|Date||June 22, 2018|
|Speaker||Randall S. JONES (Head of the Japan / Korea Desk, Economics Department, OECD)|
|Moderator||TASHIRO Takeshi (Consulting Fellow, RIETI / Deputy Director, Macroeconomic Affairs Division, Economic and Industrial Policy Bureau, METI)|
Japan has achieved a comparatively high level of well-being: skill levels are high, unemployment is low and life expectancy at birth is the highest in the OECD. Since its launch in 2013, Abenomics has had a positive effect on the economy, and per capita output growth has picked up. However, to achieve inclusive growth and greater well-being, Japan needs to address important challenges to foster fiscal sustainability, narrow the productivity gap with leading OECD countries and manage the demographic transition.
Japan's short-term economic outlook
The world economy is growing very strongly at around 4%. It is led by investment and a rebound in trade. Many countries are implementing fiscal stimulus even though the economy is doing well. Monetary policy is still very relaxed in most countries, although the United States is starting to tighten it, and the European Central Bank (ECB) will start soon. Job growth has been strong, and the unemployment rate is the lowest since 1980. We have a number of risks and those are related to rising oil prices, trade tensions, financial volatility, and the impact of rising interest rates in the United States on emerging market economies. It is time to make reforms for sustainable and inclusive growth.
As I mentioned, investment has rebounded since 2014-2015. In 2016, business and public investment was close to zero. By the end of 2017, it was up to 4% and has now started to plateau. We think it might start to edge down. Trade has been growing at about the same rate as the world gross domestic product (GDP). In 2017, we had a pickup in trade that was driven by IT. In addition, we might have already plateaued in trade.
Fiscal policy is easing. After the crisis, there was a period of austerity, especially in Europe where countries tried to reduce their deficits. Now, we are at the point where countries are pursuing fiscal stimulus. In 2019, Japan will be one of the countries with a small tightening due to the planned rise in the consumption tax rate. The world economy has very high equity prices, which is a source of strength.
Turning to Japan, Japan has also benefited from the pick-up in world trade. We think this will continue for the next few years. Capital investment by the business sector has been expanding partly driven by preparations for the 2020 Summer Olympics and the 2019 Rugby World Cup. Japan has record high corporate profitability, which will help support another year of good business investment. The labor market continues to be tight. The job offer ratio is 1.6, which is the highest since 1974. All 47 prefectures have a job offer ratio above one, indicating that the entire country faces a labor shortage. The mystery is wages. Real wages have fallen since mid-2017, and that reflects a pick-up in inflation due to higher food prices. As labor shortages have gone up, many women and older persons have entered the labor force, and they are often non-regular workers, which puts downward pressure on the overall wage increase. Our projection is that wages will finally grow more in 2019 as workers demand more money because of the tax hike. The government has put pressure on firms to raise wages by 3%. There are examples of companies raising wages to 3%. The tax system is being revised to give tax breaks to companies that give higher wage increases.
Our growth projection is driven by export growth, which is relatively strong at 6.7%. We see that net exports will probably make a positive contribution to growth during the next two years. Real GDP growth in the first quarter of 2018 was negative. We expect positive growth in the second quarter, but not very strong. One of the risks for Japan is due to oil. Global demand is starting to outstrip supply, which causes the price to go up. We are worried about trade protectionism. To the extent that we see protectionist measures, they will have a more serious impact than they would have had in the 1990s, given the increased in international trade as a share of world GDP. With U.S. President Donald Trump's steel and aluminum tariffs, and the threat of tariffs on other products, leading to retaliation by India, China, Canada, and the EU, we see a very big risk. If we go the other direction and lower tariffs, we would see an increase in trade and output.
Long-term challenges facing Japan
Long-term challenges are more worrisome than the short-term challenges. The OECD's well-being indicators show a mixed picture. In terms of long-term unemployment, Japan is very low. It has low labor market security in the context of labor shortages. On the negative side, it has lots of job strain, and earnings are not so good. In housing and time off, Japan ranks rather low in well-being. Japan's life expectancy is the longest in the world, but, when asked, people say their health is not very good. Japan is at the top for education skills. Environmental quality is toward the middle. Safety and security are at the top. Overall, if you ask people if they are happy, Japan does not rank very high. This is due to, perhaps, a modest approach to answering the question and lower perceived health.
Over the period 1990-2012, per capita income growth was only 0.6% at an annual rate. Since Abenomics was launched, it has been 1.3%, close to the OECD average. Japan has thus seen a large pick-up in per capita GDP growth. If we look at the long-term trends, Japan's income has fallen to about 20% below the top half of the OECD. Japan still has a lot of labor input per capita, but productivity is relatively low, at 25% below the top half. In a sense, Japan works longer hours at lower productivity to arrive at an income that is 20% less than the top half. We agree with the idea of trying to improve the work-life balance in Japan. While that may reduce labor inputs, it would probably raise productivity.
