Japan’s economic problems are serious and getting worse. Foremost among them is the crushing burden of government debt. Who could be next in line for a gut-wrenching loss of confidence in its growth prospects, its sovereign debt, and its banking system? Think about Japan. Japan’s debt keeps rising as its tax base shrinks. So why is Japan’s government now one of the most indebted in the world, with a gross debt that’s 235.8 percent of GDP and a net debt (taking some government assets into account) that’s 135.2 percent of GDP? (In the euro zone, only Greece has government debt approaching the Japanese level.) Already, the combined costs of interest on that debt and social security are approximately equal to total government tax revenue.
But the economic disasters of our time—which involve big banks in rich countries, call into question the viability of government debt, and seriously threaten the reach of even the most self-confident nations—will not end with the euro debacle. The euro zone is well down the path to severe crisis, but other industrialized democracies are hot on its heels. Do not let the euro zone’s troubles distract you from the bigger picture: we are all in a mess.
Japan’s post-war economic miracle ended badly in the late 1980s, when the value of land and stocks spiked dramatically and then crashed. This boom-and-bust cycle left people, companies, and banks with debts that took many years to work off. Growth rates slowed after 1990, leading some observers to speak of one or more “lost decades.”
After a post-war baby boom, population growth in Japan decelerated sharply; the number of working-age people has declined fairly rapidly since the mid-’90s. Once you account for that, Japan’s economic performance looks much better. The growth in Japan’s output per working-age person—a measure of productivity for those who have jobs—has actually kept up with most of Europe’s, and has lagged only slightly behind that of the United States. Japan is a rich country with low unemployment. Its private sector is by no means broken.
After World War II, Japan built a financial system modeled on those of Europe and the United States. Financial intermediation is an old and venerable idea—connecting people with savings to other people wanting to make investments. Such a sensible use of savings was taken to a new level in Japan, the U.S., and Europe in the decades following 1945—helping to fuel unprecedented growth for entrepreneurs and a genuine accumulation of wealth for the burgeoning middle class.
But such success brings vulnerability. Modern financial systems also permit governments to borrow large sums from investors, and as finance has evolved, that borrowing has become easier and cheaper. In the most-advanced countries, governments have increasingly taken advantage of expanding markets for short-maturity debt, whose principal is due soon after the loan is made. This has allowed them to borrow far more, and at cheaper rates, than they otherwise would have been able to do. Typically, these governments then take out new loans as the old ones come due, “rolling over” their debts. This year, for example, the Japanese government needs to issue debt amounting to 59.1 percent of GDP; that is, for every $10 that Japan’s economy generates this year, the government will need to borrow $6. It will probably be able to do so at very low interest rates—currently well below 1 percent.
Publicly provided pensions were initially an amazingly good deal for retirees, who paid in little. And as life expectancies increased, retirement benefits were extended. Throughout the rich world, these benefits were predicated on rapid economic growth powered by ever-expanding populations; workers were not expected to put in as much as they would eventually take out. The demographics began changing years ago, but the political incentives did not, nor did the availability of cheap, short-term financing, rolled over regularly.
About half of the Japanese government’s annual budget now goes to pensions and interest payments. As the government has spent more and more to support its growing elderly population, Japanese savers have willingly financed ever-increasing public-sector debts.
Elderly people hold their savings in the form of cash and bank deposits. The banks, in turn, hold a great deal of government debt. The Bank of Japan (BoJ – the country’s central bank) also buys government bonds—this is how it provides liquid reserves to commercial banks and cash to households. Similarly, Japan’s private pension plans—many promising a defined benefit—own a great deal of government bonds, to back their future payments. Few foreigners hold Japanese government debt—95 percent of it is in the hands of locals.
For ordinary Japanese, public promises about retirement benefits and price stability will be broken just as their private savings collapse.
Given Japan’s demographic decline, it would make sense to invest national savings abroad, in countries where populations are younger and still growing, and returns on capital are surely higher. These other nations should be able to pay back loans when they are richer and older, supplying some of the funds needed to meet Japan’s pension promises and other obligations. This is the strategy that Singapore and Norway, for example, have undertaken in recent decades.
