Parsing Japan's latest fiscal and economic blueprint
(August 3, 2015)
The Japanese government makes major policy decisions every year in late June, and this year was no exception. On June 30, the cabinet approved an economic and fiscal management blueprint and a growth strategy, which are the revised fiscal 2015 versions of the Basic Policy for Economic and Fiscal Management and Structural Reform, and the Japan Revitalization Strategy.
These documents, written in flawless bureaucrat-ese, are difficult to understand. This often leads the media to criticize them from beginning to end as mushy or lacking teeth. Public interest in economic issues is particularly low at the moment, given the logjam in parliament in connection with controversial security bills. Nevertheless, the economic and fiscal management blueprint and the growth strategy contain a number of points that deserve attention:
The blueprint has two positive points. One is the position taken by the cabinet of Prime Minister Shinzo Abe that there can be "no fiscal health without economic revitalization." Vague expressions, such as "the compatibility of the economy and public finance," and "the inevitability of fiscal health for economic revitalization," appeared frequently.
In terms of macroeconomic policy, the government often gave priority to fiscal health over economic revitalization. The consumption tax hike in April last year illustrates this. The Finance Ministry's role as keeper of the keys to the safe prevailed over broader macroeconomic management. But it has become difficult to put Japan's fiscal house in order because the sales tax increase in April has weakened the economy. Getting the economy back on track should be the priority.
Therefore, the general concept of the blueprint is appropriate.
The other point deserving attention is the blueprint's call for an overhaul of the tax system. Although Japan's corporate tax rate is higher than that of many countries, the effective rate is due to be lowered to around 31% in two years. But the planned cut is still inadequate by international standards. To ensure the competitiveness of Japanese companies, a reduction to around 25% is necessary.
Between the lines
One of the fundamental problems with the tax system lies in the income tax, which is low for middle-income earners in Japan. It must be raised, although politically that is extremely difficult to do. Despite the challenges, a fundamental re-evaluation of the tax system cannot be avoided. The blueprint was correct to mention it.
On the other hand, the blueprint leaves many important issues unaddressed, the biggest being limits on spending. The government must do its utmost to curb spending, while promoting economic revitalization. Rather than a patchwork effort, a fundamental rethink of the social security system is indispensable. Social security accounts for one-third of public expenditures in Japan.
The bureaucratic language of the blueprint is interesting on this point: There are eight sentences dealing with medical and nursing care, seven of which end with pledges to "study" the issue. On pension reforms as well, there are many long sentences concluding with vows to "continue studying" the problem.
The Liberal Democratic Party's Council for the Promotion of Social Security System Reform is tasked with deliberating on these issues, having effectively taken over the task from the National Council on Social Security System Reform set up by the previous Democratic Party of Japan government. Changes to the structure of the LDP council, including reorganization, may be necessary.
The blueprint says the Government Tax Commission will discuss an overhaul of the tax system. But issues of this importance should be taken up by the Council on Economic and Fiscal Policy, which directly reports to the prime minister, rather than the Tax Commission, which is strongly influenced by the Finance Ministry. That is how former Prime Minister Junichiro Koizumi's government dealt with this question. Abe's team should do the same.
At stake is how to bridge the gap between the blueprint's general concepts and the specific policies needed to put these ideas into practice.
The Cabinet Office announced an estimate of the government's fiscal position in 2020 in February to establish a basis for discussion of medium-term reform, specifically moving from a primary deficit to a surplus. In July, the office released a revised version of the estimate. But the forecast is biased, making the deficit look larger than it is likely to be. This calls the discussions themselves into question.
The original estimate said that Japan will have to overcome a revenue shortfall of 9.4 trillion yen ($75.1 billion) to attain the 2020 fiscal reform target. Although the revised version cut the projected shortfall to 6.2 trillion yen, it still paints a dire picture. This may strike some people as odd; the government's estimate has been widely criticized for forecasting economic growth of 2%, a number many consider too high.
But Abenomics is aimed at achieving a high rate of growth. It is therefore natural to adopt a fiscal reform plan based on the idea that the target can be met. Critics who call the 2% growth target unrealistic should go all the way and criticize Abenomics as well.
The problem is not the assumed growth rate of 2%, but two other factors. One is the elasticity of tax revenue versus gross domestic product, which is set at a low 1. Although the elasticity is around 1 in the long run, it rises to about 3 or 4 during an economic recovery.
The other factor is the estimated 2% rise in the consumer price index, which is based on the assumption that the Bank of Japan will hit its inflation target. But the estimate also assumes an increase of a little more than 1% in the GDP deflator. While the GDP deflator is lower than the CPI under deflation, the two measures show comparable growth rates when an economy leaves deflation behind.
The Cabinet Office revised its tax revenue shortfall estimate of 9.4 trillion yen when government departments began submitting budget requests for fiscal 2016. The revised estimate is 6.2 trillion yen. But the revision will not drastically change the basis of deliberations on fiscal reform. It is simply fine-tuning that factors in the current increase in tax revenues, and envisages restraining the growth of fiscal 2016 expenditures by around half the current rate of inflation.
In other words, moderate adjustments to current conditions can cut the deficit by as much as 3 trillion yen in 2020, suggesting the medium-term outlook for fiscal management can be readily changed by altering the assumptions for GDP elasticity and the GDP deflator.
