The following OECD assessment and recommendations summarise chapter 3 of the Economic survey of Japan published on 7 April 2008.
Japan has made progress in fiscal consolidation…
Japan has reduced its fiscal deficit from 8.2% of GDP in 2002 to around 4% in 2007 (on a general government basis excluding one-off factors), with the improvement divided almost equally between spending cuts and revenue increases. Government expenditure has fallen in nominal terms, primarily as a result of continued declines in public investment and the public-sector wage bill, although this has been partially offset by increased social security spending in the context of population ageing. On the revenue side, the government phased out the temporary income tax reduction and raised social security contributions, but a significant share of the increase in revenue was due to the economic expansion. Overall, about one quarter of the decline in the budget deficit since 2002 is explained by cyclical factors. On a primary budget basis, the deficit fell at an annual pace of around ½ per cent of GDP, adjusted for cyclical factors, between 2002 and 2007.
The evolution of the fiscal situation in Japan between 2002 and 2007
Fiscal situation (per cent of GDP)
1. OECD estimates.
2. Difference in percentage points.
3. Major one-off factors include the transfer of the basic part of corporate pension funds to the government, the transfer of debt from the highway corporations to the newly established Expressway Holding and Debt Repayment Agency, and the transfer of the reserve fund from the Fiscal Loan Fund Special Account to the central government.
Source: Cabinet Office and OECD, OECD Economic Outlook, No. 82 Database, OECD, Paris.
… but achieving a further cut in the budget deficit to meet the government’s medium-term fiscal objectives is crucial…
Despite the reduction in the budget deficit, government debt has continued to rise, reaching around 180% of GDP in 2007, the highest level ever recorded in the OECD area. Further progress in fiscal consolidation is urgent, as Japan is increasingly vulnerable to a rise in the long-term interest rate from its current low level of around 1½ per cent. The government’s medium-term plan targets a small surplus in the primary budget of central and local governments combined by FY 2011 as a first step to reduce the government debt ratio in the 2010s. With the primary budget deficit on a general government basis estimated at 3% of GDP in 2007 (excluding one-off factors), achieving a surplus in 2011 would require an acceleration in the pace of consolidation to about ¾ per cent of GDP per year. Moreover, stabilising the government debt ratio may require a significant primary surplus of 1% to 2% of GDP (on a general government basis), while an even larger surplus is necessary to achieve the objective of reducing the debt ratio.
Japan’s public debt ratio is the highest among OECD countries
Gross government debt as a share of GDP¹
1. The five countries in this figure had the highest gross debt ratios in the OECD area in 2000.
Source: OECD, OECD Economic Outlook, No. 82 (December 2007), OECD, Paris.
… with the priority on further reductions in government expenditure…
Further cuts in government outlays should be the priority to achieve the fiscal targets. In 2006, the government announced reductions by spending category through FY 2011. This important step should help maintain public confidence in the government’s fiscal consolidation plan. However, the spending cuts are calculated relative to a baseline of 3% nominal output growth – higher than the 1.7% projected by the OECD for 2007 09 – which implicitly allows government expenditures to increase at an annual rate of between 1.2% and 1.7% over the period 2007 11. Thus, the medium-term spending plan is not sufficiently ambitious and may allow government outlays to rise as a share of GDP. A stricter spending plan is needed to make sure that the fall in government expenditures over the period 2002 07 is not reversed. Maintaining the sustainability of the social security system, which is excluded from the government’s medium-term fiscal target, is important to ensure that a primary budget surplus for central and local government combined is not achieved through a deterioration in the fiscal balance of the social security system.
… focusing on public investment, government employment…
Much of the spending restraint to date has been achieved by cutting public investment from 6% of GDP in 2002 to 4% in 2007, but even this lower level is still above the OECD average of 3%. This suggests that there may still be scope for further reductions, which should be accompanied by a better allocation of investment to enhance its productivity. Indeed, public investment has not been an efficient instrument to reduce regional disparities, which should be addressed by other policies. The government expects the cost of maintaining existing infrastructure to exceed new investment by 2011 and completely crowd out new investment by 2022. It is important to develop a plan to close underutilised infrastructure, based on strict cost-benefit analysis in the context of a declining population, to retain some room for productivity-enhancing public investment. Spending has also been reduced by a cut in the in the total compensation of central government workers (including employees of central government corporations) from 2% of GDP in FY 2001 to 1.7% in FY 2005. The government aims to reduce it further so as to halve its share of GDP by FY 2015. Spending reductions should be extended to local governments, all public enterprises and government-affiliated organisations, which account for more than 90% of public-sector employment. In any case, the scope for expenditure cuts in this area is limited by the fact that public-sector employment per population in Japan is already well below the level in other major OECD economies. In addition to public investment and government wages, it is thus important to identify other areas for spending reductions.
Rising renewal and maintenance costs of public infrastructure are crowding
out new public investment¹
1. Social infrastructure built and managed by the Ministry of Land, Infrastructure and Transport only. Central government investment is assumed to fall by 3% and local government by 5% a year after FY 2005.
Source: Ministry of Land, Infrastructure and Transport, White Paper on Land, Infrastructure and Transport in Japan, 2005.
… and the social security system
Controlling social security spending in the context of rapid population ageing is essential to limit the growth of government expenditures. Despite the reform of the public pension system in 2004 and some changes planned in healthcare, the government projects that gross public social spending – pensions, healthcare, long-term nursing care and welfare – will rise at a 3% annual rate over the next decade, boosting it by almost 1% of GDP to 18.4% by FY 2015. Pension reform was intended to limit pension spending to around 9¼ per cent of GDP over the next decade and ensure the sustainability of the system for 100 years, but the recent confusion about the accuracy of pension records creates doubts about pension administration. Moreover, the 204 projections were based on strong assumptions. Despite the fact that some of these assumptions were revised downward in 2007, they are based on past trends and could prove to be fairly optimistic. Any slippage from the spending target should be resolved by a hike in the pension eligibility age, rather than by a further rise in the contribution rate, which is already set to increase from 13.6% in FY 2004 to 18.3% by FY 2017, and by measures to boost the return on the pension fund’s assets. As for public healthcare spending, the government aims to limit the rise from 5.4% of GDP in FY 2006 to 5.8% in FY 2015, a figure still below the current OECD average of 6%, despite population ageing. The increase in public healthcare spending is expected to be reduced by a number of reforms, including a reduction in medical fees and a new healthcare system in FY 2008 for those over age 75. However, the hike in the share of medical expenses to be paid by patients between 70 and 74 has been postponed for a year. In addition, healthcare spending is to be limited by preventing lifestyle-related diseases and reducing the length of hospital stays, although the impact of those reforms on healthcare spending remains uncertain. The key to achieving higher quality and greater efficiency in healthcare is accelerating regulatory reform, in part to allow a greater role for the private sector.
The Policy Brief (pdf format) can be downloaded in English and in Japanese. It contains the OECD assessment and recommendations.
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For further information please contact the Japan/Korea Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Randall S. Jones, Masahiko Tsutsumi and Taesik Yoon under the supervision of Stefano Scarpetta. Research assistance was provided by Lutécia Daniel.