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Appendix: Japan's Fiscal Management

Let us explain Japan’s fiscal management since 1950 following Doi and Ihori (2009). Figures 1.A1, 1.A2, and 1.A3 summarize trends in general account tax revenues, total expenditure, and government bond issues. Trends in the debt dependency ratio and major expenditure items are also shown.

A1 Trends in general account tax, revenues, total expenditures and government bond issues (Source

Fig. 1.A1 Trends in general account tax, revenues, total expenditures and government bond issues (Source: Japanese Public Finance Fact Sheet. 2016 Ministry of Finance. http://www.mof.go. jp/english/budget/budget/fy2016/03.pdf)

A2 Government bond issues and the bond dependency ratio (Source

Fig. 1.A2 Government bond issues and the bond dependency ratio (Source: Japan’s fiscal condition (FY2016 draft budget). December 2015 Ministry of Finance. http://www.mof.go.jp/ english/budget/budget/fy2016/02.pdf)

A3 Transition of major expenditure items in the general account (Source

Fig. 1.A3 Transition of major expenditure items in the general account (Source: Japan’s Fiscal Condition (FY2016 draft budget). December 2015 Ministry of Finance. http://www.mof.go.jp/ english/budget/budget/fy2016/02.pdf)

A1 The 1950s

The features of fiscal management in the 1950s can be summarized as follows. First, the fiscal investment and loan program was established to promote economic growth. Second, under the balanced budget principle, tax was not raised and an increase in tax revenue caused by economic growth was transferred to the private sector as a tax reduction; thus, the size of government was small in terms of public expenditure. As a result, the private sector had many resources for the accumulation of capital. Third, the fiscal built-in stabilizer mechanism was not used a great deal.

In a country with small government, business fluctuations in the 1950s were affected by the balance of payments under the fixed exchange rate system. When the economy was prospering, imports increased, thereby raising trade deficits. In order to maintain the fixed exchange rate, the monetary authority raised the rate of interest to reduce aggregate demand. However, when the economy was in a recession, a trade surplus occurred because of a decline of imports. Thus, the monetary authority reduced the rate of interest in order to stimulate aggregate demand. The stabilization policy was mainly conducted through monetary policy.

A2 The 1960s

In the 1960s, the balanced budget principle was maintained as in the 1950s. However, in the recession of 1965, the government first issued the deficit bond to finance a shortage of revenue. In 1966, the construction bond was issued and an excessive fiscal policy was temporarily employed to stimulate aggregate demand. However, restrictive fiscal management was then employed again to reduce the debt dependency ratio.

The fiscal management approach of the 1960s pursued the principle of small government as in the 1950s; thus, the government distributed resources to the private sector to promote private capital accumulation by reducing taxes and spending. However, at the same time, public capital, which was complemented with private capital, was accumulated for items such as roads and ports since public capital was too little and its productivity was large. Overall, public investment increased from the early 1960s.

The Japanese economy experienced high growth. The average real growth rate in the 1960s was about 10 %, producing a large increase in tax revenue. Then, in the late 1960s, the government gave subsidies to the agricultural sector, small-size firms, and less developed rural areas that had not benefited from high economic growth.

These measures involved a redistribution policy that used fiscal variables. Since economic growth led by private investment did not improve the living environment a great deal, the government provided money to improve amenities in urban areas. This expenditure was financed by the fiscal investment and loan program together with central government’s general account.

A3 The 1970s

In the 1970s, the macroeconomy in Japan experienced serious fluctuations because of negative shocks caused by oil price increases. Thus, fiscal policy was required to stabilize the economy by the use of discretional Keynesian measures. Fiscal management became the main political concern and stabilized the Japanese economy significantly. Following the first oil crisis in 1973, high economic growth ended. However, the budgetary structure still assumed high economic growth under the optimistic expectation that GDP and hence tax revenue would recover soon.

Actually, the macroeconomy was slow and the fiscal deficit increased. At the same time, in 1973, when medical services for elderly people became free in the first year of the welfare state, and pension benefits were raised, welfare spending began to increase rapidly. An increase in welfare spending together with the economic slowdown resulted in the fiscal deficit accumulating significantly. Figure 1.A1 illustrates trends in general account tax, revenues, total expenditure, and government bond issues.

A4 The 1980s

In 1980, the government had two objectives: fiscal consolidation and the structural reform of the administrative and fiscal systems. Because the Japanese economy faced a world recession due to the second oil crisis, there was a trade-off between the mid- and long-term objectives of fiscal consolidation and structural reforms, and the short-term stabilization policy to attain full employment. In the early 1980s, the government took restrictive measures to reduce the fiscal deficit but did not adopt discretionary stabilization measures to realize full employment.

In the late 1980s, the US economy recovered; hence, exports from Japan to the US increased, helping the recovery of the Japanese economy. As a result, the excessive fiscal policy of the US made it possible for Japan to conduct restrictive fiscal management during a boom. Then, Japan had a significant balance of payments surplus and serious trade conflicts.

During the 1980s, the fiscal balance improved. Based on structural reforms, fiscal management was rather restrictive but monetary policy was rather expansionary. Moreover, the bubble economy of the rapid increase in asset prices in the late 1980s raised tax revenue more than projected. Finally, the government could avoid issuing the deficit bond. This meant that the official target of fiscal consolidation was attained.

A5 The 1990s

After the bubble economy burst in the early 1990s, the economy was in recession for a long time, resulting in a decrease in tax revenue. Fiscal management again became a serious matter. From 1994, the deficit bond was issued. Politically, Japan experienced a coalition government and the fiscal deficit accumulated rapidly.

