RIETI Report May 2006

Japanese Fiscal Sustainability - Plotting a Viable Course

Greetings from RIETI

Despite the abundance of spring rains in Japan this year, on Shikoku (the smallest of Japan's four major islands) many are embarking on the 1,440-kilometer, hachijuhakkasho-meguri (88-temple pilgrimage). Inspired by the 9th century Buddhist monk Kukai (often known as Kobo Daishi), who reportedly attained enlightenment on Shikoku's southern coast, the pilgrimage first reached high popularity in the 14th century. Henro (pilgrims), clad in a white smock and straw hat, would walk the circuit of temples seeking in the process to ascend through four spiritual phases - awakening faith, religious discipline, enlightenment and nirvana. Modern-day henro are a mix of retirees, restructure victims, adventuresome 20-somethings and the occasional foreign tourists. Many make the trip by bus or car, (though recently the 60-some-odd-day walk is coming back in vogue). The event has become largely secular, with heavy crowds, plentiful souvenirs and the simple fact that Shikoku offers some spectacular hiking and feelings of being worlds away from the hectic life of Japan's modern cities. Nirvana or not, the pilgrimage has adapted itself in a very Japanese way and its merits remain open to the interpretation of each pilgrim.

Japanese fiscal policy is also open to interpretation and adapting itself. Faculty Fellow DOI Takero published the paper, "Simulation Analysis of Debt Management Policies to Ensure the Sustainability of Japan's Public Debt" this April. RIETI Report interviewed Dr. Doi about this work, which analyzed Japan's fiscal sustainability and debt management policy, and how his perspective and methodology improve upon recent popular works.

RIETI Featured Fellow

Dr. Doi joined RIETI as a Consulting Fellow in 2003 and has been a Faculty Fellow for the last two years. His research fields cover Public Economics and Political Economy. Dr. Doi was Assistant Professor of the Faculty of Economics at Keio University from 1999-2002 and has served as its Associate Professor since April 2002. Also, he has held numerous key positions at academic and research institutions: Visiting Scholar, Graduate School of International Relations and Pacific Studies, University of California, San Diego (2001-2002); Visiting Senior Economist, Policy Research Institute, Ministry of Finance, Government of Japan (2004-present); Visiting Economist, Economic and Social Research Institute, Cabinet Office, Government of Japan (2004-2005). He received a B.A. in Economics from Osaka University, and an M.A. and Ph.D. in Economics from the University of Tokyo. His major publications include "Paying for the FLIP," (with Takeo Hoshi) in Magnus Blomström, Jennifer Corbett, Fumio Hayashi and Anil Kashyap eds., Structural Impediments to Growth in Japan, University of Chicago Press, 2003; "The System and Role of Local Bonds Permits in Japan," in Toshihiro Ihori and Masakazu Sato eds., Government Deficit and Fiscal Reform in Japan, Kluwer Academic Publishers, 2002; "Government Financial Institutions: What and how to reform?" in Takatoshi Ito, Hugh Patrick and David E. Weinstein eds., Reviving Japan's Economy, The MIT Press, 2005; Ari to kirigirisu no nihon keizai nyumon [Ant and Grasshopper's Introduction to the Japanese Economy], Toyo Keizai Inc., 2003.


RIETI: You have led RIETI's "Empirical Analysis of the Sustainability of Public Debt and Government Bond Management Policies" project. Could you tell us the background of this research?

Doi: Christian Broda and David E. Weinstein published their 2004 paper "Happy News from the Dismal Science: Reassessing Japanese Fiscal Policy and Sustainability" (in Takatoshi Ito, Hugh Patrick and David E. Weinstein eds., Reviving Japan's Economy, The MIT Press, 2005) amid a time when Japan's government debt was rising to unprecedented levels. I myself was involved in the joint study by Japanese and U.S. researchers that included this publication, but felt there was room for further detailed analysis of issues such as the debate over whether to view government debt in gross or net terms and the future prospect of tax hikes. It was at this time when RIETI President Masaru Yoshitomi approached me with the idea of sorting out and analyzing government debt issues more thoroughly at RIETI, and that is how this project was launched.