Instead, the Japanese government is using private savings to fund current spending, such as pensions and wage payments. With projected annual budget deficits between 7 and 10 percent of GDP, Japanese savers are essentially tendering their savings in return for newly issued government debt, which is not backed by hard assets. It is backed only by an aging, shrinking population of taxpayers.
Japan’s taxpayers are already rebelling against small tax increases needed to limit escalating deficits. This leaves little room for hope that future taxpayers will accept the larger tax increases needed to repay debts.
Japan’s demographic decline will be hard to reverse—and even in the best-case scenario, the positive effects of a reversal would not be felt for decades. The economy, roughly speaking, is as healthy as it is likely to become. Yet the government seems incapable of steering away from the cliff, a characteristic that should strike no one as uniquely Japanese—just look at Europe. A crisis in Japan would most likely manifest as a collapse of confidence in the yen: At some point, Japanese citizens will decide that saving in any yen – denominated asset is not worth the risk. Then interest rates will rise; the capital position of banks, insurance companies, and pension funds will worsen (because they all hold long-maturing bonds, which fall in value when rates rise); and fears of insolvency will surface.
Japan has some buffers against calamity— particularly, its assets held outside the country (including more than $1 trillion in foreign-exchange reserves) and its unmatched ability to export. Nevertheless, the real value of the roughly $14 trillion in government bonds will fall significantly once people fully realize that the tax base is aging and shrinking. Presumably, the yen will also depreciate, perhaps sharply.
The fact that government debt is held mostly by Japanese citizens is not sufficiently reassuring. The same was true in Germany during the 1920s and Russia during the 1990s, yet in both cases the elderly lost their savings to high inflation. Today, Italian and other European savers who hold their own government’s debt are already nervously edging toward the exits. Relative to the size of the world economy, global debt markets overall are two to three times their size in 1970. As in Europe, the financial system in Japan could face a wave of insolvencies, triggering a broader loss of confidence.
The shock felt around the world will result not just from the realization that Japan is unable to meet its pension and other social obligations. Investors will also be horrified to see the disappearance of the private savings previously used to buy government debt, whether through debt defaults and bank failures or through high inflation. For ordinary Japanese, public promises about retirement benefits and price stability will be broken just as their private savings for retirement collapse. No one can predict the timing, but without radical political change that creates a more responsible fiscal trajectory, this will happen.
But Japan illustrates the other half of the phenomenon—the extent to which finance has allowed and encouraged politicians to make attractive short-term decisions that are eventually damaging. This may ultimately yield worse crises than the one we faced in 2008 or the one now unfolding in Europe. Greece, Ireland, Portugal, Spain, and Italy found their own ways to economic devastation, but each road was paved with easy credit. Those whom the gods would destroy, they first encourage to borrow cheaply.
The Europeans have ruined their economies— and the USA has benefited from the consequent inflow of capital to their government debt, which has pushed rates down. When Japanese investors begin abandoning their home country, the US will benefit again.
Elderly Japanese refuse to consider changing their pension system. We all have political systems that have figured out how to promise far more than can be repaid, to be paid by future generations.
Japan’s trade balance is about to go negative for the first time since 1980. Land values and Nikkei stock values have fallen to about 30 percent of 1989 levels. Now, educated young Japanese women are emigrating, Japanese companies are shifting production overseas (even to the U.S.), national politics are in gridlock (six prime ministers in the past five years), and last year Japan experienced its first mass street protests in decades.
The economic troubles are symptoms of at least three sets of deeper social problems. Regardless of what policies Japan now adopts, its troubles can only increase unless those social problems are solved. While all three of these also beset other industrial societies, certain local attitudes make them more severe in Japan.
