The Greek fiscal crisis has sent shockwaves through markets around the world. In just two years, Greece’s budget deficit jumped from 4 percent of GDP to 13 percent. Now other EU countries seem under threat, and the EU and the IMF 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 percent — much higher than in Greece, where the figure stands at around 110 percent. 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. Japanese Prime Minister Yukio Hatoyama’s Democratic Party of Japan (DPJ) thrashed the Liberal Democratic Party, which had governed for almost 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 percent 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 1990s, 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.
However, 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 (US$12 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 healthcare 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 percent — low in comparison with other industrialized countries.
Tax hikes alone, however, will not close Japan’s fiscal black hole. What is most needed is consistent and stable macroeconomic management.