Japan: Demography, Deficit & Debt
Japan currently faces 4 pernicious problems of an ageing population, a growing and persistent government budget deficit, a burgeoning debt problem and decades of deflation.
Most of these issues are inevitably interconnected but I will focus on the first three problems of shifting demographics, continued deficits and growing debt. The relationship between the problems is summarized in Figure 1.
While all the problems are difficult to handle and require varied solutions, my analysis reveals that shifting demographics is the key problem given the current dynamics and addressing this issue should definitely be the first step to tackling Japan’s problems.
2 Shifting Demographics Is Key Problem Given Current Dynamics
While shifting demographics might not have been the cause of all the problems, it is certainly the key problem given the current dynamics.
As noted from Figure 1, the aging population creates social security pressures that lead to continued budget deficits. Continued budget deficits then contribute to the growing debt problem while larger debt in turn result in higher interest payments that put further strain on the budget deficit and debt problem. Furthermore, shifting demographics puts a strain on the debt problem because there are less savings to fuel debt purchases.
Accordingly, the problem of shifting demographics is the key problem given the current dynamics and interrelations between the problems.
2.1 Shifting Demographics Increases Pressure on Budget Deficit
The shifting demographic structure in Japan is putting significant pressure on the government budget deficit because of social security problems. As Japan’s population continues to age rapidly, there is a marked shift in the population pyramid and the dependency ratio. For example, in 1950, there were 12.1 workers / retiree. In 2009, this number had declined to 2.8 workers / retiree. This is much lower than the OECD average of 4 workers / retiree and to make matters worse, this number is projected to fall further to 1.3 workers / retiree by 2050. This creates an unprecedented strain on the government budget and is expected to push the budget further into deficit. It is expected that by 2050, 70% of the budget will be spent on social security expenses and debt financing.
2.2 Vicious Cycle of Deficit & Debt Problems
Furthermore, the problems of continued budget deficit and debt are related in a vicious cycle because the Japanese government has to issue new debt to finance the persistent and growing budget deficits. However, high debt levels increases the risk of a default on the debt and issuers generally have to pay even higher interest on the debt to entice investors to take up further debt issues. The irony is that larger debt financing puts a strain on the budget again.
This is clearly observable in Japan. It has been running consistent budget deficits since 1992 and this has accumulated into a huge debt burden for the nation. In 2000, the debt to GDP ratio was already 142.1% - enormous by developed world standards. However, failure to tackle the budget problems resulted in even more debt issuances to finance the deficits. Today, the debt to GDP ratio stands at 220.3%!
2.3 Shifting Demographics To Put Strain On New Debt Takeup
Finally, shifting demographics will also put a strain on new debt takeup. As more people retire in Japan, they will naturally save less and spend more in accordance with the Life Cycle Theory of Savings. Accordingly, there will be a lower take up of Japanese Government Bonds (JGBs). This is a serious problem because almost 90% of government debt is held domestically and if the local population stops purchasing new debt issuances, the government may have to tap international debt capital markets that will inevitably demand a significantly higher interest rate from Japan.
Accordingly, my analysis has shown that the problem of shifting demographics is the key problem given the current dynamics and relations between the problems. It is either driving or exacerbating the other issues and the Japanese government should begin by tackling this issue.
Tackling the demographic problem will take many years and is a long term process. In the near term, there is a need to address the social security pressures which are the immediate symptoms of the demographic problem.
3.1 Tackling Social Security Issues
There are several ways to tackle the social security issues. The government should first consider social security reforms. If budget deficits persist, there might be a need to increase taxes.
The government can make social security reforms to make the system more sustainable. This might include increasing the retirement age, decreasing pension benefits, increasing contributions from the working population and companies. Another point worth considering is increasing taxes to help finance the growing social security expenses.
3.2 Alleviating Demographic Problem
To tackle the overarching demographic problem, the Japanese government will have to try and increase immigration and fertility rates.
In the near term, the government can offer incentives and policies that increase immigration into Japan. One example is granting scholarships to outstanding overseas students while imposing a condition that they will have to serve out a bond in Japan upon graduation.
In the longer term, the government can increase the fertility rate by offering better incentives to have children. Examples include offering large financial incentives such as cash grants, heavily subsidized education and more maternity leave.
Admittedly, the Japanese government will face significant resistance from the population while trying to institute these policies. Many of them will cause more hardship for the people in the near term while other policies might conflict with Japanese culture. Unfortunately, given the current situation, these sacrifices have to be made and the government will have to muster the political will to make these difficult and unpopular decisions.
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