12 Comments on “Managing Public Costs in the Japanese Health and Nursing Care Sector,” “Challenges in Creating a Cohesive System for Health Care, Pensions, and the Needs of the Elderly,” and “Avoiding a Fiscal/Demographic/Economic Debacle in Japan”

Keimeir Kaizuka, and Anne Krueger
Published Date:
July 2006
  • ShareShare
Show Summary Details

Comments by Peter S. Heller

Chapters 9, 10, and 11 have presented a clear perspective on the broad set of issues and problems associated with the long-term financing of Japan’s social insurance system. All of them suggest that in recent years, Japan has undertaken some important policy reforms in the sphere of social insurance. Pension reform in particular has seen a number of structural changes that have enhanced the underlying financial sustainability of the pension system. In particular, some automatic adjustments in pension benefits are now built into the system; the minimum retirement age has been increased; the pension accrual rate has been reduced; the age of minimum eligibility for retirement benefits has been increased; there has been a shift from wage to price indexing; some tax exemptions for the elderly have been removed; and a defined contribution system—albeit modest—has been introduced. The establishment of a long-term care insurance system has also been innovative relative to other industrial countries. In the sphere of health care, Japan starts from a reasonable position in terms of the share of its total output devoted to health care spending (although Professor Kotlikoff notes that the pace of growth in such outlays has been worrisome in recent years).

All of these chapters (including that of Dr. Aaron (Chapter 5)), nevertheless suggest that despite these reforms, the aging of Japan’s population, under current legislation, will still lead to an increase in the financial burden of social-insurance-related schemes as a share of GDP (although there is no obvious agreement on the size of problem faced by Japan in financing the costs of an aging population).

Where the authors differ is in the extent to which they see a need for a substantial reform in these programs in the context of an aging population. For example, Professor Kotlikoff calls for urgent, radical and substantial change, not only in Japan’s social insurance system but also in the thrust of its monetary and fiscal policy. In particular, he calls on Japan to essentially print money in order to engender higher inflation that would reduce the real value of Japan’s outstanding government debt; to close down its existing defined benefit pension scheme in terms of the accrual of new benefits, substituting a defined contribution scheme; and to replace Japan’s medical insurance system with a medical voucher system (related to an individual’s health status) that would rely on a privatized, insurance-based system. In contrast, Dr. Oxley’s chapter emphasizes that while there is still much to do in reforming Japan’s medical care system—as is the case for every other industrial country—if prospective cost pressures are to be restrained, there is no sense that these reforms must be taken with enormous urgency. Equally, Professor Kaizuka (and Dr. Aaron as well) seem to suggest a need for only gradual reforms over time.

These chapters clearly will contribute to a dialogue on the kinds of reforms that would be important for Japan’s social insurance system. Even in the absence of the substantial design changes proposed by Professor Kotlikoff, it will be necessary for further reflection on how to address specific distributional and allocational issues. Specifically and first, who should bear the financial burden of programs benefiting the elderly? Should the essentially pay-as-you-go nature of the existing system be retained, where future working cohorts would bear the principal burden of a higher dependency rate? Or should there be a renegotiation—tapping the incomes or assets of the elderly? Second, how to address the inequality of assets and wealth among the elderly? For example, in the medical care sphere, one would want to ensure that the approach chosen for financing such costs does not compromise access to medical care by low income elderly. Similarly, in the pension sphere, should one ensure some type of means-tested transfer system in order to keep the elderly out of poverty? Third, what are the potential allocative implications of alternative reforms? This may relate to the distortions caused by higher tax or social contribution rates or the moral hazard or behavioral consequences of benefit transfer design. And finally, what might be the potential macroeconomic consequences of alternative reform proposals, in terms of the impact on private sector savings or the fiscal balance?

Similarly, in the sphere of medical care, the scope and urgency of reform will need careful consideration in the light of evolving research and cost developments. As a start, the size of the challenge that Japan faces in this sphere is still very uncertain. There is obviously uncertainty on the underlying demographics that will be faced (concerning future trends in life expectancy or fertility rates). But there is also still little consensus among scholars worldwide on how the fact of a rising number of elderly will affect the demand for medical outlay. Some argue that the improvements in health status and the availability of new technologies, which are extending life expectancy, will also push back the time at which high medical costs will be borne (namely, the few months before death). Others argue that the elderly will still have higher medical demands relative to working cohorts even in the years before they die. The magnitude and cost of technological change equally remains a large question mark. Can new technologies be absorbed without major cost pressures? For example, are there opportunities for cost reducing innovations or the substitution of low-cost supply sources? Are there opportunities for “importing” medical care in the form of medical tourism, say from the Philippines or Thailand? Can the cost of long-term care be “outsourced”?

