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Japanese Economy Update

Does Japan Have a “Small Government”?

Jun SAITO
  Senior Research Fellow

2021/09/21

The United States is known for its economic policy principles based on a laissez-faire approach, trusting that free market leads to best outcome of the people, and is often described as having a “small government”. In contrast, Sweden is famous for being a welfare state, implementing wide range of social policies to improve the well-being of the people, and is considered to be a leader of a “big government”. Then, how about Japan? Is she more like the US or like Sweden? Does Japan have a “small government” or a “big government”?

Japan seems to have a “small government” in terms of the size of government expenditure

An obvious starting point to answer this question is to look at the size of the government in terms of government expenditure.

Figure 1 shows the data on general government expenditures, in ratios to GDP, of the OECD countries. It shows that the US has a very small ratio while Sweden has a very large one. It seems to confirm that US has a “small government” while Sweden has a “big government”. As for Japan, the ratio is much closer to that of the US than of Sweden implying that Japan has a “small government”.

Government’s size may not be an appropriate indicator

However, can we really say that Japan has a “small government”?

Figure 1 compares a wide range of countries which differ in living-standards and in population. If the demand for government service differs among the countries with these differences, general government expenditures may be different only because of these factors and not because of the differences in economic policy principles as we implicitly assume to be the case.

In order to take these factors into account, Figure 2 shows the correlation between per capita GDP and per capita general government expenditures.

It shows that there is a positive correlation between the two, implying that as economies develop and living-standards rise, people seem to demand for more intensive government services. Moreover, if there is a kind of a fixed cost in establishing a government and a variable cost that reflects the difference in per capita GDP, it can be said that the ratio of general government expenditures to GDP (whic corresponds to the slope of the line connecting the origin and a point of the country) would gradually fall as per capita income increases. If that is the case, decline in the ratio does not necessary reflect the difference in economic policy principles (i.e. laissez-faire vs. welfare state).

Of course, if you look at the figure more closely, US and Japan lie below the regression line while Sweden lies above. Also, Sweden has a higher per capita GDP than Japan, but has a higher ratio of general government expenditure to GDP as we saw in Figure 1. It suggests that Sweden spends more than Japan even after controlling for per capita GDP. They can be seen as evidence that Sweden has a “big government”.

Nevertheless, there do seem to be a need to complement the above observation with other information. Is there any other information that would tell us the difference of countries in terms of economic policy principles? In the following, three alternative sources of information will be suggested: breakdown of government expenditure by functions, indicator of product market regulation, and degree of income redistribution by taxes and transfers.

Breakdown of government spending by functions

First is identifying the differences of the countries by comparing the breakdown of government expenditure by functions identified by the System of National Account. SNA identifies ten functions of the general government, namely (1) general public services, (2) defense, (3) public order and safety, (4) economic affairs, (5) environment protection, (6) housing and community amenities, (7) health, (8) recreation, culture and religion, (9) education, and (10) social protection.

Figure 3 shows the percentage shares of general government expenditure spent for those functions in the three countries, US, Sweden, and Japan.

Figure 3 shows that, against the impression of the many, US spends quite a lot of her resources for many of the functions, sometime more than other countries. The only exception is the spending for social protection (e.g. sickness, old age, and unemployment): For social protection, US spends less than half of that by Sweden. In contrast, Sweden spends a significant amount for most functions but particularly for social protection. The difference in spending for social protection do seem to reflect the difference in economic policy principles of the two countries.

As for Japan, it is noteworthy to mention that the share of government expenditure spent for social protection is more than Sweden. On the other hand, what is striking is the fact that Japan spends the least for education among the tree countries. It seems to support the claim that Japan is a country that spends a significant amount for the aged but not so for the young. It shows that Japan is not a full-spec welfare state as Sweden.

Government regulation on economic activities

Second is comparing the degree of intervention to the economic activities by the government. To see that, Figure 4 shows the product market regulation (PMR) overall indicator provided by the OECD. According to the indicator, US has the most regulated market among the three countries. In contrast, Sweden has the least regulation on economic activities. It is just the opposite of the image we have about the US and Sweden. As for Japan, she falls right in between the two countries.

The reason for US having a high PMR overall indicator can be explained by the barriers to domestic and foreign entry. With regards the former, there seems to be a significant administrative burden on the start-ups in terms of licenses and permits. With regards the barrier against foreign entry, treatment of foreign suppliers seems to be the problem. It should be noted that the problems regarding start-ups in US have also been mentioned in the World Bank’s Ease of Doing ranking: In 2019, US was the 6th among the 190 countries in the overall ranking, but the ranking in terms of “starting business” was the 55th.

It shows that there is an involvement in business by the government and is creating some problems in the functioning of the free market in US. The idea of US having a laissez-faire regime may need to be modified.

Income redistribution measures

Third is comparing the degree of income redistribution by taxes and transfers. The magnitude of the income redistribution achieved can be measured by the difference between the inequality which existed at the market income level (before tax and transfers) and at the disposable income level (after tax and transfers).

However, just looking at the difference may be misleading because countries with limited market income inequality do not have the incentive to redistribute much. It means that we need to judge the magnitude of the redistribution done by the government, taking into account the inequality that existed before redistribution.

In view of this, Figure 5 shows the relationship between the Gini-coefficients of market income and those for disposable income in the OECD countries. If there is no redistribution made, the points should be on the 45 degrees line. Since the point in the figure are all more or less below the line, it shows that income redistribution has been made in all of the OECD countries.

However, countries differ in terms of the magnitude of the redistribution made (the magnitude can be measured by the vertical distance between the country’s point and the 45 degrees line). Figure 5 shows that redistribution made by Sweden (reduction of Gini-coefficient by 0.153 points) is somewhat smaller than by Japan (reduction by 0.167 points). However, since inequality in market income was lower, it was sufficient to bring down the disposable income inequality to below Japan’s. In fact, it is interesting to finds that all Nordic countries, while they differed in terms of market income inequality, ended up in an almost the same disposable income inequality (around 0.25). By engaging in redistribution, Nordic countries have been able to achieve the lowest inequality among the OECD countries after redistribution.

In the case of US, market income inequality was something similar to Japan’s. However, redistribution made by taxes and transfers were limited so that disposable income inequality ended up being much higher than that of Japan.

Above observation leads us to conclude that redistribution function is the greatest in Sweden and smallest in US, and somewhat in between lies Japan. It is consistent with the view that Sweden, as a welfare state, is more concerned with equality issues compared to US and Japan.

Governments’ economic policy principles needs to be identified from multiple aspects

When we refer to US as having a “big government” and Sweden a “small government”, we tend to focus on the “size of the government’s expenditure” in making those judgement. However, focusing on the size could be misleading because government’s expenditure is not determined only by economic policy principles but also by population and by living-standards. In addition, there are also other aspects that we need to consider, in particular, the “magnitude of the government’s impact on the economy”.

By making use of three measures, the countries’ characteristics become clearer. US has, in many cases, a “small government” feature but sometimes she is found not to. Sweden’s case was the opposite, having a “large government feature” but sometimes not. As for Japan, we find that, in some aspect, Japan has a lot in common with the US. In that sense, Japan is a “small government”. But in other aspects, Japan is more like Sweden and has a “big government” feature.

The discussion shows that we need to specify from which aspect we want to make the assessment and to look into the details from that particular aspect. Relying on a single indicator and simplifying the situation may only lead to a confusion.


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