How can Taiwan avoid fiscal cliff?

By Lee Wo-chiang 李沃牆  / 

Fri, Oct 26, 2012 - Page 8

There is a saying, “the north wind makes you cold, but debt makes you poor.” Governments the world over have tried to borrow their way out of the financial crisis, or to sidestep it by injecting more cash into the system by printing more money, hoping that this would help maintain economic growth. The trouble is, they cannot control what comes after: The mounting debt and parlous finances that are left to younger generations to deal with.

The worst-hit countries in the EU, the so-called “PIIGS nations” of Portugal, Ireland, Italy, Greece and Spain, are by no means alone: Even economic superpowers the US and Japan have been sucked into the mire.

According to a report from the US Congressional Budget Office published this May, if former US president George W. Bush’s tax cuts are allowed to expire this year, and the huge expenditure cuts kick in next year as planned, the federal budget deficit will fall by US$607 billion, or 4 percent of GDP, in the fiscal year from Oct 1. However, the US economy will also contract by 1.3 percent, which will cause a tightening of government expenditure and falling investment, with businesses also likely to be reluctant to take on new staff. This means the US economy could fall back into recession.

This sudden fall in government expenditure means there is a risk of a creating a “fiscal cliff” — so called because the line representing expenditure on the graph of government finance drops off dramatically. And if this happens, the repercussions will go beyond the US moving into recession: They will be felt throughout the global economy.

Does a similar fate await Taiwan? Could there be a fiscal cliff in government expenditure here? There are three main factors pertinent to this: The size of the government budget deficit; how much is allocated to welfare expenditure; and demographics, including Taiwan’s birth rate and aging population.

As of the end of last month, the Ministry of Finance’s National Debt Clock — showing the debt burden expressed as an average amount for every person in the country — stood at NT$216,000 (US$7,392).

However, the national debt figure is misleading. Once you account for finance scheduling in the government expenditure budget for next year, which will add another NT$291.4 billion, and include hidden debt, the true national debt could be as high as NT$14.5 trillion.

A full NT$438.9 billion has been set aside for social welfare in next year’s government expenditure budget. This is the highest single budgetary item, at 22.6 percent. By comparison, the amount set aside for economic development comes in at fourth place, being NT$272.6 billion, only 14 percent of the budget. The rather contentious pension bonus is going to cost NT$139.9 billion, or 7.2 percent.

The aging population, and the increase in welfare payments that this entails, is likely to be a significant drain on government expenditure. According to The Economist, several wealthy European nations with large welfare states are casting about for possible solutions to the expanding government debt caused by their aging populations. The same is happening in the US. The baby boom there meant that in the 1960s every five people were providing for one person receiving support within the social security system; now, there is one retired person for every three people still employed.

Asian countries are in danger of getting stuck in the same rut that Western countries have got themselves into. By the year 2035, China will have a situation in which every five workers will be supporting two retirees.

In Taiwan, the population will start shrinking by 2030, at which point there will be one retired person for every three members of the younger generation. This younger generation will be burdened by an increasing dependency ratio coupled with a falling savings rate and decreased national competitiveness.

In essence, the nation’s slowing economic growth is dragging down tax revenues, a situation exacerbated by years of politicians’ promises to the electorate of more social welfare and lower taxes. Add to this the increased welfare payments required by the aging population and the fact that the National Pension fund, the pension fund for retired military personnel, public school teachers and civil servants and the Labor Insurance Fund are all facing impending bankruptcy.

All of this is taking away from the country’s ability to pay for public construction projects and is putting more strain on government finances, raising concerns that Taiwan could become another Greece.

Something needs to be done before it is too late.

Taiwanese do not want to find themselves in the same predicament facing Europe, the US and Japan. The US Federal Reserve has already implemented another round of quantitative easing.

However, the question is: What weapons does Taiwan have at its disposal to deal with a potential looming fiscal cliff?

Lee Wo-chiang is a professor in Tamkang University’s Department of Banking and Finance.

Translated by Paul Cooper