I would, however, be opposed to scrapping Japan’s existing medical insurance system as proposed by Professor Kotlikoff. As to the specifics of his proposal (which is only roughly sketched out in his chapter so that I may not be doing it justice), I have doubts whether insurers would be willing to take on the risk of patients with poor medical profiles, even if they are accompanied by higher medical vouchers. Adverse selection has proven an important challenge in the provision of medical insurance in the United States and would similarly be an issue in Japan. Neither does his proposal offer ideas on how to limit the cost pressures in the medical sector associated with an aging population or technological change.

But beyond the issue of the specific reforms that might be needed to individual components of Japan’s social insurance framework, there remains a fundamental question that could be raised on the basic issue of how to address the financial consequences of an aging population. Specifically, does the source of Japan’s long-term fiscal challenge arise from the combination of an aging population and the specific design features of its social insurance system? Or is the latter only a subsidiary issue? I tend to agree with Dr. Aaron’s view (Chapter 5) that Japan’s long-term fiscal challenges arise more from the fact that:

  • Japan has accumulated substantial government debt and, given continuing high fiscal deficits, is at risk from a possible increase in real interest rates

  • Japan has not been able to raise significantly its long-run potential real growth rate and there are uncertain prospects for raising the rate of growth of productivity

  • Japan has had difficulties in overcoming the political (and some would say economic) costs of raising the share of taxes in the economy or of cutting back on subsidies and other inefficient spending, and

  • Japan’s intergovernmental fiscal framework constrains its capacity to rein in inefficient public spending and there appear to be important political economy challenges to reforming this framework.

If the latter issues are the source of potential long-run fiscal sustainability concerns, then these bear addressing far more urgently than any particular reform to the social insurance scheme. Here I would argue that Drs. Oxley and Kaizuka probably fall more in this latter camp, whereas Professor Kotlikoff clearly sees the current design features of Japan’s social insurance system as far more problematic. Personally, I would weigh in with Drs. Oxley and Kaizuka.

This leads me to offer some further general observations on the fiscal challenges that Japan must confront as its population ages. First, raising Japan’s prospective economic growth rate remains absolutely indispensable. Any reform policies undertaken must thus be compatible with this objective, with particular emphasis on promoting productivity growth. Second, achieving fiscal sustainability is a further clear prerequisite, given Japan’s high outstanding debt. Third, achieving higher labor force participation rates of women and elderly would appear very important. Fourth, cross-country comparisons suggest that there would be room for Japan to mobilize a higher share of taxes in GDP.

Finally, there are several issues to consider in approaching the reform of the existing social insurance system. These include:

  • The politics of reform. Japan does not lack knowledge as to alternative policy options and their pros and cons. What has impeded action have been the political constraints.

  • The need to gauge the likely behavioral response of Japanese households and producers to alternative policies. One cannot necessarily rely on studies derived from households in the United States or Europe for inferring how Japanese households will respond to specific policy actions. A number of illustrations are obvious. The way in which Japanese workers will respond, in terms of their labor force participation, to reforms in the pension and long-term care system (for example, a lower replacement rate; taxation of benefits; the availability of long-term care for a worker’s parents; higher personal income tax rates) may differ from what would be observed, say, in Germany. Japanese households may have a very different elasticity of demand to higher co-payment requirements for medical care. Their response to an increase in mandatory contributions to a defined contribution pension scheme or to policies that promote fiscal sustainability may equally have a different impact in terms of savings rates than would be observed in the United States or other industrial countries. Not surprisingly, Japan has always made its own adaptations of Western policy approaches, reflecting its own cultural traditions and behavioral attributes.

  • The fact that Japan, as other countries, must formulate policies that address long-term challenges in the face of multiple, obvious, uncertainties affecting the long-term fiscal environment These include uncertainties as to: future trends in fertility and longevity; the state of global economic competition as well as Japan’s geopolitical environment (the situation in China and North Korea); the potential impact of climate change on Japan; the consequences of higher potential energy prices, and so on. Such uncertainties argue for choosing a fiscal policy framework that provides future fiscal leeway and scope for policy action. It also argues for policies that are risk-averse with respect to likely fiscal outcomes in the next 10-15 years, but not excessively conservative in terms of adjusting policies for the longer term, given these many uncertainties.

