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Can Kan revive Japan?

by Kevin Rafferty

HONG KONG — Naoto Kan, Japan’s new prime minister, pledged to make the country’s sickly economy his first priority and to pull Japan from its “quagmire of an ever- bulging debt.” But that is easier said than done. It is not merely a question of when to stop the government stimulus and where to put the knife to spending. Japan needs a radical overhaul, which will have to include sweeping changes in the country’s socioeconomic structures.

Japan’s government debt-to-GDP ratio is about twice that of Greece — 218.6 percent at the end of 2009 (IMF figures) against 113 percent for Greece. Japan’s government debt is ¥6.93 million per Japanese, while Greece owes ¥3 million per Greek, even including local bonds.

Whereas Athens has been forced to take savage cuts to tackle its deficit, the political debate in Japan is how many extra government bonds to issue in the current year. As finance minister, Kan wanted to keep the bond issuance for the fiscal year 2011 that begins in April next year below the unprecedented ¥44.3 trillion issued this year. But some ministers, notably Shizuka Kamei, the leader of the People’s New Party, a vital partner in the ruling coalition, want public spending to be maintained to continue boosting the economy.

The other focus of discussion is when and by how much to raise the consumption tax, currently 5 percent. Most politicians have begged off serious discussion of an imminent rise, warning that putting the tax up would hurt growth.

In spite of Kan’s concern about the ballooning debts, there is an air of unreality about the tax debate. The Industrial Structure Council under the ministry of economy, trade and industry has proposed a 5 percent cut in Japan’s corporate tax in 2011 to bring the tax to between 25 and 30 percent in the “medium term” with a corresponding rise in the consumption tax.

Robert Feldman of Morgan Stanley MUFG Securities commented that: “It is unlikely that the tax system debate will move anywhere quickly. The debate is too divided among experts, and the politics are too complicated.”

Similar unreality is shown about economic growth. The Japanese media reported that the ruling Democratic Party of Japan draft manifesto “calls for achieving an average nominal economic growth of 3 percent and real growth of 2 percent in the years through fiscal 2020.” On the other hand, “The LDP hopes for nominal growth of 4 percent and real growth of 2 percent, LDP lawmakers said.” How nice if the real world were as simple and real growth for 10 years ahead worked neatly according to politicians wishful formulas.

Some economists, including foreign ones, say that Japan can relax even with higher ratios than Greece. One reason is that the published figures are gross debts and the net figures are much lower, closer to half the gross ones. More importantly, Japanese debts, unlike those of Greece, or the U.S. or Britain, are predominantly owed to Japanese, not foreigners.

This has allowed Japan to get away with low interest rates on its debts as well as not to worry about a selloff. The benchmark 10-year government bond yield is steady around 1.3 percent because of brisk demand from domestic life insurance companies and banks. According to the Bank of Japan, domestic investors held 94.8 percent of Japanese government bonds at the end of 2009. Cynics say that the old boy network of the Japanese elite means that the institutional investors have no real choice except to swallow the bonds, and no foreign investor would look at such low yields.

But even with these factors in Japan’s favor, Kan is correct to worry. The rise in numbers is scary. The ministry of finance forecasts that Japan’s central government debt could reach ¥973 trillion by the end of the current fiscal year.

Apart from conventional concerns such as government borrowing crowding out the private sector and the fear of reaching a tipping point when markets will declare they have had enough even of the Japanese government, the country is running up a heavy burden that future generations will not be able to bear.

Japan is rapidly aging. By 2015 one in four Japanese will be 65 or over, and by 2025 there will be only two workers to support each elderly person (against six workers in 1990), meaning higher bills for social security and health care paid for out of falling tax revenues.

Damaging effects are already being seen, in household savings rates that have fallen below those of the U.S., and in huge unfunded pensions at big companies because of the low yields of government bonds and the falling stock market, less than 24 percent of its 1989 peak. Unfunded liabilities at Hitachi are ¥1.1 trillion and those at NTT are ¥576 billion, huge gaps and potential disappointments for workers expecting a comfortable retirement, who will then find that the state has no money to pay for their medical and pension bills.

What should worry Kan most of all is the lack of any realistic debate on the wide socioeconomic implications of heavy debts, economic stagnation and an aging society. Indeed, Japan Inc. seems to be sleepwalking toward its inevitable doom. Economic reform, restructuring and deregulation are dirty words in the political lexicon. In terms of ideas, from schools to the big companies and the media, South Korea, India, and even China within strict political limits, are livelier than Japan.

Tadashi Nakamae, former chief economist of Daiwa Securities, calculates that Japan’s manufacturing operates with 30 percent excess capacity. Eliminating this would spark competition, increase efficiency and create new jobs. The bill would be high, 10.5 million workers (or 5 percent) unemployed unless they can be shaken into the new more efficient and profitable jobs that would be created. Instead, so far, the government has pumped money to preserve a system that isn’t working.

Kevin Rafferty is author of “Inside Japan’s Powerhouses,” a study of Japan Inc. and internationalization.