Another problem is low productivity in small firms relative to large firms in Japan. Small firms in Japan do not tend to grow which shows a lack of dynamism in the small- and medium-sized enterprises (SME) sector.
Demographics is another headwind to growth. Japan is the oldest society as measured by the share of people over 65 years old. By 2050, Japan will still be the oldest society. Korea will compete with Japan in this regard.
Another concern we have is income inequality stemming from labor market dualism. Young people who are essentially non-regular workers start with the same skills as the regular workers, but they are paid a bit less. Over time, their wage stagnates as they have less seniority. Labor market dualism is the fundamental cause of income inequality in Japan, and relative poverty is the seventh highest in the OECD area.
Achieving fiscal sustainability in the context of an aging and shrinking population
In 1991, Japan had a debt-to-GDP ratio of about 60%. Over time, social spending has taken off and tax revenue has stagnated. Consequently, today we have a debt ratio of about 225%. People have been asking how long it can continue rising. One thing that is keeping it going is that the Bank of Japan has a yield curve control policy that helps keep long-term rates at zero. That is reducing the already low borrowing rate. So the government is able to borrow more cheaply and that means that the debt-to-GDP ratio is starting to stabilize even with a budget deficit because of this low interest rate. It seems that Japan can keep a low interest rate for the time being.
In 2010, we supported the government's target of a primary balance by FY2020. However, many OECD countries thought that 10 years was too long; the target should be achieved earlier. The progress stalled after 2015, and we are now looking at FY2025 as our new target. Of course, it will be difficult because the share of the population that is 75 years or older will be larger in 2025. I had argued that setting the target before 2025 would be better so that Japan could prepare for the extra fiscal burden related to the increased number of people reaching age 75.
On the tax system, we need to have more revenue. Japan's tax revenue tends to rely relatively more on direct taxes, with a fairly large share of revenue from payroll taxes (i.e., social security contributions). That reflects the fact that the pension contribution rate has risen very sharply from 6% to 18.7%. However, the value added tax (VAT) is relatively low. At the OECD, we argue that countries should choose taxes that are less distortionary, such as property taxes, environment-related taxes, and consumption taxes. Personal income tax in Japan is relatively low because it has a very narrow base compared to other countries. The corporate tax rate has gone down.
In terms of VAT (i.e., Japan's consumption tax), Japan has the third-lowest rate in the OECD. In April 2016, Secretary-General Ángel Gurría and I met with Prime Minister Shinzo Abe. On the question of the consumption tax, our preferred option was to raise the rate gradually with a hike every six months or every year by a half point or one point. That would eliminate the economic volatility. Our idea was let's raise the consumption tax rate very gradually, and that will take away the distortion to private consumption. People argued that this is too difficult, but I do not agree. The second option was to go ahead with the rate hike from 8% to 10%.
In Japan, it is not feasible to finance a European-style safety net using taxes on wages and capital. As in Europe, Japan needs to rely more on the VAT. I also worry about increases in the VAT being used to finance more spending. The VAT needs to be used primarily to run down the deficit. The other problem is having two rates. This happens in France as well. In Japan, there will be a lower rate of 8%, which leads to fraud and distortion; most of the benefits go to the wealthy people.
A real concern is trying to control the exponential rise of health and long-term care while maintaining equitable access for the general population. The number of hospital beds used for long-term care is very high in Japan. Providing long-term care in hospitals is more expensive. The priority is, I think, to bring every prefecture toward the best practice, which would lead to significant savings. Another thing we find in all countries is that 15%-20% of healthcare spending is ineffective or even harmful. It is important to identify such treatments and take them out of the national health insurance package. In short, we need to think about fundamentally improving the healthcare system.
The government projects that spending on public pensions, long-term care, and healthcare spending will rise by 7%. This biggest change increase will be in long-term care spending. My view on the pension system is that the key is not to keep raising the contribution rate nor to cut the replacement rate. If we keep cutting the replacement rate, we will not have sufficient income for the elderly. The key is raising the pension eligibility age, going beyond the current plan of boosting it to 65.
In sum, achieving fiscal sustainability will require a range of actions: raising the pension eligibility age above 65 and applying macroeconomic indexation, a detailed schedule of reforms to limit spending increases, including taking long-term care out of hospitals, gradually raising the consumption tax rate, and introducing an earned income tax credit for equity.
