Japan has had two decades of sluggish growth as it went through the bursting of the late 1980s bubble and a subsequent banking crisis. Are many of the Western economies that saw their own bubbles burst after the 2008 financial crisis going to follow a similar path? And is Japan, whose ratio of public debt to gross domestic product is the highest among industrialized nations, headed for the same fiscal crisis that has gripped several European economies in recent years?
These were among the questions pondered by four veteran journalists from Britain who discussed various economic challenges facing both the United Kingdom and Japan during a June 24 symposium in Tokyo organized by the Keizai Koho Center. Naoki Tanaka, president of the Center for International Public Policy Studies, served as moderator of the discussions.
Despite its mounting public debt and lack of government action to reduce it, Japan is not likely to face a fiscal crisis anytime soon but will not be able to avoid consolidation efforts much longer, said Jeremy Warner, assistant editor of The Daily Telegraph.
“How come Japan, which has extreme high public indebtedness, has managed to avoid a fiscal crisis? If Japan manages to live with this high level of public debt, can’t the U.K. do the same? This is a question much asked in the political left in the U.K.,” Warner said.
The Conservative-Liberal Democrat coalition government of Prime Minister David Cameron has introduced a set of aggressive fiscal consolidation measures to rebuild Britain’s public finances in the wake of the recent banking crisis.
Meanwhile, Japan, whose public debt-to-GDP ratio of around 200 percent is already the highest among industrialized economies, has not been able to formulate viable plans to reduce its public debt.
What Britain has gone through following the 2008 financial crisis, Warner noted, is “very similar to what started to happen in Japan 20 years ago,” after the burst of its asset-inflated bubble in the late 1980s.
When a bubble goes bust, an economy suffers a sharp shrinkage of credit, and the private sector reduces its demand and use of debt. If the government wants to maintain output at a reasonable level, “the public sector has to step in, become in essence the consumer and the borrower of last resort,” Warner said. “That is what’s happened to Japan for 20 years and what is happening in the West now. In all major advanced economies, we’re seeing an extreme buildup of public debt.”
But while some of the economies, including Britain, have started efforts to reduce government borrowing, Japan is essentially doing nothing at the moment to reduce its budget deficits, he pointed out. Still, Japan, in sharp contrast to some European economies that have faced fiscal crises, has so far not suffered any distress in the bond market, with the yield on Japanese government bonds remaining low, he said.
Some of the reasons Japan can avoid disturbances in the sovereign bond market, Warner noted, are its relatively high government-owned financial assets and the high household savings.
“Japan is by far the wealthiest country from a household savings perspective,” whereas there is little left for Britain if household debts are subtracted from household savings, he said.
Another reason Japan faces no fiscal crisis for now, Warner said, is that its level of taxation is one of the lowest among the major economies. “What it demonstrates is that debt is not really a problem for Japan if it’s going to raise its level of taxation to more European levels. (With tax hikes) the deficit will be gone overnight and (the government) will begin the process of repaying the public debt,” he said.
The problem, however, is that “it is politically very difficult to do that in Japan at the moment,” Warner said. Debate over a substantial hike in the consumption tax to cover the increasing costs of social security has been going on for years, but a solid consensus remains elusive among lawmakers wary of voter backlash amid continuing political instability that has seen five new prime ministers since 2006.
Warner said the devastation brought about by the March 11 earthquake and tsunami means that Japan, at least for the time being, will have to keep accumulating debt because it needs to spend heavily on reconstruction of the disaster-hit areas.
Still, all these factors do not mean that Japan can keep avoiding fiscal consolidation over the long term, Warner said.
“You cannot keep piling up public debt at this rate,” he said. “Eventually, even the Japanese investors who largely finance the bond market here will lose their confidence and take the money abroad. That is a serious risk for Japan.”
Warner said there will be only three ways to reduce the public debt, with two of the ways — inflating or defaulting on the debt — politically unacceptable.
“So the only way out is to essentially tax the private surplus that has built up,” he said. “Japan must raise its taxes and cut its spending. . . . There is a very substantial fiscal consolidation that Japan has to make if it is to get its debt back to a more sustainable level.”
“Japan at the moment has no credible deficit reduction strategy. There is a vague target about halving the primary deficit by the middle of the decade and eradicating it by 2020, but very few measures have been announced that will enable the government to actually deliver that target,” he said. “So the public debt will keep rising relative to the GDP if nothing is done. The question is, is that a sustainable position?
“I would argue that for the time being, it is,” Warner noted.
The March 11 disasters “will perhaps allow Japan a little bit more time to think about how it’s going to get its public finances back in order. There is a little bit of leeway that the markets will be prepared to give Japan: Its bond market is 95 percent financed domestically, and Japanese companies and households are likely to keep their investments at home for the time being,” he said.
But there is no room for complacency for Japan, he warned.
“If in a year’s time you’ve still got this political paralysis and there is no announcement of a credible road map for dealing with the deficit and getting the public indebtedness down, there will eventually be a fiscal crisis,” he said.
What lessons can the U.K. learn from Japan in dealing with post-bubble economic woes?
Simon Nixon, the European editor of The Wall Street Journal’s Heard on the Street column, said the road to recovery in Britain “will be very long and hard — maybe harder than we had anticipated.”
