Saturday, May 13th, 2017
Article By: Lakshya Narula
Japan’s central government is more than 1,000,000,000,000,000 Yen in debt ($11 Trillion), which is about 245% of its GDP (Gross Domestic Product) and over $80,000 per capita. There’s little chance of it ever being paid back and things can get a whole lot worse if right policies at the right time are not implemented.
Let us see how government accumulates debt in the first place.
Each year, the government receives money from the households and corporations in the form of taxes and other revenues. It then spends in the economy on public services and other commitments. If the government has to spend more than what is collected from the nation, it has to borrow the difference. It does this by issuing debt securities called IOUs or government bonds.
A government bond is a piece of paper which says that government is borrowing some money from you and will pay you the fixed interest rate, called yield of the bond, for the whole period the bond is issued.
The investors (people who have money and can lend it to the government for that long time) buy those bonds and government receives the money. Now the government can spend more on services than the revenue collected and the investors are paid their interest rates.
The difference between the amount the government receives and the amount it spends on services (generally greater than it receives) is called the fiscal deficit of a nation/country/government.
But when the outstanding debt gets too large, investors start to worry that the government won’t give back their money (called the principal amount). Since now the investor has given a lot of money, the next time he wants to lend, he will ask the government for a higher interest rate than previous because he knows that government needs the money (demand is high) and so the price will be high (the interest rate is the price of borrowing money).
This is where the Central Bank comes in. The Central Banks lower the interest rate, which means that it prints money and buys those bonds from the investors so that investors do not increase the interest rate. So, it’s a win-win situation for both; the government and the investors.
Sounds great? Well, there’s a catch. Over time, continual interest rate suppression and printing money develop an inescapable trap.
Let’s see how it works.
Now, the government has an added expense of giving money equivalent to the interest rates (yields) every year to the bondholders in addition to public services and other projects it spends on. Considering a fixed government revenue, some part of the revenue collected by the government now goes to the interest payments of the investors and the amount to be spent in the economy decreases by that much.
Over time, even if the interest rates are constant, the debt pie gets bigger and bigger and there will come a time when all the revenue generated will go into the interest payments of defaults.
How does Japan's debt fit in this scenario?
Everything is same, just that now, the investors are the population of Japan, who have invested/saved their money with their government. So, all the debt which Japan has is now the public debt.
The interest rate right now is about 1% and debt is 24.5 times the collected revenue, this means that 24.5% of the total collected revenue is used just for paying back the interests. Foreign investors will insist on increasing the interest rate because they can see that Japan is a total mess and can default anytime in long run, so the interest rates will rise and there will come a time when the interest rate would be around 4.3% (keeping debt and revenue fixed), the whole revenue would be used for giving the interest payments and there’d be no option for Japan then to default.
Problems and solutions –
The main problem in Japan is its decreasing population and increasing aged people. More and more people are retiring and they will now ask the government to give back their money which they have saved with them. When this happens, the government has no other option than to issue more debt. Since the people of Japan are not investing anymore (no growth and aged population), Japan has to look out for foreign investors who can invest at the same or a lesser interest rate, which seems next to impossible.
It is advised by analysts to increase the retirement age, start pension funds after the age of 65 or above.
Forget analysts, when I told my mother about this (I wanted to revise and I told her in a layman’s language), she said the same thing, increase the retirement age. She also suggested that people should come forward and do something in this regard because after all, it's all their money.
The other problem is of increasing unemployment due to a lower population and lesser young professionals, hence decrease in production and GDP. For this, the immigration laws should be relaxed so that more people are employed, hence more production.
“Womenomics” is a word being used which means raising the female employment rate from 68 percent to 73 percent by 2020. The government has required corporations to increase the appointment of women to management positions. The government argues that raising women’s wages and status in the labor market will also increase fertility rates, pointing to countries like Sweden and Denmark that have both higher female employment and higher fertility.
There is a term called Debt to GDP ratio in economics, which aims to measure the level of debt in an economy to their GDP.
Even if in some fantasy world, Japan is able to maintain the level of debt and tries to increase its GDP by growing the economy, it can’t do so. This is because of many policies which restrict the foreign trade (most of the economy of Japan relies on exports to other countries), and people are getting aged, so reduced spending. If they try to increase the taxes, then also it will affect the economy and they tried this in 2016 when they increased the consumption tax to 8% from 5% but they didn’t keep in mind the simple demand rule that if price increases, people reduced the spending, so that policy backfired.
Also, from the past 20 years, Japan’s growth is almost constant, so the numerator (debt) is getting bigger and denominator (almost constant), so the situation is getting worse.
William W. Grimes, a Professor of International Relations and Political Science at Boston University, and a Research Associate for the National Asia Research Program says -
It is not possible to simultaneously reduce the current level of public debt without creating a serious recession, if at all. Japan’s central government is currently running fiscal deficits in the neighbourhood of 8% of its GDP. It is just not feasible to cut deficits by that much in a short timeframe—even the disastrous Hashimoto fiscal consolidation efforts of 1997 did not go that far. Even if the Japanese government did somehow manage to stop the growth of debt (the numerator of the debt-GDP ratio) quickly, the shrinking of the GDP (the denominator) would mean that the ratio would not level off.
What are your thoughts on Japan's current economic situation?