In the aftermath of their financial sector nightmares and attempts to buy their way out of economic setbacks, many East Asian governments face a large and increasing burden of debt. China and Japan have been running large public-sector budget deficits in an attempt to halt deflationary conditions. Many other governments have issued new debt to cover the cost of restructuring the banking system.
The inevitable consequence of these acts is that taxpayers' debt burdens imposed upon them by these government policies has grown considerably. As the carrying cost of public sector debt rises, it tends to crowd out private sector spending due to rising taxes and higher interest rates.
During the 1990s, Japan's government launched nine economic stimulus packages. Over ?112 trillion has been spent on public-works projects for developing infrastructure. Alas, it was to no avail since the Japanese economy continues to languish in recession. Japan's government debt is now in excess of ?600 trillion. As a percent of GDP it stands at over 120 percent, the highest among the advanced industrialized economies.
China's official debt-to-GDP ratio is only about 10 percent. However, state-owned banks have an estimated 1,000 billion renminbi (US$121 billion) worth of bad debts. Assuming a normal recovery rate of about 30 percent as is observed in other countries, then China's effective debt-to-GDP ratio would be closer to 80 percent or higher. Credit Suisse First Boston projects that 43.5 percent of Beijing's total tax revenue will be used to service debt in 2000. This proportion is nearly four times the debt service ratio in 1994.
Unfortunately, declines in real economic growth will hamper the ability to service this mounting debts. Average growth rates for the region are expected to be below 6 percent per annum, considerably lower that the 8 percent to 9 percent annual growth rates enjoyed during their "miracle" phases.
A significant portion of current and future tax revenues must be used just to cover interest payments. Indonesia has the most severe debt and deficit problems with carrying costs equal to around 17 percent of GDP. Others have a mixed record, but the heavy interest burden will mean that total government debt throughout the region will continue to rise before stabilizing and then declining.
The additional debt will depend on the final costs of bank restructuring. These costs will depend upon the recovery of bad loans. World Bank reports indicate that in South Korea and Thailand, recovery ratios on business loans have been around 20 percent while the rates on real-estate loans have been about 50 percent.
Higher debt levels can reduce growth prospects by increasing public-sector borrowing. When governments compete for scarce capital, it drives up interest rates and crowds out investments in the private sector. Similarly, attempts to increase income and corporate taxes will reduce incentives to invest.
There are several lessons from this alarming trend. First, it is hoped that taxpayers will learn that politics leads to considerable misallocation of spending. Cronyism continues to influence direct government spending as well as bailouts of banks and corporations.
Second, it should be evident that attempts to stimulate economies with boosts in government spending will always come to grief eventually. The only thing worse than not working is when they do work since such deficit spending packages lead to rising interest rates and/or inflation. In all events, deficit spending is normally meant to address cyclical problems. It does little or nothing to remedy the structural difficulties observed in East Asia's economies.
One bad bit of advice relates to the suggestions that taxes be raised. Indeed this is perhaps the single worst policy choice that might be made during an economic downturn. Higher taxes inevitably lower household spending and business investment or both. The IMF encouraged governments that sought assistance to do just than. Attempts to follow this conditional may have worsened the economic conditions of those countries affected by the crises.
Dealing with these problems places many of East Asian governments in new territory since they previously ran surpluses and had relatively low levels of public sector debt. But there are a few choices that can be implemented rapidly. Steps can be made to increase tax efficiency by eliminating those that introduce distortions while replacing them with taxes that provide incentives for capital formation and investment.
In Japan, radical reform of the tax structure with permanent tax cuts would set off a supply-side boom in the economy. Accelerating plans for privatizing public assets could increase revenues while costs could be cut by introducing incentives to raise public-sector efficiency that would allow for downsizing the number of government employees.
Christopher Lingle is an independent corporate consultant and adjunct scholar of the Centre for Independent Studies in Sydney and is the author of The Rise and Decline of the Asian Century.
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