RIETI: In analyzing Japan's fiscal sustainability, Broda and Weinstein insist that the figure of gross government debt is misleading and look at net government debt. However, you have a different stance on how to perceive the level of government debt. How does your perspective differ, and why?

Doi: I believe we need to keep in mind that not all financial assets held by the government can be used to repay its debts. It is true that the financial assets held by the social security account can be used to counterbalance future social security payments (debt), and short-term government bonds, which are backed by financial assets, can usually be used to offset the two. However, the remainder of the financial assets held by the central and local governments is held simply as a buffer in terms of fiscal policy management to provide against revenue fluctuations that might stem from such situations as economic upswings and downturns, and is not held with the intent of using it to repay existing debts. I felt it was necessary to conduct an analysis based on such points. When this difference is taken into account, it becomes clear that the ratio of government revenues to gross domestic product necessary to make Japan's government debts sustainable is roughly 1% higher than the figure cited in Broda and Weinstein's paper. This means that when this gap is converted into a rate of consumption tax (Value Added Tax), the rate would have to be about 2% higher than what Broda and Weinstein estimate.

RIETI: What are key differences between Broda and Weinstein's analysis and yours?

Doi: The differences are that I corrected the understanding between government financial assets and liabilities, as I mentioned earlier, and that I updated the data used. They used 2002 data as the start of their analysis, but I used data from 2005. Unfortunately, even under the administration of Prime Minister Junichiro Koizumi, the ratio of Japan's outstanding government debt to GDP has continued to rise, and when the effects of this are taken into consideration, naturally, more government revenues become necessary. My analysis has shown that when the effects of this continued rise are taken into account, the ratio of government revenues to GDP necessary to keep Japan's government debts sustainable would be about 1% higher than the figure given in Broda and Weinstein's paper. This would become necessary separately in addition to the difference I mentioned in the previous question.

RIETI: How would you like to see your findings influence future policy?

Doi: At present, Japan's policy environment has a strong tendency to avoid tax hikes, but the longer tax hikes are put off, the higher the tax rate will have to be when it is actually raised. In this sense, I would like policymakers to understand the message of my analysis and do away as quickly as possible with the desire to avoid tax hikes. I would also like to see objective debate on a nationwide scale on when and by how much taxes should be raised.

There are those who say that if tax hikes are discussed first when debating specific measures to rectify the nation's finances, efforts to cut expenditures slacken, but I do not believe this is true. Rather, if people become conscious of a future tax hike, they should be able to understand that a thorough streamlining of government expenditures is necessary to make that tax increase smaller.


Dr. Doi's paper, "Simulation Analysis of Debt Management Policies to Ensure the Sustainability of Japan's Public Debt" (RIETI Discussion Paper Series 06-J-032) is available at http://www.rieti.go.jp/en/publications/summary/06040008.html



Brown Bag Lunch Seminars

All BBLs run 12:15 - 13:45, unless otherwise stated.

MATSUSHIMA Shigeru, Professor, Faculty of Business Administration, Hosei University
Title: "IT Strategy for Revitalization of SMEs" (in Japanese)

Jane E. FOUNTAIN, Director, National Center for Digital Government / Professor of Political Science and Public Policy, University of Massachusetts Amherst
Title: "Current Issues in the Development of Cross-Agency Governance"

OTSUKA Keijiro, Professorial Fellow, Foundation for Advanced Studies on International Development (FASID)
Title: "Cluster-Based Industrial Development: Evidence from Wenzhou and Chongqing" (in Japanese)

Harry HARDING, Director, Global Macro, Asia, Eurasia Group
Title: "China's Political Risk" (tentative)

YASUNAGA Yuko, Director, Research and Development Division, Industrial Science and Technology Policy and Environment Bureau, METI
Title: "Strategic Technology Roadmap 2006" (tentative, in Japanese)

AHN, Se-Young, Professor, Dean, Graduate School of International Studies
Title: "Korea's FTA Policy: Focusing on the Japan-Korea FTA and US-Korea FTA" (tentative)

For a complete list of past and upcoming BBL Seminars, http://www.rieti.go.jp/en/events/bbl/index.html

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This month's featured article

Japanese Fiscal Sustainability - Plotting a Viable Course

DOI TakeroFaculty Fellow, RIETI

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BBL Seminars

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