Concluding Remarks

Keimeir Kaizuka, and Anne Krueger
Published Date:
July 2006
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Anne O. Krueger

In these concluding observations, I want briefly to outline my views of the fiscal challenges facing Japan and then to address the options for handling them. As the chapters in this volume make clear, there is much agreement among fiscal experts and policy makers on the underlying fiscal problems, but less of a consensus on the need for speedy actions and on what those actions should be.

Japan’s current fiscal situation and its long-term prospects

Japan’s public debt is very high, fed by a decade of high fiscal deficits. Gross public debt is now 170 percent of GDP, the highest level of any advanced country; and the fiscal deficits continue to be uncomfortably high. The debt situation could be even worse than the headline numbers might suggest, once contingent liabilities (from various guarantees or losses from the Fiscal Investment and Loan Program) are considered.

This high public debt ratio is clearly a cause for concern, especially in view of the continuing fiscal deficits. But there is another, equally daunting, fiscal challenge now facing the Japanese economy. One of the most important issues raised during the conference was the extent to which budgetary pressures from an aging population are set to increase sharply in the coming years. With no change in existing policies, social security spending is projected to rise by 2.5 percentage points of GDP over the next two decades. The aging population also means that health care costs would also increase sharply under existing policies.

Even starting from a balanced budget, both of these fiscal challenges—the high level of public debt and the growing fiscal pressures from an aging population—are formidable in terms of the public policy response needed. Either one would be difficult to resolve, even over the medium term. They are that much more difficult to tackle when the starting point is a budget deficit.

But what makes tackling Japan’s fiscal problems so much more urgent is the fact that these two structural fiscal challenges cannot be separated. The budgetary pressures building up as the population ages rapidly come at a time when the public debt position is already in need of remedial action if it is to be sustainable over the longer run. And tackling the high level of government debt is made far more difficult than it would be without the fiscal deficit and without the additional pressures on the social security and health budgets that an aging population will impose.

Fiscal adjustment is therefore unavoidable. And although financing strains are not yet evident the interaction between the two fiscal problems makes the case for early action unanswerable. Policy changes now are far preferable to a forced and more rapid, and far more painful, adjustment later. Early action towards achieving fiscal sustainability would enable the situation to be stabilized and prevent the further deterioration that would otherwise be a consequence of an aging population. It would also improve intergenerational fairness and it would allow time to introduce reforms of social security programs which the demographic changes make inevitable. So it is encouraging to see the broad consensus on the need for fiscal consolidation reappear as a common theme through many of the chapters in this volume.

The authorities have prepared projections that show how the gross-debt-to-GDP ratio can be stabilized by the early 2010s, based on the achievement of a small primary surplus (excluding social security). An impressive amount has been done by the Japanese authorities, of course. And there seems to be a good prospect for further action to tackle the problems.

The Japanese public seems to accept the need for fiscal consolidation. Discussion seems to focus mainly on the pace and nature of consolidation rather than whether it is needed. The improving resilience of the economy should make it easier to build on this consensus to develop a plan for sustained consolidation efforts. Improved economic performance should be seen as providing the opportunity for early action rather than an excuse for further delay.

Identifying a medium-term strategy

Given the general acceptance of the need for action, the key issues in the policy debate are how to decide on the appropriate program of further consolidation and how to implement it. The short- and medium-term fiscal strategy should be to achieve a meaningful primary surplus, excluding social security. Under conservative macroeconomic assumptions, stabilizing the debt will require the primary balance, excluding social security, to shift from a deficit of 4 percent of GDP in 2004 to a surplus of around 3 percent by the fiscal year 2013. This implies an average annual adjustment of 0.75 percent of GDP, which is somewhat higher than the government’s current goal of 0.50 percent of GDP.

To achieve this adjustment expenditure and revenue measures will both be desirable. The scope to trim discretionary spending is limited, but some savings might be found in the public investment budget (although significant savings have already been made here). So revenue measures will need to comprise a significant part of the adjustment, and here there is considerable scope: Japan’s government revenue to GDP ratio is low relative to most other developed economies. Possible steps would be to broaden the tax base and to increase revenue from consumption tax. Plans for the latter should be developed as rapidly as possible.

But given the size of the necessary adjustment, the consolidation plan also needs to involve reform in two other areas: intergovernmental fiscal relations and social spending. Further reforms to the system of local government finance are needed. The goal should be to improve accountability and efficiency among local governments: this would facilitate expenditure revenue and revenue mobilization. In time, reform of the local allocation tax (a block grant from the center to the periphery that is poorly targeted) could play an important role.

The conference also highlighted the importance of the ongoing program of fiscal decentralization and the need to resolve the outstanding issues relating to the reform of local government finance: for example, by strengthening the mechanism for imposing market discipline on local government borrowing.

The demographic changes mean that social spending is set to become an ever-growing share of the budget and prompt action is needed to limit growth in this area, particularly in health care spending. Several of the contributors to this volume suggested possible options for further work here.

Pension finances have been strengthened by the 2004 reforms, but they still need to be closely monitored. In particular, if the underlying macroeconomic and demographic assumptions turn out to have been overly optimistic, further adjustments will be needed.


In Japan, as in other countries, achieving fiscal consolidation involves difficult policy choices. Work carried out by the IMF suggests that the impact of the fiscal withdrawal should be manageable, given that the economy has become more resilient and that fiscal multipliers are, by most estimates, small. The Fund’s assessment, and that of this volume as a whole, suggests that taking the appropriate fiscal action in Japan would have a limited impact on the global economy (and strengthening the Japanese economy by stabilizing the fiscal situation will be beneficial for the rest of the world). Complementing fiscal consolidation with comprehensive structural reforms to raise productivity growth would, of course, improve Japan’s own economic performance and so contribute to improved global prospects.

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