Panel 5: |
Gary R. Saxonhouse It goes without saying, but, as with so many others over this weekend, that won’t stop me from saying that it is really wonderful to be back at Yale at an event of this kind among so many old friends. I take particular pleasure in noting that six close contemporaries of mine in graduate school, in addition to four past or present colleagues from Michigan, have been speakers these past three days, so I really feel right at home. In this connection, I would like to say that I think it highly appropriate at an event of this kind for alumni to express gratitude to their mentors. I certainly owe a great debt to many Yale faculty, including most certainly the moderator of this panel. I think I would also be remiss, however, particularly since some are in the audience here today, if I did not acknowledge that I also feel a great debt of gratitude to the other graduate students of my generation. at Yale. I found my contemporaries here at Yale extremely supportive of each other. In the Yale of my day we had a very strong faculty but, as in every great economics department, the after-class discussions among the graduate students was where some of the most significant education went on. Today I would like to depart from my assigned topic at this panel and speak about Japan’s economic recovery, albeit from a long-term perspective. The evidence of the past few quarters suggests that developments in the private sector can easily undo the Ohbuchi Government’s efforts to use expansionary fiscal policies to pull Japan out of its almost decade-long recession. For example, the increase in government spending in the last quarter of 1998, by itself, would have been sufficient to lift the growth rate of Japanese GDP to 2.8% on an annual basis, had not private sector demand. fallen off so sharply as to leave Japanese GDP declining instead at a rate of 0.8%. By contrast, in the first quarter of this year, Japanese public sector spending grew no faster than it did the quarter before, but a rebound in household spending was enough to give Japan its best quarterly performance in three years. While the experience of the past year makes it clear economic recovery will not occur without private sector participation, given the current state of Japanese public finances, and contrary to expectations of so many policy makers on both sides of the Pacific, expansionary government budgets are unlikely to be the key to eliciting this participation. In this connection, I want to emphasize that it is difficult to be too alarmist about the state of public finances in Japan. At 22% of gross domestic product, Japan’s net public debt is by far the lowest among the G-7 countries. This figure, however, is wildly misleading. It is so low largely because Japan’s huge public debts are balanced by the assets of Japan’s social security system. Such a consolidation may be appropriate for some G-7 countries, but it does not make sense at all for Japan. Japan will soon have the very oldest population among the G-7 countries. The social security system’s assets are already spoken for. As Japan makes the transition from having the youngest population among the advanced industrialized countries to having the very oldest, these assets will soon be claimed. Far from being able to shore up the rest of Japan’s public finances, its pension system is grossly under-funded by any reasonable actuarial standard. To make matters worse, many of the assets held by Japan’s public pension system are suspect. Much of the revenue received by Japan’s public pension system winds up being lent to special accounts, public corporations and other public institutions that do the bidding of the Japanese government. While many of these entities may once have played an important role in promoting Japan’s economic development, today, too many of the projects and activities they have undertaken are of uncertain value. For example, the assets of Japan’s public pension system, directly or indirectly, are being used for activities such as propping up Japan’s small and medium-sized enterprises and for bailing out the corporate shell of what was once the Japan National Railway. But for these loans being government-guaranteed, Japan’s public pension system, together with Japan’s enormous postal savings system, whose funds are invested in exactly the same way, might well be facing a bad loan problem far exceeding that currently crippling Japan’s banking system. There is nothing unusual in loans of this type being made or guaranteed by a government. What is unusual is the extent to which these liabilities are being kept outside Japan’s public accounts. It is precisely for this reason that official net debt figures mask the crisis in Japan’s public finances. Once such off-budget liabilities are brought back on-budget, the Japanese government’s financial obligations soar far above 100% of Japanese GDP, becoming significantly greater than those of any of the other G-7 countries. This continuing, extraordinary deterioration in the state of Japan’s public finances can depress household spending behavior. This is not because households