Crisis a chance for consolidation

Postwar social market economy model seen at crossroads amid mounting public debts

by Takashi Kitazume

The European debt problem triggered by the Greek crisis this year provides a good opportunity for both Japan and Germany to start fiscal consolidation efforts in the face of mounting public-sector debts, experts from the two countries told a recent symposium in Tokyo.

Germany has to “re-establish” its post-World War II social market economy model as its welfare expenses have ballooned, they said. Japan needs to pursue more deregulation while seeking new ways of providing safety net for its workers, they noted.

The experts were speaking at the June 18 symposium jointly organized by the Keizai Koho Center, the Japanese-German Center Berlin and Konrad-Adenauer Stiftung under the theme “The social market economy in Europe and its implications for Japanese businesses.” Mikio Sugeno, a senior writer for the Nikkei business daily’s Financial News Department, served as moderator of discussions.

German Chancellor Angela Merkel has announced plans to cut government spending by 81.6 billion euro (roughly ¥8.9 trillion) over four years beginning in 2011. In Japan, Prime Minister Naoto Kan of the Democratic Party of Japan-led ruling coalition entered the House of Councilors election campaign by putting a future consumption tax hike on the agenda.

Both countries face the common challenge of reducing public-sector debt, which in Japan has accumulated to double the amount of its gross domestic product.

While there is criticism of the massive spending cuts and fears that consumption may be negatively affected, “there is at least a little bit of understanding” among a majority of the German population that welfare spending in the country has gone too far, said Michael Eilfort, director of the Berlin-based think tank Stiftung Marktwirtschaft.

“With the Greek crisis came the end of the illusion that deficit spending can be a never-ending story. It is not, and we have to do cuts,” said Eilfort.

Eilfort argued that the social market economy model, established in the former West Germany’s post-World War II reconstruction by rejecting both socialism and Anglo-Saxon capitalism, took a wrong turn in the 1970s when state help for the socially weak became more of a permanent policy than emergency aid for bad economic times.

The concept combines market economy with government measures to ensure fair competition, low unemployment and better working conditions and social welfare. Under the model, the state — not the market — ensures social justice, Eilfort explained.

The model has had its advantages. “We have a high degree of social peace and social cohesion” and working conditions have improved since 1948 — with weekly working hours reduced from 48 to 38 and annual holidays increased from 12 to 30, he said. The system of redistribution is so strong in Germany that the top 10 percent of earners account for 50 percent of the nation’s income tax revenue, and “after tax there is some kind of balance between high income earners and low income earners,” he noted.

So what are the problems of the social market economy today? The strong redistribution system comes in multiple layers — from the progressive tax system and health insurance premiums to kindergarten and public TV fees — and in some instances a family with jobless adults — with the state aid and free health insurance and other public services — may get the same net income as a family with a working father, Eilfort pointed out.

“We have to find a new balance for social market economy,” Eilfort said. “The welfare state in Germany definitely became too expensive.” Initially, the state was to serve as a referee who makes rules and regulations, but not as an actor in the economy. However, after the government began offering aid money and other subsidies for people through deficit spending in times of recessions starting in the late 1960s, this assistance was continued even when the economy picked up, leading to mounting public debts over the years, he said.

Eilfort said the European debt crisis this year “is a good thing for reforms” because “only in times of crisis can you convince a large part of the German people to accept reforms.” With the global financial crisis of 2008 and this year’s Greek crisis and the European problems “people are aware that we can’t go on like that,” he noted.

“The social market economy is not a static model,” said Martin Schulz, a German researcher at Fujitsu Research Institute. “It is a dynamic concept of how to run your economy . . . how to integrate state intervention, state action and laws into the economy.”

Both the Japanese and German postwar models have been “extremely successful” but they are “not doing that well anymore, so we have to fix them,” he said.

The Japanese and German models worked “when their societies were young and markets were dynamic with new ideas, new companies and everything was growing,” but the problem today is that both people live in aging societies with much less dynamic markets, Schulz said. At the same time, pursuing a more Anglo-Saxon economic model would likely not be an option because both countries have the growing elderly population that would need strong government support and services, he added.

Many of Germany’s problems attributed to its social market economy model are also relevant to Japan, where the government has similarly intervened heavily in the market economy, said professor Naohiro Yashiro of the International Christian University in Tokyo. However, Japan has its unique problems that must be addressed as the nation faces the prospect of low growth and an aging population, he pointed out.

In Japan, the manufacturing industries today are driven by market forces while its agriculture and service sectors remain under strong government control, the professor said. This dual structure has resulted in large gaps in competitiveness and productivity between these two segments of the economy, Yashiro said.

Also unlike in Germany, much of the safety net for workers has been provided by individual corporations, which in turn gets government support, he noted. This has resulted in an increasing gap in labor conditions between the “insiders” — regular workers of major companies — and “outsiders” — people hired by subcontractors to those firms as well as part-time and temporary workers, who today account for about 30 percent of Japan’s labor force, he said.

