Japan drops to number three

CHINA has now officially supplanted Japan as the world’s second largest economy.
The question for Japan is whether or not the country will continue to tumble down the list of the world’s great economies, or whether its politicians will return to a path of reform that can revive growth.
That the ruling Democratic Party of Japan (DPJ) now seems trapped in a power struggle between prime minister Naoto Kan and party power broker Ichiro Ozawa suggests that serious economic reform is not at the top of the party agenda.
In the 1980s, Japan’s annual GDP growth averaged 4.5%; since the early 1990s, the economy has been virtually stagnant, averaging barely 1% annual growth.
In the 1990s, Japan’s government, grossly misjudging the sources of the economy’s difficulties, vastly increased government expenditures on public works, but ignored supply-side adjustments.
This policy created new vested interests, and thus a new political environment, as construction companies and other beneficiaries of government contracts began donating heavily to the ruling Liberal Democratic Party (LDP).
This kept the LDP’s coffers brimming, but posed the risk of a serious financial crisis in the late 1990s.
It was in these circumstances that prime minister Junichiro Koizumi took office in April 2001.
Under Koizumi’s leadership, insolvent banks were made whole again.
At the start of Koizumi’s government, 8.4% of bank loans in Japan were non-performing. By the end of his tenure, the rate was down to 1.5%, restoring the country’s potential for growth.
Indeed, this was one reason why Japan was so little affected by the “Lehman Shock” that incited the global financial crisis.
But macroeconomic reform came to a screeching halt after Koizumi stepped down in 2006.
A series of short-term prime ministers began a pattern of huge government outlays.
Not surprisingly, the economy deteriorated.
Frustrated by the long-ruling LDP’s poor political and economic management, voters opted last year for change at the top.
However, the pattern of economic mismanagement, far from being reversed, has only become worse.
Huge spending increases were directed at farmers and households.
As a result, the share of tax revenue to total spending this fiscal year slipped below 50%, something unseen in Japan’s entire post-war history.
Despite the parlous fiscal position, for now the market for Japanese government bonds remains stable. But this is because government bonds are purchased mostly by domestic organisations and households.
In another word, the government’s negative saving is financed by the private sector’s positive savings.
However, that private-sector safety net of savings is fraying.
Japanese households hold savings of about ¥1.1 trillion in net monetary assets.
In about three years, however, the amount of Japanese government bonds will exceed the total assets of Japanese households.
Government debt will no longer be backed up by taxpayers’ assets.
Confidence in the Japanese government bond market will likely decline.
Moreover, as Japan’s society ages, the household savings rate will decrease dramatically.
This will make it difficult, if not impossible, for the domestic private sector to finance the budget deficit indefinitely.
In about five years, all baby boomers will be over 65, but pressure on government expenditures for pensions and health care is expected to start sooner, around 2013.
Japan’s new government, led by Kan, started discussing a consumption-tax hike to offset the growth in spending. – Project Syndicate
nHeizo Takenaka was minister of economics, minister of financial reform, and minister for internal affairs and communications under prime minister Junichiro Koizumi. He is currently director of the Global Security Research Institute at Keio University, Tokyo.