Japan's Pension Crisis: Growth Is The Only Way OutRudi Dornbusch
Japan has so many crisis scenarios, it is hard to keep track of them. The most serious of all, however, is the pension crisis. Japan, of all industrialized countries, has the largest unfunded pension bill. To make matters worse, its aging population problem is arriving a decade earlier than Europe's or America's, at a time when the economy is hollowing out, banks are experiencing balance sheet troubles, and the political system remains weak. The current crisis is very real.
A recent working paper by the International Monetary Fund states the extent of the problem: "...In the absence of consolidation measures, the general government deficit would rise to 10% of GDP in 2020...while the debt ratio would grow exponentially. Expressed as a ratio of GDP, the resulting fiscal gap amounts to about 4% of GDP in 1996--that is, a combination of tax increases and spending cuts amounting to 4% of GDP would have to be implemented to generate a sustainable long-run fiscal balance."
There is, of course, great irony in Japan's fiscal mess. Japan's criticism of U.S. deficits throughout the 1980s still rings in our ears. The U.S. has done much to bring its deficit under control, to the point of enjoying the smallest deficit, as a percentage of GDP, of any major industrial country. Moreover, balanced-budget discussions are under way in Washington, in plenty of time to address far-off fiscal difficulties.
WARY PUBLIC. It is obvious that Japan's peculiar system of governance has much to do with the problem. Its Ministry of Finance has gotten Japan into one problem after another--protectionism has fostered antagonism from trade partners, regulation has repressed the standard of living, and lack of supervision has caused the banking system to crash. Now, on top of everything else, the government seems to be bankrupt. Solving problems in smoky back rooms no longer works. And the public is becoming more unwilling to let politicians have a mandate.
Where are the answers to the fiscal dilemma? The most obvious one, and surely the worst, is to increase taxes. Japan has already scheduled a boost in the consumption tax to contain the present deficit. Of course, in an economy that has not had a sustained upswing for five years, that tax increase may mean an economy that continues to crawl. Higher payroll taxes are being proposed as a solution to the pension problem. Nowhere in the world has taxing jobs been a good idea for growth. Japan won't be an exception.
Much better answers involve a dramatic review of the supply-side possibilities. This starts with a look at the absurd employment strategy. In the restructuring of Japanese corporations in the recession of the past few years, more and more companies are shedding labor and thus kicking out potential taxpayers. Business is going offshore and taking with it the tax base. The government must create an environment where business wants to stay and expand. Women who today are pushed out of the labor force once they reach the age of 28 or when the economy is in recession, whichever comes first, must be encouraged to stay. The more employment there is, the smaller the crisis.
REGULATORY KNOTS. To get more job opportunities, a few steps are essential. If the government cleaned up the banks, there would be increased commercial lending, and with that, investment and growth. Since the government will have to pay the bill in the end anyway, why procrastinate and run up bigger public debts? Next, massive deregulation of industry, services, trade, and agriculture will open up a range of business opportunities, jobs, and output growth. That, in turn, will provide a wider tax base and hence, revenue growth. Because Japan is so tied up in regulatory knots, it has tremendous growth potential. Of course, pervasive deregulation, as the case of the U.S. and many emerging economies shows, is not a gentle step. There will be inequality, reallocation, and stress. But covering up bankruptcy, as Japan does now, cannot avoid the difficulty. Ultimately, the government will have to look for revenue, and without growth, this is a much more punishing task.
Finally, the Bank of Japan has an important responsibility in creating a supply-side-friendly macroeconomic climate. There is not the remotest risk of inflation in Japan: Unemployment is high, capacity utilization is low, and nobody thinks of raising prices. In fact, deflation is a more apt description of the business climate. The Bank of Japan must keep interest rates at rock bottom for years. If rates are pushed up, the fiscal problem will move from a time bomb that might be defused to an outright early explosion. Japan needs economic growth to work through its pension crisis. It's running out of time.
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