Marriage and Babies
Throughout the industrial world, birth rates are falling, and fewer people are marrying. Japan’s rate (7.31 births per year per 1,000 people), already the world’s lowest, is still dropping. If its rate of decrease over the past two years is extrapolated, it reaches zero by 2017. Naturally, this dire outcome won’t actually happen, but the calculation does emphasize that the problem is increasing.
In the U.S. and most European countries, in contrast, birth rates are still more than 10 per year per 1,000 people, and in Nigeria and Tanzania, they are more than 40.
Japan’s marriage rate is low, too, even by industrial-world standards: 5.8 marriages per year per 1,000 people, compared with 9.8 in the U.S. The average age of marriage in Japan is now 31, and 18 percent of Japanese women 35 to 39 have never been married.
These numbers don’t reveal whether the reluctance to marry and to have children is on the part of men, women or both. In the absence of rigorous sociological polling, I’ll summarize interviews that Japanese friends have conducted for me. They report that most single adult Japanese still live with their parents, because it’s comfortable to live at home and expensive to leave.
Young Japanese feel more comfortable communicating with each other electronically than by phone or in person. “Over the years that the formerly widespread practice of arranged marriage almost completely disappeared,” one person explained to me, “the digital revolution made it increasingly difficult for Japanese to develop the social skills necessary to woo a potential spouse themselves.” Among men, the biggest reasons given for not marrying are worries about their economic future and their ability to bear the responsibility for a family.
Married women tend to manage the household finances and take care of both their own and their husbands’ parents, and many of them now swear they will be the last generation to be saddled with those burdens. Career women, who find strength in their education, jobs and earning power, are capable of supporting themselves in the style to which they aspire, and are buying condominiums and planning for their own retirements. If they do want to marry, they find that their age is an obstacle, because Japanese men over the age of 40 want much younger women. If they do want children, Japanese societal support for working mothers is low. Hence they either forgo children, or leave the workforce or even leave Japan, and that represents a big loss of human capital for the country.
Much of what has just said about marriage and babies applies to some degree around the industrial world. Why should these issues be acute in Japan? In most other countries, women’s new opportunities are creating tension between men and women, but it has been manageable because male society has made some accommodation. Japan is the industrial country where women’s roles were, until recently, most stereotyped; hence male resistance to women’s expectations is still the greatest there.
Old People, Immigrants
Again throughout the industrial world, falling birth rates and improved medical care have resulted in aging populations, making it harder to fund retirement systems over the long term. Those trends reach their extreme in Japan because of its record – low birth rate and relatively healthy lifestyles. It is the country with the largest share of population (22 percent) over 65 years of age. Except for Monaco, it also has the longest life expectancy, 84 years.
But numbers alone don’t indicate the extent of the problems. After all, the percentage of the population over 65 in other First World countries is between 14 percent and 20 percent. What makes the problem so serious in Japan is the country’s refusal to do what other countries have done: admit massive immigration of younger people from overseas. It is very difficult to immigrate to Japan, and (having immigrated) even harder to obtain citizenship. Japan is the world’s most homogeneous large country.
This rejection of immigration not only bodes ill for the future of Japan’s retirement system, but also deprives the country of the pool of workers, artists, scientists and inventors that immigrants represent for the U.S., Western Europe and Australia. Many notable Americans have been immigrants or their children. The long list includes, in recent times, Albert Einstein, Sergei Rachmaninoff, Vladimir Nabokov, Wernher von Braun, Henry Kissinger and our current president. Differences in immigration policies contribute directly to the big gap between the U.S. and Japan in Nobel Prizes. The U.S. leads the world in those awards, while Japan wins few despite high government outlays for science. The education system is rote memory based with little intuitive thinking – this inhibits innovation. Scientific advances are essential to a technology-based economy. Thus, while immigration creates big problems, lack of it creates bigger ones.
No industrialized country is self-sufficient in renewable natural resources, especially forest products and seafood. Some must be imported.
If the world’s forests and fisheries were well managed, forest products and seafood could be harvested sustainably in perpetuity. Unfortunately, most harvesting is destructive and non-sustainable. Most of the world’s major fisheries are declining or have already collapsed.