Productive discussions on fiscal reform for 2020 are impossible without objective and reasonable estimates. One can always argue that an optimistic economic estimate makes policymakers less sensitive to the need for spending cuts, but such cuts will be necessary. On the revenue side, government should not have raised taxes to increase revenue last year. What is needed now is steady spending cuts based on a reasonable macroeconomic scenario.
Back Numbers of Policy School (June 2015-)
The Latest Population Projection for Japan
(May 8, 2017)
A new Population Projection for Japan released in April
The National Institute of Population and Social Security Research (IPSS) released its latest long-term population projection for Japan on April 10th. It is the updated version of the projection which was last published in January 2012. It is an important publication not only because it is the most respected projection produced with a significant input of resources available to the national institution, but also because it is going to be the basis on which the review of national pension plan, which is expected to take place in 2019, will be made.
The population projection of 2017 has its upsides and downsides.
The upsides of the Population Projection
The upside is that the population revised upwards the last population projection made in 2012. The population for 2060 (the final year of the formal projection made in the previous projection), for example, has been revised upwards from 86,737 thousand to 92,840 thousand , an increase by 7.0 percent. (The figures cited are those of the projection based on medium fertility and medium mortality assumptions, unless otherwise mentioned.)
This is due to the recent improvement in the total fertility rate witnessed in Japan. The fertility rate was 1.45 in 2015, up from 1.42 in the previous year, and is a continuation of the upward trend that has been observed since it fell to a record low of 1.26 in 2005. In view of the improvement, the long-term assumption for the total fertility rate has been revised upward to 1.44 from 1.35 in the previous projection.
The increase in fertility rate has led to a downward revision of the share of aged over 65 in total population, notwithstanding the longer life expectancy during the projection peirod.
The life expectancy of the elderly in Japan is extending: the latest figure for 2015 is 87.05 for females and 80.7 for males. The long-term life expectancy in 2065 is assumed to extend further to 91.35 for females and 84.95 for males in the latest projection, both being an upward revision from 90.93 and 84.29, respectively, for 2060 in the previous projection. It means that the number of the elderly aged 65 years old and over will be revised upwards; it is expected to increase to 35,403 thousand in the latest projection from 34,642 thousand in the previous one.
However, since more younger children is expected because of the rise in fertility rate, the share of the elderly (65 and over) in the total population is expected to fall to 38.1 percent compared to the previous figure of 39.9 percent.
The downsides of the Population Projection
On the other hand, the downside of the latest projection is that the decline in the population is still projected to continue. During the 50 years’ period starting from 2015, the latest projection expects that the total population of Japan will fall from 127,095 thousand in 2015 to 88,077 thousand in 2065, a decline by 30.7 percent. The annual rate of decline during the period is estimated to be 0.7 percent.
If we add the projection from reference scenario that extends the projection to 2115 by assuming fixed fertility and mortality rates after 2066, the population is expected to decline further to 50,555 thousand in 2115, a population that is only 39.8 percent of the total population in 2015 (Figure 1). The annual rate of decline between 2065 and 2115 is 1.1 percent.
It is projected that, not only the young (under the age of 15) and the matured (from 15 to 64 years of age, traditionally known as the “working-age population”), but also the elderly (65 and over) is expected to decline. After reaching the peak in 2042, the number of the elderly is expected to decline thereafter. With the declining total population as its background, it leads to the stabilization of the share of the elderly in the total population at around 38 percent in mid-2050s.
It implies that a huge burden is going to fall on the matured in term of sustaining the social security system. The old-aged dependency ratio, or the ratio of the numbers of elderly to the matured which roughly corresponds to the ratio of the number of those receiving pensions to the number of those paying premiums, is projected to rise from 43.8 percent in 2015 to 70 percent in 2061, and reach 74.6 percent in 2065 (Figure 2). The reference projection further shows that it will rise gradually to 75.0 percent in 2115. It implies that a pensioner who is supported by 2.3 premium payers in 2015 will have to be supported by 1.3 premium payers in the long-term.
The projected decline of the total population is robust across different scenarios. The decline in population is projected even under a most optimistic scenario: A combination of high fertility and low mortality rates still leads to a projected decline in population from 127,095 thousand in 2015 to 96,571 thousand in 2065, a decline by 24.0 percent, or by an annual rate of 0.5 percent.
Difficult requirement for the policy solution
The new projection that shows the continuation of the declining trend of population leaves us with uneasiness. With less available labor input, it would be a drag on the potential growth rate that is already below 1 percent (0.8 percent according to the Cabinet Office). The downward pressure would be reinforced by the lower available capital input that results from the lower savings rate due to aging. Unless total factor productivity sufficiently rises to offset these negative factors, the potential growth rate can be as low as zero or even negative in the long-term.
The further rise in fertility rate is obviously the most fundamental solution to the situation. It is unarguably not an easy task to achieve because, in order to raise the low fertility rate in this country, marriage rate has to improve: it is essential since about 97 percent of the children born in Japan are to formally married couples.
The problem is more serious if we take into account the inertia in population dynamics. As the auxiliary simulation results to the population projection of 2017 shows, even if Japan succeeds in raising the fertility rate to 2.2 towards the 2020s, the population will still continue to decline until the 2070s.
We will have to seek a solution to deal with the long-term downward pressure on potential growth which is expected to be with us even when more optimistic scenarios realize.
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