Policies to increase productivity and encourage inclusive growth
We are going to need more women in the labor force. The number has gone up over the past five years, but about half of the increase is in non-regular employment, raising concern about the quality of jobs. We need to facilitate the advancement of women to high-level management positions. Along with that, we need to promote work-life balance and childcare.
We can utilize robots as a way of saving labor. The progress is a bit slower in digitalization in Japan. One of the reasons is because companies underinvest in knowledge-based capital. In many countries, these technologies are aimed at reducing labor costs. In Japan, labor flexibility is limited by high employment protection for regular workers, thus reducing the gains of investing in digitalization. In terms of innovation, Japan is not involved in the global innovation framework in terms of joint co-authorship, invention, and research and development (R&D). Venture capital is a hot topic in many countries, as it leads to more investment in start-ups. Japan has a disadvantage because it has a bank-centered financial system instead of a capital market approach. On the demand side, entrepreneurship is lower in Japan, especially for women. Japan's view about entrepreneurship is more negative than in many countries. Regarding trade and investment, Japan needs to be more open. Barriers to trade and investment are still high.
Services play a key role in manufacturing exports and in productivity. There are areas in the services sector trade where Japan can become more open, and that would help attract foreign direct investment (FDI). More integration into the world economy through FDI and trade is important. Foreign-owned enterprises in Japan do not export much, whereas FDI in Korea is aimed at exporting to China or other countries.
On SME policy, Japan provides a high level of support through credit guarantees. The goal is to focus policy on making SMEs more productive. We also need better exit of non-viable SMEs to create space for innovative SMEs that will grow. That requires more entry and a better exit framework.
To finish on energy, we have seen a big rise in carbon intensity following the Fukushima accident in 2011. Japan is a member of the Paris Agreement and has a target of lowering its greenhouse gas emissions by 26% by 2030 and by 80% by 2050. We think the electricity reform that is coming from METI will help to increase the size of renewables in Japan, which is the lowest in OECD.
To summarize the recommendations to boost productivity: raise SME productivity, improve the exit policy, promote entrepreneurship, focus SME policy on productivity, and break down labor market dualism. This would also help increase female employment.
Q1: I think the largest risk of the Japanese economy is on the government side. As you showed in chart 28, Japan's fiscal situation is terrible. However, referring to chart 29, do you seriously believe this optimistic government projection? Primary surplus will be automatically recovered to zero despite continued increases in social security expenditure. How can it be possible? It is because of the optimistic assumption of macroeconomics? I think it is a tricky question and OECD should say something about it.
Randall S. JONES
We have achieved 2% nominal growth during the past few years. Hopefully, Japan can maintain 2% nominal growth (1% real in line with potential and 1% inflation). The government talks about doubling productivity growth to 2% by 2020. Doubling productivity growth in two years is extremely difficult. Therefore, we have to think in terms of 2% nominal growth, which is the baseline scenario in the government's projection. As for in the short run, the baseline scenario is the most likely outcome. In the longer term, Japan has scope to raise productivity and growth. To me, it is a question of corporate dynamism. Japan has lots of technology, high R&D, high education, smart people, lots of physical capital, and enterprises with lots of money. Nevertheless, their rate of return is very low. A certain cautiousness exists in the corporate sector, and they hold cash as a security. Until we can change that mentality, I think it is hard to think about raising Japan's productivity significantly. In addition, I think that seniority-based wages do not encourage workers to maximize their talents and stand out. Trying to move toward a performance or job-based pay system might help unlock some talents that the Japanese labor force has. This is something that will take time to do.
Q2: You stressed the importance of corporate governance reform in Japan. The popular view is that the increase in the number of outside directors or female directors will change Japanese management. However, I do not think it will be effective to promote risk taking from the companies. So, do you have any specific idea about what measure is effective to cause firm risk taking?
Randall S. JONES
Looking at the case of Korea, what we find is that in markets where there is severe competitive pressure, the business groups (chaebols) do less funneling of money back and forth to their family, and they become more productive. Therefore, I think the key is the intensity of competitive pressure because it forces companies to take risks to stay alive and compete with other companies. Regulatory reform, increased direct investment, and trade will all increase pressure on firms, and if they want to survive with innovative companies in the emerging markets or the United States, Europe, or Korea, they will have to take those risks. The problem with outside directors is that, in many countries, they are not really outside. An outside director who is independent and knowledgeable about the business is hard to find and even harder to find quickly.
Q3: Your observation from Japan and Korea sounds like Korea is following Japan's path in 10 or 15 years. It seems like demography determines everything. Sometimes, many economists or experts say that we should learn from Korea, but your argument sounds different from that kind of observation. What would you suggest for Japan based on your experience working in both Korea and Japan?