Hence many government agencies and nongovernmental organizations around the world are working toward sustainability. One might naively predict that Japan, a small country that is one of the most dependent on resource imports, would be the world’s leading promoter of sustainability. But the reverse is true: Japan may be the First World country most opposed to sustainable policies. Its imports of illegally sourced and unsustainably harvested forest products are much higher than those of the U.S. or European Union countries, whether calculated on a per-capita basis or as a percentage of total forest product imports.
And Japan is a world leader in opposing prudent regulation of fishing and whaling. Incredibly, in 2010, Japan saw it as a great diplomatic triumph that it blocked international protection for Atlantic/Mediterranean bluefin tuna — even though the fish, whose stocks are declining, is especially prized and widely consumed in Japan.
Even my Japanese friends are puzzled by this stance. They suggest three explanations. First, Japanese people see themselves as living in harmony with nature, and until recently they did expertly manage their own forests — though not the overseas forests and fisheries that they exploit. Second, national pride causes the Japanese to dislike bowing to international pressure. The country especially does not want to give in to the anti-whaling campaign of the Sea Shepherd conservation organization, even though few Japanese eat whale meat; the whaling industry operates at a big loss; and tsunami relief funds have had to be diverted to subsidize whaling escort ships.
Finally, because Japan is aware of its own limited home resources, it has for the past 140 years maintained at all costs, as the core of its national security, its right of unrestricted access to the world’s natural resources. In today’s times of declining availability, that insistence is no longer viable.
To an outside admirer of Japan like me, its opposition to sustainable resource use seems sad and self-destructive. Unrealistic quests for resources drove the country to self- destructive behavior once before, when it made war simultaneously on China, the U.S., the U.K., Australia, New Zealand and the Netherlands. Defeat today is as inevitable as it was then — this time, not by military conquest, but by exhaustion of both renewable and nonrenewable natural resources. If I were the evil dictator of another country who hated Japan and wanted to ruin it without resort to war, I would do exactly what Japan is now doing to itself: destroy the overseas resource bases on which it depends.
Since Japan’s economic problems result from its social problems, their solution will require changes in Japanese attitudes toward women’s roles, immigration and sustainable resource use. Can Japan undertake the painful reappraisals this will require?
One cause for cautious optimism is the country’s history. Twice in modern times, Japan has accomplished selective change. The most drastic example came with the Meiji Restoration that began in 1868. The forced opening of ports by Commodore Perry in 1853-54 raised the specter that Japan might be taken over by Western powers. But the country saved itself with a crash program: it ended its isolation from the outside world and jettisoned its shogun leader, its samurai class, its feudal land system and its ban on guns. It adopted a constitution, a cabinet government, a national army, industrialization, a European-style banking system, a new school system and much Western clothing, food and music.
At the same time, it retained its emperor, language, writing system and most of its culture. Japan thereby not only preserved its independence, but also became the first non- Western country to rival the West in wealth and power.
Again, after World War II, Japan made drastic selective changes, abandoning its military tradition and its notion of a divine emperor in favor of adopting democracy and developing an export economy.
Once again, Japan can selectively reappraise its core values, let go of those that no longer make sense, and retain the ones that still do and that give the country strength.
So far, however, this doesn’t seem to be happening.
What to do?
When the world’s second largest economy, after 40 years of impressive economic growth, stagnates for six years with no real recovery in sight, one would think that people would regard the causes of that economic stagnation as a truly burning issue. Yet even now there is a strange casualness in the way that most people – including, unfortunately, many Japanese – discuss the nation’s problems. Instead of a serious, thoughtful analysis, all one usually hears is a long list of things wrong with Japan. The country, we are told, has a weak financial sector; it is over-regulated; there is not enough competition; Japanese firms are moving production to Southeast Asia; and so on.
