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Noah Smith

The Two Sides of Japan's Deficit Trap

The elderly and local political backers will fight spending cuts.
Cutting this much won't hurt.

Cutting this much won't hurt.

Photographer: Kazuhiro Nogi/AFP/Getty Images

Japanese Prime Minister Shinzo Abe looks like he's trying to get serious about deficit reduction. This is a good thing. The economy has mostly normalized -- a highly relative term in an economy whose long-run real potential growth is only slightly above zero. Japanese unemployment is at its lowest level in 18 years. That means that the time for fiscal stimulus is over. But with a budget deficit of 7.7 percent of gross domestic product in 2014 (compared with 2.8 percent in the U.S.), Japan now needs fiscal consolidation. Recognizing this, the Abe government has released a fiscal blueprint that includes flexible spending caps. 

Abe’s measures, although a step in the right direction, won’t be anywhere near enough to get the job done. The administration’s projections for deficit reduction rely on an incredibly rosy assumption for 2 percent annual GDP growth. In the U.S., 2 percent would be respectable, or even a little slow. In Japan, where population is shrinking, it’s pie in the sky. It's about as realistic as the 4 percent growth rate that Republican presidential candidate Jeb Bush has promised to deliver if elected. Unless Japan decides to suddenly open its borders to a truly huge and unprecedented inflow of immigrants, the 2 percent thing isn't going to happen.