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Issue Report

Collection of full-length papers and in-depth analysis of economic and management issues.

The Implication of Growing Fiscal Deficits for the Japanese Economy

The Implication of Growing Fiscal Deficits for the Japanese Economy

KOO Bon-Kwan

Dec. 31, 2008

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Originally released on September 3, 2008

ABSTRACT

While groaning over an extraordinarily high government debt to GDP ratio which is estimated to be over 180%, Japan adopted a strategy of rebuilding its fiscal structure alongside the inauguration of Junichiro Koizumi, and formulated a blueprint aimed at turning the primary balance into a surplus by 2011.

However, within the ruling party there has been growing disparity between those in favor of economic growth and those supporting fiscal soundness. In addition, with a lack of leadership and action plan, coupled with a deterioration of the economy, the Japanese government lost its drive for fiscal structure reform.

Even worse, the share of economically-active people in Japan is projected to decline by 40% by 2050. The drastic change in Japan's demographic structure could lead to a sharp increase in social security-related expenditures, causing Japan's potential economic growth rate to turn negative by the late 2010s at the earliest and up to the late 2030s at the latest. Japan is now facing a possible fiscal meltdown without needed reforms to improve its fiscal operations.

The policy options available for Japan that will help deter a slide into fiscal crisis are quite limited: increase economic growth potential by promoting an opening of its economy; increase stable tax income by raising consumption taxes; and establish strict controls on social security-related expenditures. Domestic lawmakers' sensitivity toward the voices of people in rural areas, the government's passive attitude and a prevailing sense of protectionism together with the general public's overall negative sentiment towards foreign investment will possibly act as stumbling blocks along the road to market opening.

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