Many Japanese firms guaranteed employment and seniority-based pay for their workers up to retirement age, but that was possible only as long as the nation had high economic growth, the professor said. As Japan entered a protracted period of sluggish growth in the 1990s, companies relied increasingly on non-regular workers, who get lower pay and lack employment guarantee, he said.

Today, the government, rather than trying to deal with this dual structure of the labor market, is moving to restrict the use of temporary workers in the hope that such restrictions would prompt companies to hire them as regular employees, Yashiro said. However, the number of full-time employees will likely remain limited as firms try to survive low economic growth, and the government should instead try to the expand the safety net to cover the non-regular workers as well, such as by widening the coverage of unemployment insurance, he said.

In Japan, the safety net for workers is as much an issue of employment practices as it is a question of social security system, the professor said. The country should seek to narrow the gap between regular and non-regular workers, and reform its labor market so that it can cope more flexibly with diverse ways of work, he said.

For workers, Yashiro said, the biggest safety net will be a high economic growth, which increases jobs for unemployed people and provides non-regular workers with better employment opportunities.

The Japanese government has relied on deficit spending as a way to boost domestic demand, but that is no longer going to be sustainable given that its fiscal debts have ballooned to as much as 200 percent of the nation’s GDP, he said. Also with the aging population, further increases in welfare expenses are unavoidable, and tax and social security premiums could skyrocket if the government tries to cover all the welfare costs through fiscal measures, he added.

Instead, the government should turn to creation of demand and jobs through the deregulation of sectors currently restricted by rigid entry rules, uniform prices and vested interests, Yashiro said. Such a market-based approach to growth and job creation, he said, would be the right path for Japan — and Germany — as they both face a rapidly aging population.

Both Japan and Germany can be called social market economies in the sense that their economic systems differ from the Anglo-American market-oriented capitalism, said professor Sahoko Kaji of Keio University.

A social market economy will not function when a set of conditions that make it work — such as the principle of self-responsibility, private-sector safety net, and public-sector policy to intervene in case of market failures — are not met, she said. And this happens when lawmakers pursue populist policies without requiring voters to carry out their own duties, when a mature society needs to be supported by a mature economy, and when there are downward wage pressures due to increased global competition, the professor said.

For a social market economy to function better, the government needs to prepare safety nets for workers, end populist policies and implement reforms, while the private sectors must become more self-reliant, she said.

Kaji noted that attempts by a mature economy to grow without deregulation will inevitably create financial and real estate bubbles. It is therefore important for the government to push through politically unpopular deregulation in the real sectors, she said.

What is important, Kaji noted, is to get the people to fully understand the choices they have and the consequences.

Given that most of the major economies have accumulated fiscal debts to such an extent, there is no way that they can rely on deficit spending much longer, and that leaves deregulation as the only path for growth, she said.

“If people do not want deregulation, there will be no growth. Efforts must be made to have everybody understand that,” Kaji said. If people still believe that Japan needs growth because it has to support the growing elderly population, then they need to choose what to give up, and it is the politicians job to properly explain all this to the voters, the professor noted.

Kaji concurred with Eilfort of Stiftung Marktwirtschaft that this year’s Greek debt crisis provides a good opportunity for countries to embark on fiscal consolidation because it enables policymakers and voters at large to share a sense of crisis to some extent.

Still, Yashiro of the International Christian University said the problem in the ongoing debate in Japan about raising the consumption tax rate — from the 5 percent possibly to 10 percent — is that there is not much discussion on how to use the revenue from the tax hike.

There are two ways of thinking behind a tax increase, he said. One is to rebuild the fiscal balance, and the other is to raise taxes in order to avoid cuts to wasteful expenditures, he added.

In that sense, a mechanism needs to be installed in the tax system to prevent populism by lawmakers — and the best option is to clearly link the revenue from the tax to a specific purpose, Yashiro said.

“In Japan — and in Germany as well — social security expenses including pension, medical and elderly care are set to increase in the years to come, and it is extremely difficult to cut these expenses,” he said. “So the government should let the voters decide — whether they would choose, for example, to raise the consumption tax specifically to increase pension benefits.”

The current system is so opaque that people will not know how much of the revenue from an increase in consumption tax would be used to cover social security expenses, “and politicians are taking advantage of such a lack of transparency,” Yashiro said.

Schulz of Fujitsu Research Institute said an effective tax system needs to be sustainable and based on appropriate figures. ”In Japan, the debt problem was building up over the last 15 years. Everybody agrees that this is not sustainable, so something needs to be done,” he said.

From an economist’s viewpoint, “increasing debt is basically the same as raising taxes — with the problem of timing” because it shifts back some part of the tax burden to the future generation, which, in an aging society, is set to become smaller in size, he said.

Schulz noted that the public debt problem “is not too different” in Japan and Germany. Japan’s public pension system is forecast to face real problems beginning in 2015, and it takes at least three years to get effective reforms running, he said. “If we do not get into fixing the debt problem and the pension system problem, say, by next year, we are running into a big problem in Japan,” he said.