By Jerry Schiff
(Version in 日本語)
As a Japanese proverb has it: “Knocked down seven times, get up eight.”
In a display of its resilience, Japan is getting up once again after the devastating earthquake and tsunami of a year ago. But the world’s third largest economy still faces multiple challenges, and in our latest assessment of the country’s economy, the Japanese mission team at the International Monetary Fund has proposed a range of mutually reinforcing policies to strengthen confidence, raise growth and help restore Japan’s economic vitality.
A year and four months ago, Japan was reeling from the Great East Japan earthquake and accompanying devastation. As well as the tragic loss of life, the economy was badly shaken. Supply chain disruptions brought production in parts of Japan to a virtual halt. Yet, since then, the country has shown its resilience, with reconstruction contributing to strong first quarter growth of 4¾ percent.
But despite this hopeful sign, all is not well.
A contentious debate over how to address the large and growing public debt has occupied the political center stage. Deflation continues to affect economic activity, euro Area turmoil is casting clouds on growth prospects, and the appearance of an army of office workers in “cool biz” attire is a reminder of continuing energy shortages. Against this backdrop, the IMF conducted its regular health check of the world’s third largest economy.
Following that annual checkup, and in response, Fund staff are proposing a virtuous circle of positive, integrated policies: well-designed fiscal adjustment plans to strengthen confidence, and structural reforms to raise growth and support central bank actions to end deflation. Indeed, an end to deflation would help fill fiscal coffers and support activity, and so on.
The first order of business is to put Japan’s fiscal house in order. Net debt has increased ten-fold since 1990 and—at 130 percent of GDP—is the highest of any advanced economy. Over the same period, social security spending has risen from 10 to 22 percent of GDP while associated revenues have remained flat.
These developments threaten fiscal sustainability, but also place an enormous burden on the young. A typical household with head aged between 20 and 29 can expect to make net resource transfers to the government of 16 years of their income over a lifetime.
So, how should Japan address this rising debt burden? The crisis in Europe offers two critical lessons.
Lessons from Europe
Once investor confidence is lost, regaining it is no simple task. So, while bond yields are low and there is no imminent threat of a crisis, it is critical for Japan to put in place as soon as possible, a credible medium-term adjustment plan.
The recent passage by the lower house of parliament of a doubling of the consumption tax to 10 percent by 2015 is an important step. More will be needed, but this is a strong statement of purpose.
Secondly, adjustment is necessary, but adjustment without growth is unlikely to work. Japan’s potential growth has been depressed by a shrinking labor force and weak investment. Furthermore, adjustment may weigh on near-term growth. Failure to raise potential growth will make it all the more difficult to reduce the debt burden on the economy.
A more dynamic Japan
So how to raise growth? Some potentially fruitful directions to consider:
- Fiscal adjustment can be designed to encourage growth, by enhancing incentives to work and invest. For example, a higher consumption tax rate could be combined with a rise in the retirement age—in line with increased longevity—corporate and payroll tax cuts and the elimination of distorting tax deductions.
- Increasing women in work: Japan’s declining population places a premium on raising women’s labor force participation–currently among the lowest in advanced economies. It won’t be easy, but there are policy levers, including tax reform and deregulation of day and long-term care.
- Increasing integration: Japan lives in a good neighborhood, close to rapidly growing Asian markets. It lags in both inward and outward FDI, but is increasingly integrated into the region—new auto facilities in Indonesia and expanded financial activity throughout Asia are examples. Participation in the Trans-Pacific Partnership and other free trade agreements would strengthen this momentum. And this would be good for the region as a whole: a staff paper finds positive spillovers to Asia from Japanese FDI (forthcoming 2012 IMF Spillover Report).
- Financing Growth: The Japanese financial system, while sound, could do more to support growth. Venture capital and other financing for start-ups lag badly, while less dynamic SMEs receive guaranteed loans. A reorientation of public policy is needed.
All this is easier said than done, of course, but Japan’s history emphasizes its ability to reinvent and revitalize itself. It can do so again.