Randall S. JONES
Korea is getting closer to Japan in terms of per capita income. They follow Japan to the extent that the service sector in Korea is relatively unproductive and the manufacturing sector is very productive. If you measure labor productivity in services in Korea, it is 44% of that in manufacturing. The OECD average is 84%, and there are some countries where services have the same level of productivity as manufacturing. There is no reason that services should be less productive. Korea started its heavy-chemical industry drive to try to promote manufactured exports, and everything else was unimportant. Therefore, services did not get R&D, and they did not get investment. Services are lagging behind. Korea wants to change that, but it is very hard because of vested interests. The key for Korea is not to follow Japan's example.
Another similarity is the labor market. A dualistic labor market is inherently unfair, and it slows down growth. In Japan, the aging situation will break down dualism to some extent, because most young people now could get a regular job because the job-offer ratio is over one even for regular workers. At some point, you might have that situation in Korea. The other problem is over-education, or mismatch. In Korea, students who are educated for white-collar jobs do not want to work in SMEs where there is low protection and low wages. Therefore, there is a mismatch in the labor market, which means there is not enough SME workers; they have to rely on foreign trainees. Many countries have these types of problems. Both Japan and Korea have to develop the service sector, promote corporate dynamism, and break down the dualism in the economy.
Q4: My question is not directly related to your presentation today. I find the English ability of Japanese people is relatively low. Do you think the Japanese education system is a reason for this, and do you think it has an effect on Japanese growth?
Randall S. JONES
Traditional education is difficult to apply to the future because we need training for jobs, technologies, and products that do not exist yet. Japanese people tend to stay in Japan, and a part of the reason is because Japan is such a comfortable and nice place to live. For example, in U.S. universities there used to be many Japanese students. Now, there are more Korean students than Japanese. People in Japan are happy to enjoy all or most of their life in Japan. Therefore, it seems that Japan is less internationalized as it used to be. People do not have as much desire to work in international organizations or go to a foreign university. I think that will be a problem going forward; the whole world is internationalizing and Japan is not.
Q5: My question is regarding page 48. If we can cut the government credit guarantees to SMEs by half, what is the percentage by which we can boost the productivity of the Japanese economy? Do you have any data about coordination between the government credit guarantees to SMEs and productivity growth?
Randall S. JONES
In the past when people did studies of SME policy, more money was given to SMEs, which created more SMEs. However, it was unclear whether this increased productivity and profitability. There are studies in many countries showing that companies which do receive government support tend to have lower productivity over time. In a sense, it takes out the competition—the edge—that pushes them to become more productive. In Europe, they are starting to analyze SME policies in terms of its marginal impact on SMEs and not just on how big the SME sector is.
Q6: You showed on page 20 that during the Abenomics period, Japan's per capita GDP growth rate picked up. The increase is perhaps the result of good policy or good luck, such as global economic growth. What percentage do you think is due to Abenomics?
Randall S. JONES
Abenomics has three arrows. I always start with the monetary policy arrow because the yen was overvalued and now the yen is weaker. More recently, Japan's market shares have leveled off and even increased a bit. I think that correction in monetary policy was really a key factor, perhaps half. Fiscal policy has been up and down. It was very strong in the beginning (we had the consumption tax rate hike), and then they went back to making it more expansionary. Fiscal policy would account perhaps for about a quarter of growth. Then, the rest of the improved growth (around a quarter) is probably due to economic reforms, including more opening through trade agreements, some reform in agriculture (the rice market has been partially liberalized), along with electricity. When Abenomics started, I would have hoped it would have been 80% reform because that would be permanent and the rest would be fiscal and monetary. It is hard to find the key, but we need to keep pushing key reforms trying to raise productivity. I think we need to be bolder. If we want to double the productivity in two years, then we need to do something imaginative and bold to try to get that kind of increase.
Q7: Referring to page 6, I wonder why so many countries follow the same direction. During the European financial crisis, so many countries faced tightening, but now we are expanding. Do you have any idea why we do such kinds of unreasonable things?
Randall S. JONES
I think economists talked a lot about fiscal space, and when interest rates go down, you can spend more. Basically, economists convinced many policy makers that there is significant fiscal space. There is also an emphasis on productive fiscal spending; fiscal spending on education will pay off; fiscal spending on childcare or infrastructure will make you richer. Politicians who are happy to find a reason to spend say that fiscal space is bigger so we have more room to spend, and we have positive areas to spend in to raise our growth potential. There is some truth in that. Spending on childcare might allow more women to work. However, I think that some of the infrastructure in Japan and elsewhere does not necessarily do much for boosting productivity. Caution should be exercised before accepting the argument that more spending is needed—an argument that politicians seem happy to accept.
*This summary was compiled by RIETI Editorial staff.