  • The importance of considering other elements of Japan’s budgetary framework. Recent work by Heller and Hauner (2005) and Hauner (2005) suggests that even if one were to allow for rising per capita outlays in non-age-related areas, there would still be room for a declining share of these expenditure categories in GDP. Even cutbacks in age-related expenditure are possible, notably in education. The scope for such savings may lessen the need to adjust the parameters or features of the social insurance system. However, one important challenge relatively specific to Japan is its legacy of future maintenance on the many public works projects completed in the last decade. Keeping such outlays within bounds will require fiscal restraint and an openness to accepting the “planned obsolescence” of some of the more unproductive of these assets.

Finally, I wish to address Professor Kotlikoff’s proposal to inflate away existing government debt. I would be concerned that inflation, once unleashed in Japan, could trigger many unexpected consequences. While it is possible that Japanese households have money illusion in relation to different levels of deflation (that is, not discerning the relative impact of a fall in the price level by 2 percent as opposed to 4 percent), I would be doubtful if they were indifferent or unaware of the implications of much higher levels of inflation. In particular, I would think that, in this highly informed globalized world, the nominal interest rate would be particularly responsive to an increase in inflation, thus limiting the potential to reduce the real burden of Japan’s government debt.

Comments by Yasushi Iwamoto

Professor Kaizuka, Professor Kotlikoff, and Dr. Oxley have done excellent work identifying the problems of our social security system and providing various good ideas for resolving them. Since these authors covered a wide range of issues, it is impossible for me to address them all. I would like instead to elaborate some remaining points which I think are important. First, since the public pension reform of 2004 cut future benefits, how to control health care costs and long-term care costs is now a pertinent yet difficult question. Second, we should consider who can control these costs. Since the public sector is not likely to do such a job well, the private sector should play a more active role. Finally, the reform should be carefully designed, because the control of these costs must meet two different goals.

The future of social security benefits

According to the projection made by the Ministry of Health, Labor, and Welfare in May 2004, total social security benefits are expected to grow from 23.5 percent of national income at factor cost in 2004 to 29 percent in FY 2025 (see Table 12.1).1

Table 12.1.Projection of social security benefits and burdens
Fiscal year
(May 2004 projection)
Social security benefits23.525.427.029.0
Public pension12.612.812.912.2
Health care7.
Welfare etc.
Long-term care1.
Social security burdens21.324.226.629.5
Social insurance premium14.215.516.718.3
Government subsidies7.18.79.611.2
(May 2002 projection: before pension reform)
Public pension15.1
Note: Numbers are a percentage of national income at factor cost.Source: “Projection of Social Security Benefits and Burdens,” Ministry of Health, Labor, and Welfare.
Note: Numbers are a percentage of national income at factor cost.Source: “Projection of Social Security Benefits and Burdens,” Ministry of Health, Labor, and Welfare.

The trend varies with programs. Public pension benefit will not grow and will actually become slightly lower than the current level in FY 2025. This stabilization of future pension benefit was achieved by the pension reform of 2004. As shown at the bottom of the table, under the governmental projection made in May 2002, when the former public pension rule was in force, pension benefits showed steady future growth and were expected to be 15.1 percent of national income in FY 2025.

The benefits cut was possible because controlling the contributions became the top priority in the public pension reform of 2004. Before this reform, the contribution rate of the pension program for private employees was planned to gradually increase from 13.58 percent of earnings to 19.8 percent in FY 2020. When the forecast was revised based on new population projections, the final contribution rate was expected to reach 23.1 percent if the benefit rule were not changed. Since this rate seemed unacceptable, limiting the contribution rate became a major objective of the reform. The final contribution rate was reduced to 18.3 percent, and a significant cut in benefits in the future was agreed. However, this reform does not solve all of the major problems. Since the benefit will be cut gradually, the reform fails to remedy the intergenerational imbalance of net benefits. An immediate cut of benefit and increase in contribution should have been necessary to reduce the intergenerational inequity.

The fastest growing components of social costs are now the benefits of health insurance and long-term care insurance. Health care benefit will increase by about 4 percentage points in the next 20 years as a share in national income, and the long-term care benefit will grow by about 2 percentage points.

If the growth of these benefits is capped at the rate of economic growth, the total social costs as a ratio to national income will not grow, and the most serious headache for the budget would go away. This is why controlling these benefits is now discussed prominently. However, cutting them is not so easy as cutting pension benefits, because they are in-kind benefits that provide a basic support for our life.