All of these things are true; nonetheless, a list is not the same as a real analysis. And in fact the tendency to explain Japan’s problems in terms of a long list of factors does real harm, because it encourages a sort of fatalism in the face of economic stagnation. After all, if there are so many problems, we cannot expect a quick fix. The truth, however, is that matters are not that complicated. Japan has many problems – but what country does not? The main obstacle to Japanese recovery right now is not the long list of structural difficulties but a simple lack of clear thinking and courage.
For one thing, most of the items on everybody’s list of what is wrong with Japan are things that make the economy inefficient. That is, all of these things reduce the ability of the economy to produce goods and services – they limit its supply capacity. But the immediate problem with the Japanese economy is not too little supply – it is too little demand. The problem is that the economy isn’t using the production capacity it already has – a problem for which many of the items on the usual list are simply irrelevant.
Now as a general rule modern economies are not supposed to suffer from prolonged periods of inadequate demand. There is usually nothing easier than increasing demand: just have the central bank, the Bank of Japan, increase the money supply, or have the government spend more. Why, then, has Japan suffered from low demand for more than half a decade? Well, there are some structural reasons. Japanese consumers still consume an unusually low fraction of their income, which means that companies must correspondingly be persuaded to maintain a high investment rate if the economy is not to have too little demand. The problem is aggravated because the troubles of the banking system have restricted the flow of credit. So to push demand high enough to get the economy back to more or less full use of its capacity would require a big stimulus. Still, why not provide that stimulus?
The standard answer goes like this: interest rates are already very low, so the Bank of Japan has done all it can. Meanwhile, the government has a severe fiscal problem, so it cannot increase spending or cut taxes. There is, in short, nothing to be done except pursue structural reforms and hope for an eventual turnaround. This answer sounds hard-headed and responsible. In fact, however, it is based on a completely false premise – the idea that the Bank of Japan has reached the limits of what it can do.
The simple fact is that there is no limit on how much a central bank can increase the supply of money. Could the Bank of Japan, for example, double the amount of monetary base – that is, bank reserves plus cash in circulation – over the next year? Sure: just buy that amount of Japanese government debt. True, even such a large increase in the money supply might not drive down interest rates very much, since they are already so low. But an increase in Japan’s money supply could ease the economic problem in ways other than lower interest rates. It is possible that putting more cash in circulation will stimulate spending directly – that the extra money will simply “burn holes in peoples’ pockets”. Or banks, awash in reserves, might become more willing to lend; or individuals, with all that cash on hand, will bypass the banks and find other ways of investing. And even if none of these things happens, when the Bank of Japan increases the monetary base it does so by buying off government debt – and therefore makes room for spending increases or tax cuts.
So never mind those long lists of reasons for Japan’s slump. The answer to the country’s immediate problems is simple: PRINT LOTS OF MONEY. But won’t that be inflationary? Well, remember that the Bank of Japan is supposed to be impotent: if it prints more money, people will simply hoard it rather than save it. But printing money is only inflationary if people spend it, and if that spending exceeds the economy’s capacity to produce. You cannot first argue that monetary policy is ineffective as a way to increase demand, then reject a proposal to print more money on the grounds that it will cause inflation.
So why doesn’t the Bank of Japan just go out and print lots of money? The best theory I have heard is that the bureaucrats at the Bank of Japan and the Ministry of Finance are still mesmerized by the memory of the “bubble economy” – the wild speculation of the late 1980s, which pushed the prices of stocks and real estate to crazy levels (remember when the grounds of the Imperial Palace were supposedly worth more than the whole State of California?). They believe that loose monetary policy created that bubble – which may be true – and that the bursting of the bubble caused the slump of the 1990s – which may also be true. And so they are afraid to increase the money supply now for fear of repeating the experience.
There is an old joke that may be useful here: A driver runs over a pedestrian, who is left lying in the road behind his car. He looks back and says “I am so sorry – let me undo the damage” – and proceeds to back up his car, running over the pedestrian a second time. Japan’s economic managers are acting like that driver. They do not realize that 1997 is not 1987, and that doing the opposite of what they did then only compounds the country’s problems.