“The option of financing through very large deficits for years (like Japan) is simply not available to Britain because we have a very high reliance on external financing from foreign investors to fund our deficit,” Nixon said. “The private sector deleveraging could be much more prolonged and painful than we had anticipated.”
The Japanese experience suggests that Britain may see declining living standards “for many, many years,” Nixon said.
Warner pointed out that before its 1990s banking crisis, Japan’s per capita income was roughly on the same level as the United States, but the figure is now down to around 75 percent.
Britain has already gone through the biggest squeeze in living standards since the 1930s, but Japan’s prolonged post-bubble woes suggests that the process will not stop anytime soon, Nixon noted.
Although the relative decline in U.K. living standards in the past few years were largely due to high inflation as a result of the pound’s devaluation — rather than through wage cuts — “clearly, there is a long process lying ahead,” Nixon said. “That, of course, will have consequences on consumer confidence and domestic demand.”
The situations differ in many respects, Nixon said. While Japan has now been in a post-bubble economic climate for two decades, the British economy was in a boom until recently, when it suddenly went bust. Japan has high savings, relatively low tax rates and a strong currency; whereas savings are low, tax levels are high and the currency is weak in the U.K., he noted.
And while Japan continues to have revolving-door political leadership, “it appears in the U.K. we have a pretty stable government for the next five years,” he said.
The central challenge for the U.K., which was left with huge debts not only in the government but household and corporate sectors as a result of the banking crisis, is “how to control the inevitable deleveraging we’re going to go through,” Nixon said.
Britain’s policy response under the new government that replaced the Labour administration last year “has been to try and reduce the public sector deficit but also to try and force the banks to deleverage” through new regulatory measures, he said.
The government has taken a “fiscal gamble” in its approach to the problems and the strategy “depends on the government to deliver its cuts — borrowing costs remaining low, banks continuing to lend, housing prices remaining steady and not undermining consumer confidence,” Nixon said. “And above all, it depends on companies starting to spend again.”
After trying to grapple with the crisis for three years now, “the balance sheet is not particularly healthy,” Nixon said. The government recently made a series of U-turns on some of the political strategy — although not on the deficit-reduction strategy itself — and that raised some concerns about its willingness or ability to stay committed to the program, he noted.
But so far, Britain appears to have retained the confidence of financial markets, he said.
Phillip Inman, an economics correspondent of The Guardian, meanwhile, urged Japan to learn from the experience of the U.K. and not follow the British experience in its pension reforms, which he said has aggravated the generational gaps in pension benefits and left “winners and losers in great extremes.”
Japan “has an opportunity to cut the costs of your pensions and health care, and do it fairly and for everyone to share because of the way your system is constructed at the moment,” Inman said.
The U.K. reforms introduced about a decade ago have resulted in “greater inequality in pensions,” he said. “Some people may be lucky enough to be in an industry where they preserve their pensions … but everywhere, slowly, the remedy is to freeze or end their pensions and shift them into something that are stock market-related, cheaper pension. The older you are, the more likely you are to have many years of guaranteed pension rates.”
The younger generation — whose unemployment rates are higher than their older counterparts — “are the most likely to be offered the cheapest pension or no pension at all,” Inman said. And Japan faces the same problem after it has allowed a large proportion of the younger workforce to go into temporary jobs, he pointed out.
Martin Sandbu, an economics editorial writer for the Financial Times, discussed some of the oft-repeated “preconceptions” about Japan and its economic problems.
One typical Western perception, he said, is that Japan’s past development of its powerful manufacturing sector had been driven by a “special kind of innovative spirit or a culturally specific type of entrepreneurship — and that the spirit has been lost as Japan is not seen as leading the world anymore.”
It is misleading because innovation is still there, as a quick look at the latest technologies of many Japanese manufacturers will show, Sandbu said. However, “innovation does not seem to produce the same spectacular growth anymore” for Japan, he noted.
This is inevitable as manufacturers, which combine both high-skilled and low-skilled processes, move more and more of their production overseas and try to keep only the high-skilled activities in Japan, Sandbu said. But the question, he said, is whether “the society at large has quite taken in what that means in terms of how Japan as a society and as an economy is going to change from what we are all used to seeing it as.”
If the future of Japan’s manufacturing is to be something much more like Apple Inc., whose headquarters does not engage in any manufacturing operations but creates all the value-added processes, “productivity that is going to drive Japanese growth will have to be more and more in service-like activities, research, management, training and so on, as well as in the service industries themselves,” Sandbu said.
Here, the problem for Japan will be its service sectors, whose productivity remains lower than the manufacturing sectors, and the government spending on public education, which continues to be much lower than in many other advanced economies and will be a necessary investment if the nation is to pursue knowledge-intensive productivity growth, he said.
A bigger challenge, Sandbu noted, is for Japan to identify certain conflicts of interest as it tries to shift priorities. The fault lines of the conflict of interest may lie between men and women, between the home and the workplace, between service and manufacturing, or between the young and the old.
“Now, progress for Japan depends on shifting from where you have traditionally put your priority along those dividing lines,” he said. “That is never easy, to make those shifts with as little pain as possible, but it’s crucial to start by recognizing that those conflicts are real and that they are there.”