When discussing Japan’s debt, most people get caught up in the issue of fiscal solvency. As everyone by now knows, Japan has a very high level of debt versus gross domestic product:
This attention-grabbing number—about twice the level of the US—often gets people asking whether Japan will default. Some believe a default is likely when the country runs out of domestic buyers for government bonds, causing interest rates to rise. Others think the Bank of Japan can simply print money and buy government bonds without causing devastating hyperinflation. Shrewd observers point out that Japan’s debt isn’t quite as large as the headline number suggests, since much of it is held not by the public but by various arms of the Japanese government.
The solvency question surely is an important one. But it’s only one part of the larger issue. Since the vast bulk of Japan’s government debt is owned by Japanese people, the question isn’t about paying back external creditors. It’s a matter of distribution of economic resources among the Japanese people.
If the government defaulted on its debt tomorrow, it would certainly hurt the financial system and cause a recession. But the most lasting effect would be to let Japanese taxpayers off the hook, while Japanese bondholders would find themselves less wealthy. The country wouldn’t have a fundamentally weaker economy—all the factories and land and people and know-how would still be there. But the promises about who gets to receive the fruits of that economy would be shifted.
The real problem with Japan’s debt, therefore, isn’t so much the danger of default; it’s that the government has made lots of promises to transfer real economic resources from young, working Japanese people to old, retired, bond-holding Japanese people. But Japan has a lot of old people and not many young people—27 percent of the population is over 65, higher than any other country. Forcing that shrinking group of young people to keep the economic promises that the government has made on their behalf represents a crushing economic burden. And if that economic burden makes it harder to raise children, fertility will be suppressed, making the problem even worse in the future.
So the Japanese government needs to find some way of making the retiring baby-boom generation a little bit poorer and the hard-working younger generations a little bit richer. Raising taxes, as Prime Minister Shinzo Abe’s administration has already done and is trying to do once again, won’t accomplish this goal—tax collection is just a way of the government making good on its promises to old people, at the expense of the young. A better idea is to cut spending.
Some outside observers, recalling Japan’s wasteful construction binge in the 1990s, are prone to calling for cuts in public investment. But this was already done, long ago—government investment in Japan is barely half its former level in inflation-adjusted terms, and as a percent of GDP it’s less than half. Besides, construction spending benefits both young and old, so cutting it isn’t an efficient way of easing the burden on the young.
That leaves social security and health care the Japanese electorate is dominated by older people. So the government is, wisely, resorting to methods that are less likely to cause a public outcry.
The first is the so-called macroeconomic slide. Starting in fiscal 2018, when the country experiences either price or wage deflation, pension benefits will fall—but when there’s inflation or wage gains, benefits rise more slowly. This system is similar to the way that companies often cut real wages for workers—simply let inflation do the job. The macroeconomic slide made the fiscal outlook rosier in 2014, when inflation briefly surged above the 2 percent target. But inflation has once again disappeared, despite continued monetary easing, proving how difficult it is for central banks to generate even moderate inflation.
Health care is a thornier issue. Japan has one of the cheapest and most cost-effective health systems in the world, but the sheer size of the aging problem is steadily increasing total spending:
Japanese policy makers and academics are thinking about ways to cut health care outlays even further, with minimal damage to the welfare of its elderly population. One idea is to have the government limit the amount of care that people are allowed to consume.
So Japan is making progress on reducing the amount that it redistributes from young to old. But there’s also the issue of rich versus poor—pension cuts, for example, will fall hardest on the elderly poor. Japan can mitigate this by making the pension system more redistributive by reducing benefits only to wealthier retirees.
This much is certain—Japan’s young people can’t bear the burden of the promises that politicians made on their behalf in decades past. Raising taxes isn’t the solution, debt default would cause unacceptable economic chaos, and generating inflation is hard to do. Lowering pension and medical benefits to well-off elderly people, though it’s a harsh and draconian measure, looks like the least-bad option.
Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs atNoahpinion