Japan: Deficit, Demography and Deflation

Date: June 12, 2006 Pham Thi Thuy Ha

The bursting Bubble and Globalization:

The performance of the Japanese economy in 1990s was poor with slow growth. Banks needed to merger to reduce nonperforming debts. Firms needed to restructure their business activities such as seek viable strategy, reduce loans, improve corporate governance and begin to compete. Deflation began due to excess capacity, falling asset prices and stagnant consumer demand. In 1996, Hashimoto announced a grand plan to restructure administration, deregulation, education system, social security and fiscal policy. Japanese financial markets were deregulated to become free, fair and global. The government started to cut budgets, long-term spending and reduce public works. Bank supervision of the Ministry of Finance was taken away. The primer minister was granted more power and his cabinet could have final control over fiscal policy.

Demographic Crisis:

Aging population is one of serious problems Japan needs to address. Due to decrease in birth rate and increase in life expectancy, Japan’s population is getting older, shrinking labor force and leaving a heavy burden in social security, pension and medical care funds.

Pension system: The first pension system was created in 1940s with a single layer, remuneration-based, proportional pension. It was revised in 1954 to two layer system. The 3rd version was created in 1961 to add national pension for self-employed workers, agriculture, forestry and fishery workers. The basis pension system was financed by fixed amount of insurance premiums. The problem with the pension system is that there are more people enjoy pension benefits while there are fewer workers.

Health care: health care funds need to be risen due to rapid aging and longevity. In Japan, almost all people are insured by health care and elder people go to hospitals more often than elder people in other developed countries. As a result, Japan will face a problem in raising health care funds in the future.

The Koizumi Reform:

Koizumi took office in 2001 with a four-part economic reform: 1) privatize the post office; 2) force banks to write off bad debts; 3) accelerate the implementation of structural reforms; 4) cap the insurance of Japanese government bonds. To implement this plan, Koizumi used the Council on Economic and Fiscal Policy, which is the cross-ministry organization. This council changed the decision-making process for preparing the government budget by coordinating the policies proposed by different ministries to control the overall spending in line with long-term goal of reaching the budget balance in 2012.

1) Privatization of post office: to break the postal service into 4 parts: mail delivery and post office management parts would be under the government control; a bank and an insurance company would be spun off through IPO.

2) Force banks to write off bad debts: the government used three-pronged approaches: accelerate the disposal of nonperforming loans; strengthen loan-classification and provisioning practices; reduce exposure to the price risks of equity by issuing regulations that banks should lower their equity shareholding to 100% or less of their tier-one capital.

3) Pension reform: The pension reform was approved by the Diet in 2004. This reform package includes 3 issues: premium levels, benefits and government subsidies. Premiums rates would rise from 2004 to 2007 and the contribution rate of 13.85% would rise to 18.3% by 2007. Benefits levels would decrease gradually through an adjustment level tied to the CPI. Government subsidies would increase from one-third to 50%

4) Fiscal reform: The government would cut public investment, limit or cut education and defense, eliminate subsidies to local governments, cut social security expenses. By raising taxes to hold government spending constant, the government hoped to reduce deficits toward the balance in 2012. At the same time, the government would apply monetary contraction by issuing more bonds thus public debts increase. To achieve deficit reduction, one-third of primary deficits could be reduced by expenditure cut, the two-third by VAT tax raise.
The prerequisites for Japan to get back its high economic growth are completing structural reforms, refinancing social security, controlling fiscal deficits and ending deflation.

Compare with reforms in Vietnam from late 1980s to 2000s:

The former Soviet Union started to cut aids to Vietnam in early 1980s and the country needed to find a way to grow itself. The Vietnamese communist party decided to change from the close to open economy and the government implemented a compete reform package. Same as Japan in fiscal reforms, Vietnam reduced the number of ministries, reformed pension benefits, cut long-term spending and issued government bonds. However, Vietnam has done different economic reforms. For example, the Vietnamese government changed currency in 1986, from 100 Dong to 1 Dong, privatized SOEs and agricultural collectives, deregulated all economic sectors, broadcast, publishing, telecommunications, established new laws and promote private sector. Reforms were also done educational privatization, electricity production, medical service, transportation, banking system.

In my opinion, the recent massive reforms in Vietnam have helped the country achieve dramatic economic growth in the right direction that fits the situation of the country. Vietnam is continuing reforms to boost the economy. Reforms are always necessary for economic growth because the local and international environments are changing fast.