NORMALIZING ECONOMIC POLICY

After bottoming out in January 2002, the Japanese economy has entered a sustained recovery phase. From the second quarter of 2004 to the end of the year, growth decelerated and briefly went into reverse, but most economists view this as having been a temporary pause that is now over. Early this year the stock market was jolted by the “Livedoor shock.” On January 23 prosecutors arrested Horie Takafumi, chief executive of the Internet firm Livedoor Co., and three other top officers on charges of violating the Securities and Exchange Law, and for three days stock prices tumbled. It seems, though, that the rout involved mainly individual investors who were selling off shares in Livedoor and other companies listed on the Tokyo Stock Exchange’s Mothers section, which is for start-ups. Because most traders saw the incident as a localized affair, the Nikkei stock average rebounded after about a week. While Livedoor is certainly a high-profile company, it is not in the class of the Internet firm Hikari Tsushin, which rocked the whole economy when it almost went under in 2000, puncturing Japan’s information-technology bubble.

At this point the pattern of growth has shifted from an export-led upturn to a sustained expansion that is clearly being fueled by consumption and capital investment. The economy’s recovery, in other words, is no longer in doubt. The debate over economic management has, accordingly, moved on to the subject of fiscal and monetary policy normalization.

Five years have passed since the Bank of Japan introduced the policy of quantitative easing in March 2001. Since it was agreed from the start that the policy would be left in place only until a pattern of increasing consumer prices set in, a new policy may soon be adopted, perhaps between the spring and summer of this year. In the meantime, however, political maneuvering to select a successor to Prime Minister Koizumi Jun’ichirô has begun, and the questions of when to terminate the quantitative easing and how to proceed on trimming the red ink in public finance have become entwined in this contest.

Some say the government should begin work on sweeping cuts in spending while leaving monetary policy unchanged in order to vanquish deflation, and they also advise the authorities to put off tax hikes as long as possible. Such is the stance, for instance, of Nakagawa Hidenao, chairman of the Policy Research Council of the Liberal Democratic Party, and Takenaka Heizô, Koizumi’s former economic policy czar, now serving as minister of internal affairs and communications. But others say there is no need for such a delay in considering tax hikes. This is the position being voiced by Tanigaki Sadakazu, the current minister of finance, and Yosano Kaoru, Takenaka’s successor as minister of state for economic and fiscal policy and financial services.

As Doi Takero laments in his article in this section, this division into camps is part of a power struggle, one that has confused people about the nation’s agenda and caused some unnecessary misunderstandings. He argues that Japan’s leaders should present the public with a combined set of proposals for cutting expenditures and hiking taxes. Taxpayers will naturally not consent to a plan that raises taxes before anything else is done, but they need to be made fully aware that reductions in expenditures will not be enough to restore health to public finance.

Alberto Alesina and Roberto Perotti conducted a study of the experiences gained by countries in the Organization for Economic Cooperation and Development during past cases of radical surgery to reduce fiscal deficits.* Their findings can be summarized as follows:

First, the countries that trimmed their deficits most successfully relied primarily on reductions in expenditures, using an average mix of 73% from spending cuts and 28% from tax hikes. This has come to be known as the 70:30 rule. Second, the unsuccessful cases were in countries that relied primarily on tax hikes. Third, of the total cuts in government spending, in the successful cases 27% came from less spending on wages and employment of civil servants, and cuts in social security expenses contributed another 23%. The unsuccessful cases relied on public investment cuts for a high 64% of the savings, while social security expenses (13%) and the government’s wage bill (5%) made relatively small contributions. This indicates that for budget-balancing efforts to have a lasting effect, they need to include sharp cuts in items like payments to civil servants and social security benefits, even though these spending items are like vested interests and are politically difficult to change. Fourth, in the successful fiscal adjustment cases, the tax hikes centered on an expansion of the base for corporate taxes and higher rates for indirect taxes. And in the unsuccessful cases, the tax hikes tended to be spread widely over all sources of revenue, including household taxes and social security contributions in addition to corporate and indirect taxes.

The Japanese government has recently changed the format in which it presents financial information. Traditionally it used cash-basis accounting for the preparation of financial statements, but now it is drawing on the principles applied in corporate accounting in a new set of statements. The article below by Aida Kazuo and Minaguchi Kôichi presents an overview of the financial reports that the Ministry of Finance released for fiscal 2003 (April 2003 to March 2004), the first year for which data was reassembled.

The time has come for a hard look at the growing deficits in public finance. The Japanese need to engage in an objective discussion on desired scenarios and specific policy steps for trimming the red ink. We need to look at the public sector as whole, both the central government and local governments, and clarify the proper scope of activities, content of services, and overall size. Plans must then be drawn up for securing public acceptance of a heavier burden in the form of higher taxes and social security contributions. (Nariai Osamu, Professor, Reitaku University)

*Alberto Alesina and Roberto Perotti, “Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects,” National Bureau of Economic Research, NBER Working Paper No. 5730, 1996.

© 2006 Japan Echo Inc.