In 1996, fiscal consolidation attempts were pursued and the Fiscal Structural Reform Act was implemented. However, in late 1997, the financial crisis experienced by Asian economies made Japan’s macroeconomic situation worse. From April 1998, the government changed its fiscal management approach from fiscal consolidation to an excessive fiscal policy.

Thus, in May 1998, a supplementary budget was imposed to reduce income taxes and raise public works. The Fiscal Structural Reform Act was also revised in order to conduct more elastic fiscal management. Then, in July 1998, the Obuchi government employed more excessive fiscal measures. The Fiscal Structural Reform Act was abandoned.

In 1999, more excessive fiscal measures such as income tax cuts and subsidies to local governments were employed using several supplementary budgets. At this time, Japan’s prime minister, Obuchi, became the worst offender for issuing public debt.

The purpose of these counter-cyclical fiscal measures was to stimulate aggregate demand by any means. The Japanese government justified this policy by arguing that if we could not attain economic recovery and fiscal consolidation at the same time, we could not attain either. However, although the fiscal deficit increased rapidly, the economy did not recover well.

The Obuchi administration’s aggressive public spending policy was continued by Yoshihiro Mori, who became prime minister in April 2000. The free-spending measures were intended to encourage demand in any way possible in order to brighten the economic environment. The reasoning was that a policy of “chasing two rabbits at once”—meaning economic recovery and fiscal consolidation—fails to achieve either objective, and that the first priority should be recovery.

However, the “do everything possible” policy, intended to yield quick results, led to a runaway expansion of the deficit, raising concerns about the sustainability of the fiscal balance. As one non-essential public facility after another was built across the country, the cost of maintaining them increased massively. The expansionary economic policy pursued by the Obuchi and Mori administrations through more spending on public works and tax cuts raised questions about the macroeconomic impact of fiscal policy. Figure 1.A2 presents government bond issues and the bond dependency ratio.

A6 The 2000s

The Koizumi administration was in office from 2001 to 2006. The prime minister was very popular and the Council on Economic and Fiscal Policy played a key role in the conduct of a clear and reliable fiscal policy. The fundamental principle of budget making, together with spending and revenue decisions, were discussed and determined. Because the Council set the basic guidelines by the summer of each year, the bargaining power of the MOF and other ministries, as well as politicians, was weakened.

The objective of the Koizumi administration for fiscal management was to limit new debt issuance in the general account to less than 30 trillion yen. In the initial budget of 2002, this target was realized, but the supplementary budget issued an additional debt of 5 trillion yen. Then, in 2003, the initial budget issued public debt of more than 40 trillion yen. Finally, in 2006, the target was attained, mainly because of the recovery of the macroeconomy.

In 2006, the government determined a mid-term guideline for fiscal consolidation known as the basic guideline of 2006. According to this guideline, the primary balance was to be in surplus by 2011. In order to achieve this, the main target was to reduce public spending by 11.4-14.3 trillion yen. However, in 2007 the global financial crisis occurred and this objective was abandoned. The government again took excessive fiscal measures to stimulate the aggregate economy. The fiscal deficit increased rapidly.

In 2007, the administration of Shinzo Abe aimed to stop debt accumulation by the early 2010s, a policy that has been continued by Shinzo Abe’s successor, Yasuo Fukuda. The revised target was to restore the primary balance by 2011. However, the planned consolidation was not achieved because wasteful public spending was not eliminated following the successful lobbying activities of interest groups.

A7 The 2010s

In the 2009 general election, Japan underwent a change in government. The Democratic Party (DP) took over from the Liberal Democratic Party (LDP) for the first time by obtaining a large majority in the Lower House. Voters at the 2009 election supported the DP’s proposal that significant wasteful spending exists in the government budget; thus, fiscal consolidation could easily be achieved by cutting such wasteful spending without raising consumption taxes. However, it transpired that the DP government could not identify large sources of wasteful spending. Consequently, although the new government intended to conduct macroeconomic and microeconomic fiscal reforms, it could not attain its objectives.

The DP government was finally forced to decide to raise the consumption tax rate from 5 to 10 % by 2015. This development helped to reduce the informational asymmetry between the Japanese government and the general voters with respect to the fiscal situation.

The LDP’s Shinzo Abe, Japan’s prime minister since 2012, now employs the so-called third arrow of Abenomics, which is a plan to pull the country out of its long economic slump. Since his concern is mainly the current macroeconomic situation, he has adopted conventional Keynesian fiscal policy to stimulate aggregate demand through public works in addition to nontraditional expansionary monetary policy. As a result, fiscal consolidation is still not handled well.

The Abe administration seems reluctant to raise consumption tax rate as scheduled, although it did raise it to 8 %, effective from April 2014. The Abe administration postponed a further increase in the consumption tax rate to 10% from October 2015 to April 2017. Then, in June 2016, it again postponed an increase in the consumption tax rate to 10 %, this time to October 2019. However, a commitment to fiscal consolidation is unclear unless the consumption tax rate is increased in the near future. Figure 1.A3 shows the transition of major expenditure items in the general account.

Questions

  • 1.1 Justify the following government activities using four main functions of the public sector.
  • (a) Public education.
  • (b) The construction of highways.
  • (c) Garbage collection.
  • 1.2 Explain the difference between two optimality theorems of the market mechanism and justify a redistribution policy even if the private market is perfect.
  • 1.3 Compare the Japanese budgetary process with the counterpart in your country.

References

Doi, T., & Ihori, T. (2009). The public sector in Japan: Past developments and future prospects. Cheltenham: Edward Elgar.

Rosen, H. S. (2014). Public finance. London: McGraw-Hill.

Stiglitz, J. E. (2015). Economics of the public sector. New York: W. W Norton & Company. Varian, H. R. (2014). Intermediate microeconomics: Modern approach. New York: Norton.

Part I

Macroeconomic Aspects of Public Finance

 
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