations are being added too by rises in net emigration. This fits poorly with rising national debts as the ability to finance them is correspondingly weakened.
These countries may well find themselves humming this refrain courtesy of The Vapors.
I’m turning Japanese
I think I’m turning Japanese
I really think so
On this road immigration suddenly seems a good idea especially if you can manage to import a skilled workforce! Although of course even if the immigrants manage to be especially fertile and have skilled children there is the issue that they will merge into the existing problem. In other words there is an element of can-kicking here. If it was a magic solution Spain would not have turned from boom to bust would it?
Have indirect tax rises helped much?
These have tended to disappoint especially when applied to a weak economy. The most extreme version of this has been in Greece where tax rises have been inflicted on a weak economy and made it weaker and thereby reduced the revenue gains too. So there are clear scenarios where a tax rises has much less beneficial impact on a govenrment’s budget than expected.
Also another factor in the current malaise is that even large changes in taxation have only a minor effect on fiscal deficits because they are so large in the first place! For example the rise in Value Added Tax (sales tax) in the UK at the beginning of 2011 from 17.5% to 20% was estimated to raise an extra £13 billion a year of revenue. But the UK fiscal deficit is even now running at a rate of around £120 billion a year. So to get rid of it would require raising VAT to 43%? Er no as the subsequent collapse in our economy would project us along the Laffer curve.
Back to Japan
So whilst we in the west worry about turning Japanese they are clearly worried about becoming more like us! To make any real dent in their fiscal and debt dynamics the planned increase in the sales tax will have to be followed by others. For example the IMF recommends that it be raised to 15%. But we know that such increases can put an economy on a downwards spiral! Talk about being between a rock and a hard place.
There is much to consider here as there is for example a clear road to an improvement under Abenomics being a mirage. Should consumers bring forward consumption to avoid the rise then a boom may look like it is in progress. But if the example of Spain is followed then this apparent boom will turn to dust and then bust after the increase has passed. Along this road it is no surprise that the Bank of Japan’s Tankan report-an economic survey- is optimistic for now.
But if we widen our outlook we see that the issue of debt dynamics and what to do with it remains. This is the underlying feature of the current shutdown of at least some of the US government. Also it is the fundamental driver behind the UK coalition government moving its planned achievement of a structural fiscal balance from the end of this parliament to the next. Making us wonder and the next? And the next?
How do I know there is a fundamental problem. Easy as I contrast the reality of deficits with the political rhetoric.
we will have a surplus in good times as insurance against difficult times ahead……Provided the recovery is sustained, our goal is to achieve that surplus in the next Parliament.
Meanwhile each of the main UK political parties presented plans for extra spending of one form or another at their respective conferences.