Notice that controlling social security benefits on health care and long-term care and controlling medical and long-term care expenditure are actually different matters. The volume of social security benefits in health care is the product of the coverage rate of social security and total medical expenditure. Therefore, narrowing the coverage of social insurance shrinks the government outlay while keeping the size of total spending of health care and long-term care unchanged. There is some room to pursue this option; for example, raising the co-insurance rate of the health insurance for the elderly. However, if we stick only to this option, the resulting coverage of public health insurance becomes extremely low.

Cutting total expenditure is unavoidable

Let me focus on health care costs. Professor Kotlikoff and Dr. Oxley pointed out that health care expenditure had grown faster than the economy. The Ministry of Health, Labor, and Welfare (MHLW) projects that spending per head will grow differently for the young and the elderly. For the non-elderly who are under the age of 70, per capita costs will grow at the same rate as per capita wages. For the elderly, they will grow by 1.1 percentage point per year faster than the per capita wage. These projections are extrapolated from the experiences of several recent years. I doubt that such a growth in expenditure for the elderly can be sustained, because the past growth occurred in the absence of appropriate assessments of medical treatments. In the future, we will implement some mechanism of technological assessment.

In addition, if a technological assessment is appropriately carried out, the growth in outlays is not necessarily a problem, because only valuable technical progress is introduced. If it creates a net benefit, we have to pay it.

Role of the private sector in the health care market

Since an appropriate assessment of the relevant technology is absent, some of the current medical treatments may be inefficient, and cutting them may help to reduce costs without a deterioration in the quality of services. Some good ideas are pointed out in Dr. Oxley’s presentation.

I avoid repeating his points, and would rather address another question. We are already aware of several reasonable ideas for improving the efficiency of medical care services. Some ideas have been around for a long time. What I would like to address here is why such good ideas are so slow to be implemented in Japan.

I suspect the dominance of the public sector under the universal health insurance has prevented good ideas from being considered. Let us compare the health care market with other markets. In the market economy, usually, consumer choice puts pressure upon providers. The consumer’s demand for better and cheaper services is no different in the health care market than it is in other markets. However, due to asymmetric information, consumer sovereignty has not been firmly established in the area of health care. Instead, a dominant part of health insurance is operated by the public sector, which is not supposed to become a driving force of the market mechanism. Providers of medical services are not subject to the discipline of strong market forces. An idea for remedying this situation is that a substantial part of the public health insurance business be outsourced to the private sector. Private actors will then play an active role as informed agents of patients.

Sustainability issue

Control of social costs is needed to meet two different goals at the same time. First, budget sustainability must be safeguarded. That means we need to cut benefits. The second requirement is that controlling social costs should not undermine the quality of services.

These two requirements come from totally different places. While the former is concerned with the aggregate amount of benefits, the latter focuses on spending per beneficiary. Therefore we need to identify a particular amount that can satisfy these two requirements. To this end, we should note two important things.

First, we cannot limit our focus to social security programs. I think a higher growth of spending compared with the economy would be unavoidable even if we can significantly cut health care costs and long-term care costs. Therefore we have to absorb the increase in social costs by using other measures. An overall reorganization of government spending programs is necessary, because the population structure will change.

Second, we should carefully design the reform so that cutting costs does not lead to a harmful deterioration in the quality of services. The quality evaluation system and Evidence-Based Medicine are necessary tools in the reform. However, it will take a little more time for them to be implemented in practical ways. We face a difficult situation: assuring budget sustainability should be done right now, but checking the validity of spending cuts cannot be done immediately. Given this difficulty, an appropriate approach consists of two steps. The first step deals with what we should do immediately. Spending cuts which are not harmful should be effected at this stage. The second step deals with what we should do later. After the quality evaluation system is firmly established, more options for cutting costs should be implemented.


    HellerP. and HaunerD.2005“Characterizing the Expenditure Uncertainty of Industrial Countries in the 21st Century,”IMF Working Paper No. 05/91Washington: International Monetary Fund.

    HaunerD.2005“Aging, Some Pleasant Fiscal Arithmetic,”IMF Working Paper No. 05/71Washington: International Monetary Fund.


I think a ratio to GDP should be used, because a ratio to national income exhibits a meaningless fluctuation when the VAT tax rate changes. Long before the VAT was introduced, the Japanese government had started to use the ratio to national income, and has not corrected the mistake.

    Other Resources Citing This Publication