June 17, 2014 7:00 pm JST

Abenomics will only heighten the financial tsunami poised to hit Japan

RICHARD SOLOMON, Contributing writer

TOKYO -- The much-awaited "third arrow" of Prime Minister Shinzo Abe's economic revitalization program is likely to fall short of the mark, according to a former economist at Japan's powerful Ministry of Finance.

     To keep its public finances out of crisis, Japan must drastically reform -- even privatize -- its pension, healthcare and other social security systems, according to Kazumasa Oguro.

     Abe later this month is due to detail the final balm of his three-pronged Abenomics prescription, which so far has focused on monetary and fiscal stimuli. It is expected to contain a broad range of regulatory and structural changes in agriculture, employment, healthcare and other parts of the economy.    

     Oguro, an associate professor at Hosei University, specializes in projecting how Japan's aging population -- as it collides with a decline in the number of working-age people -- will impact the nation's social security systems.

     While the U.S., U.K. and EU each publish long-term financial forecasts of their social security systems to at least 2060, Japan, Oguro said, projects only nine years out, to 2023. Moreover, in 2002 it ceased including off-balance-sheet items of social welfare and medical entitlements in its forecasts. This way, it can paint a rosier-than-reality picture of the sustainability of Japan's social security systems.

     Oguro joined the Finance Ministry in 1997 and was a senior economist at its Policy Research Institute for three years until 2008.

     According to his projections, the proportion of Japan's gross debt to GDP will rise from its current 190% to an unsustainable 500% by 2050. The government currently borrows 50% of what it spends every year. Gross national debt is now 20 times tax revenues. Clearly, this trend cannot continue indefinitely, Oguro said.

Shrinking workforce

Behind the sharp rise in debt-to-GDP ratio lurks the decline of Japan's working population -- 15-64-year-olds -- which is projected to shrink by about 750,000 a year until 2060. According to the National Institute of Population and Social Security Research, the number of those 65 and older will increase by 330,000 each year through 2040. By 2060, the ratio of working age taxpayers to elderly (mostly pensioners) will shrink from 3:1 to almost 1:1.

    Pension and health care entitlements are already the largest central government expenditures -- representing 33% of the national budget, followed by debt service costs. Entitlements, growing by almost 1% annually, are expected to explode by 2025, when all baby boomers will be at least 75.

    The government is hoping to cover increased entitlement costs by growing Japan's economy by 2% a year in real terms. Using OECD projections to model predictive outcomes, Oguro calculates the nation has only a 7.6% chance of achieving the needed 2% growth in any given year. The probability of achieving the target in any two consecutive years is 1% and close to zero over 10 straight years. Therefore, he said, "Japan cannot grow its way back to fiscal balance." 

     Oguro estimates an immediate consumption tax hike to 25% would also ensure fiscal stability. Wait until 2017 to impose the tax hike and the needed rate would rise to 33%, he reckons. The longer the tax hike is delayed, the higher the rate required later.

      In April, the government raised the tax rate from 5% to 8%. A further hike to 10% is possible late next year. However, with the nation's household savings ratio turning negative, future rate increases might not be practical, neither economically nor politically, if consumer spending slumps.

     Accepting 150,000 immigrants a year would also allow Japan to achieve a fiscal balance. But given a long-standing cultural aversion to inflows of foreigners and one of the world's most rigid immigration policies, this solution is a nonstarter.

     If Japan is to avoid fiscal crisis, Oguro said, the Abe administration must face the entitlement problem head-on by drastically reforming and privatizing the social security system.

Silver democracy

Yet privatization is not even on the political agenda. Japan's voting majority is made up of seniors 60 and older. The demographic represents 44% of the voting public, whereas those in their 20s make up only 13%. Politicians are well aware of the grim prospects for an economy that remains resistant to reform but won't talk about them in public, Oguro said. Doing so would be to commit political suicide.

     So Japan's economic policy remains light on reform and heavy on palliative cheer.

     The first arrow of Abenomics employs unorthodox monetary easing -- a policy Oguro calls "financial repression to keep interest rates on national debt comfortably low." That has helped lift Japan's stock market and people's spirits.

     Oguro is dubious the endorphins will last long. While stressing he has no intention to belittle the importance of the prime minister's economic policy, he said it is certain "Abenomics will increase the magnitude of the financial tsunami because it will delay genuine reform."

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