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Economy

Takatoshi Ito -- Ise-Shima summit should discuss ways of raising potential growth rate

Hotels and other facilities in Ise-Shima, Mie Prefecture, will be the main venue of the upcoming G-7 summit.

Participants at the summit of the Group of Seven major economies in Ise-Shima, Mie Prefecture, on May 26-27 are expected to discuss the possibility of policy coordination for the world under the leadership of Japan as chair of the meeting.

The world has seen a dearth of policy coordination that exerts a great deal of impact. Policy coordination involving major countries occurs and proves effective when all of them understand and share the need for it.

In April 2009, for example, the summit of the Group of 20 leading economies in London called for economic stimulation through fiscal spending. Attendees at the meeting, held amid a global financial crisis, agreed on policy coordination against the background of plunging exports and weakening domestic demand.

The International Monetary Fund's World Economic Outlook in April 2004 sharply lowered the projection of global growth from the pre-Lehman Shock level to a shrinkage of 1.3%, a downward revision of 5.1 percentage points from the year-before forecast.

The negative growth of countries led to the unusual agreement on fiscal spending at the London summit. Fiscal stimulation by all countries means exports to each other and is thus much more effective than independent fiscal stimulation.

But the G-20 summit in Toronto in June 2010 declared member countries' commitment to halving fiscal deficits as the growth projection of the Japanese economy had greatly improved by April 2010. Japan demanded an exception to the commitment and delayed cuts in its fiscal deficit.

What are the chances of the Ise-Shima summit reaching an agreement on policy coordination?

The world economy is certainly slowing. The projection of growth for 2016 has been lowered from a year earlier. But the downward revision as a whole is only 0.2 percentage point, though it is larger at 0.7 point for Japan and the U.S.

Among the G-7 nations, the U.S. does not need fiscal stimulation because its monetary policy is already moving toward an exit. Fiscal stimulation is also unthinkable for Germany because of its brisk economy.

The global economy is forecast to grow 3.2% in 2016, while the U.S. and Japan are expected to see their economies expand 2.4% and 0.5%, respectively. In light of the projections, it will be difficult for the G-7 members to agree on the stimulation of growth through policy coordination in a manner to increase fiscal deficits.

Although inflation rates of major countries remain below targets, their employment indexes are generally favorable. In Japan, the unemployment rate has noticeably declined.

Nevertheless, there is a matter of concern for Japan -- the Japanese economy is projected to contract 0.1% in 2017. Concern about Japan's economic outlook is growing stronger as the economy shrank in the fourth quarter of 2015 despite a delay in the consumption tax hike.

In Japan, the U.S. and Europe, experts are split over whether slowdowns in medium- to long-term growth are attributable to a shortage of demand or a supply-side problem, namely the slow improvement of productivity. In the U.S., some experts are calling for fiscal expenditures, especially infrastructure investment, on the grounds that there remains a shortage of demand, while many others are concerned about a slowdown in the pace of productivity improvements.

Bullish stance

Following the Bank of Japan's decision to keep its monetary policy intact on April 28, BOJ Gov. Haruhiko Kuroda said, "It is appropriate to assess the degree of penetration achieved by effects of negative interest rates" introduced by the central bank in February.

Kuroda maintains a bullish stance that the BOJ has a variety of measures, including deeper negative rates, it can take when necessary.

But the BOJ has yet to reach its inflation target of 2% despite "quantitative and qualitative monetary easing" that has lasted for three years and the introduction of negative rates. The bank has again pushed back its outlook for reaching the target.

The BOJ's easing measures are increasingly viewed as nearing their limits.

Should Japan resort to fiscal policy under the circumstances? A majority of investors in New York consider, contrary to the BOJ's explanations, that the bank's unconventional monetary policy has reached its limit.

The BOJ's latest decision to maintain the status quo has given impetus to those who stress the limit of monetary policy. They call for fiscal expenditures, especially so-called helicopter money, which is defined as the issuance of perpetual government bonds, underwritten by the BOJ and can increase fiscal spending without being counted as debt.

While there is not enough space in this essay to dwell on their assertion, money available in a "helicopter-drop" manner violates Article 5 of the Public Finance Law. Even if helicopter money is introduced through a resolution overriding Article 5 adopted by the Diet, the forcible fiscal stimulation would extremely restrict both monetary and fiscal exit strategies after achieving a 2% inflation target and recovering the potential rate of growth.

As inflation, once it starts, is highly likely to keep climbing beyond 2%, people still fear a recurrence of the 1973-1974 nightmare. Former U.S. Federal Reserve Board Chairman Ben Bernanke said in a blog message that while helicopter money is available as a tool for fiscal stimulation, it becomes necessary just before extremely rare occasions such as the Great Depression.

An accurate understanding of Japan's economic conditions is important. Although inflation appears to remain low at around 0%, the underlying inflation rate, which excludes fresh foods and energy prices, is already higher than 1%. The unemployment rate has dropped to near 3%.

The potential growth rate is less than 0.5% due to a persistent decline in the labor force, and the gross domestic product gap is below 2%. Negative growth is not necessarily so serious. The falling potential rate of growth is the fundamental problem.

Under the circumstances, it is wise to introduce measures to increase disposable income, targeting young people with high propensity to consume, and regulatory reforms to attract investment, rather than an expansion of fiscal deficits that increases government debt.

Measures of this kind should draw the nod from participants at the G-7 summit and make it possible to reach a high-quality agreement.

Refunds of employment and pension insurance premiums to low-income youths younger than a set age would be a way of increasing the disposable incomes of young people. It could well be viewed as a tax reduction with benefits -- in other words, a negative income tax.

Combined with the adoption of negative loan rates for the BOJ's loan support program for banks, an exemption of gift taxes on donations from grandparents to offspring is being considered to promote the purchase of new homes. It would also likely contribute to a rise in the birth rate.

Two possibilities

While there are numerous conceivable measures to lure investment through deregulation, two in particular are worthy of serious consideration.

One is to abolish the virtual adjustment of raw milk production through subsidies, and instead encourage the sale of high-quality products at higher prices overseas so as to develop Japanese agriculture. It is important to allow trading houses and retail chains, which have know-how for the management of products and distribution, to own agricultural land and produce raw milk.

The other is to remove a ban on mixing medical treatments covered by health insurance with those treatments not covered by heath insurance, which is planned for special zones, and to nurture doctors fluent in English and Chinese for the acceptance of foreign patients. It would be worth considering introducing high-level English conversation courses in medical schools' educational programs.

Negative interest rates offer good opportunities to build hospitals and hotels to accept affluent people from the rest of the world.

If mixing medical treatments and accepting patients from abroad are practiced across Japan, healthcare services can be made into a growth industry. Criticisms that the move would weaken conventional healthcare services, provided by health insurance, are misleading. Rather, it is expected to help ease the shortage of doctors outside of big cities by widening the provision of healthcare services.

The most important task for Japan and the world economy is to raise the potential growth rate from the supply side. An agreement at the Ise-Shima summit in this respect would be highly meaningful.

Takatoshi Ito, a Japanese economist with a doctorate from Harvard University, is a professor at Columbia University of the U.S.

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