necessarily expect future tax increases to pay for current deficits, but rather because this deterioration further undermines the already tattered credibility of Japan’s pension system. Households increasingly expect that a substantial cut across-the-board in social security benefits will be necessary. Facing this prospect, and recognizing that a reform in the way pension and social security funds are handled will take a very long time to have a significant impact, it is probable they are or will soon be adjusting their savings and spending plans accordingly. If expansionary fiscal policy in Japan can be trumped by the private sector’s negative reaction, what is to be done? For the past year, there have been increasingly insistent calls for the Bank of Japan to commit not to price stability, but to a substantial positive rate of inflation. By making it costly to defer consumption, central bank targeting of a positive rate of inflation can create new incentives for private sector spending. This approach to resolving Japan’s macroreconomic malaise has much to recommend it, but it remains hard to say with any confidence, how the Bank of Japan can actually create such inflationary expectations in a deflationary environment where monetary policy has previously been ineffective. The Japanese financial system is awash with liquidity without the slightest fear that inflation might be in the offing. It is not surprising that the Bank of Japan Policy Board, thus far, finds it pointless, or worse, to change its current policies. There may be a way out of this conundrum that can join a credible commitment to the fiscal equivalent of inflation with a resolution of the crisis in Japan’s public finances, at the same time that it allows the Bank of Japan and the Ministry of Finance to adopt mutually supportive, politically feasible policies. There have been proposals by some prominent Japanese politicians for lowering Japan’s much maligned 5% consumption tax in order to re-ignite aggregate demand. This year’s temporary incentives to stimulate Japanese housing construction are a cousin of this policy proposal. Actually, it would be better not to lower but to raise the consumption tax, and to raise it substantially and permanently.. Of course, this tax increase should not take place anytime soon. Nevertheless, it should be legislated very soon with the intention, for example, that a graduated increase in the consumption tax commence at the start of Japanese fiscal year 2001 with an initial 1% increase, and with additional increases of 2% for each of the next three years This would add Y2500bn ($23.4bn) in the first year to the government’s revenue base, and Y5000bn ($46.8bn) increments for each of the three years thereafter, and would leave Japan in 2004 with a consumption tax of 12%. Such legislated inflationary expectations can have a powerful effect on the timing of consumer expenditures, moving forward expenditures that might otherwise have been delayed. By credibly committing now to consumption tax increases in the future and repairing the state of Japanese public finances, the Ohbuchi Government becomes free to provide still more short-term stimulus to the economy now without fear of being undercut by the actions of the private sector. The anticipation of a consumption tax increase will encourage households to spend before it comes into effect, but, of course, it also means there will be less spending once the tax is actually imposed. The year-and-one-half before Japan increased its consumption tax from 3% to 5% on April 1st, 1997 saw its economy expand at a rate exceeding that of any other OECD country. This expansion came at the cost of later consumption, and it helped push the Japanese economy into its present difficulties. In the next five years, the consumption expenditures that are moved forward, together with the new fiscal stimulus permitted by the commitment to future tax increases, can be expected to generate the kind of demand pressure which fosters inflation. Given that such inflation has been generated as the ironic by-product of a move to fiscal responsibility, it should be politically feasible for the Bank of Japan to adopt an accommodating monetary policy. In the resulting environment it may finally be possible for the Bank of Japan to credibly commit to the inflation targets that can maintain inflationary expectations and higher levels of private demand in the critical period after the transition to a much higher rate of consumption taxation is completed. It is not enough to call for fiscal stimulus in Japan without attention to the crisis in Japan’s public finances. At the same time, the inflationary expectations that might stimulate private sector demand are unlikely to be generated by the Bank of Japan in the current deflationary environment. The long-standing Japanese government interest in relying more heavily in the future on expenditure taxes, rather than income taxes should be acted upon now. By committing to a timetable for increases in the consumption tax, the likelihood that the health of the Japanese economy can be restored is greatly increased. |