"Lessons from the European Sovereign Debt Crisis to Japan"

Takatoshi ITO University of Tokyo Presentation in Ossesrvatorio Asia, Rome, Italy February 29, 2012

Outline

• • • • • • • Introduction European Debt Crisis Japanese Debt Crisis (in future?) Demographic problem Puzzle. Why is the interest rate so low?

Japan’s fiscal consolidation efforts Italy and Japan: common challenges 2012/2/29 (c) Takatoshi Ito 2

Introduction

• Italy and Japan , similarities and differences – Similarity: High debt-GDP ratio • Fiscal deficits and debt-to-GDP ratio • Japan is now much worse now – Similarity: Demographic Problem • Low fertility • Demographic deficits – Difference: Exchange Rate • Italy in the Euro Area • Japan independent float 2012/2/29 (c) Takatoshi Ito 3

200

Gross Government Debt-GDP ratio

Japan used to be respectable, not anymore. Japan is much CAN: Canada worse than Italy now DEU: Germany

Japan

FRA: France GBR: United Kingdom ITA: Italy 150 JPN: Japan USA: United States

Italy Canada

100

France

50 0

Germany USA United Kingdom

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2012/2/29 (c) Takatoshi Ito 4

130 110 CAN: Canada

Net Debt-GDP ratio

Similarly, in the “Net” measure DEU: Germany FRA: France

Japan

GBR: United Kingdom ITA: Italy JPN: Japan

Italy

90

Canada

70

USA

50

Germany

30

France

10

United Kingdom

-10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2012/2/29 (c) Takatoshi Ito 5

-6 -8 -10 -12 -2 -4 2 0

General Government primary surplus (G7) A key indicator for sustainability. Italy is not bad at all

(Percent of GDP) 8

Italy

6 Canada 4 United Kingdom Germany France

Japan

United States 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: International Monetary Fund, World Economic Outlook Database, September 2011.

2012/2/29 (c) Takatoshi Ito 6

European Debt Crisis

• • • Started with the Greek crisis – Critical points of time: October 2009; May 2010; May 2011; July 2011; and December 2011 – Why couldn’t Greece, EU and IMF solve the crisis quickly? Crisis spread to Ireland, Portugal, Spain, and Italy – But very different fundamentals among the Five • Italy has primary surpluses; Spain has low debt-to-GDP ratio – Why couldn’t EU, IMF & ECB prevent contagion?

Classic view: Can we separate the fundamental crisis and contagion? Let the former default if debt overhang is too much; and assist the latter with Lender of last resort – In sum, ring fence Greece, when Greek debts go default – Why has this not been applied in Europe?

2012/2/29 (c) Takatoshi Ito 7

0 -5 -10 -15 -20 -25 -30 General Government, primary surplus (Euro Area countries with large debts) (Percent of GDP) Projection 10 Iceland

Italy

5 Portugal Greece Ireland Spain 2000 2002 2004 2006 2008 2010 2012 2014 Source: International Monetary Fund, World Economic Outlook Database, September 2011.

2012/2/29 (c) Takatoshi Ito 2016 8

Japan

• • • Trend of the government finance: 1990s and 2000s – Expenditures continue to rise – Tax revenues fell in the 1990s and 2000s • Income tax and corporate income tax fell • VAT (consumption tax) stable Last three years: – 40% of Expenditure is financed by new bond issues – – New bond issues exceeds tax revenues Not sustainable as is  Needs fiscal consolidation Current government plan – VAT 5%  8% in April 2014; – and 8%  10% in October 2015 – A step in the right direction 2012/2/29 (c) Takatoshi Ito 9

Revenue and expenditure 120 ）

101.0

100 80 60 40 20

34.1

Total Expenditures

38.8

46.9

43.4

50.6

47.2

53.0

51.5

53.6

41.9

38.2

34.9

32.4

30.5

65.9

70.5

69.3

61.5

57.7

50.8

46.8

54.9

60.1

70.5

59.8

75.1

54.4

75.9

73.6

54.1

51.9

51.0

78.8

52.1

84.4

78.5

53.9

24.5

20.9

21.9

15.7

13.8

17.3

5.3

7.2

29.1

9.6

29.0

26.9

23.7

10.7

14.0

12.9

13.5

Government Bond Issues

9.4

7.2

Tax Revenues

6.6

7.3

1.0

6.7

16.2 16.5

9.5

21.2 21.7

18.5

89.0

50.7

47.2

37.5

34.0

89.3

84.8

83.7

47.9

82.4

43.8 43.3

35.3 35.5

35.0

84.9

85.5

81.4

49.1 49.151.0

31.3

27.5

81.8

25.4

84.7

33.2

92.3

52.0

44.3

44.3

0 (20) （ FY1975-2009: Settlement,FY2010: Initial budget 2012/2/29 (c) Takatoshi Ito

Total Expenditures

（ FY ） 10

Tax Revenues by category, VAT is a best bet

（ trillion yen ）

Various Taxes

30,0 25,0 Income Corporate Excise Consumption 26,0 26,7 23,2 23,7 Individual income tax 20,0 15,0 10,0 5,0 5,5 6,2 6,6 7,8 7,9 9,3 21,4 15,4 16,8 17,4 18,0 18,4 19,0 10,8 12,0 12,8 13,6 14,1 11,3 12,0 13,1 income tax 18,4 Corporate 13,7 16,6 12,1 20,4 12,4 19,5 19,0 19,2 13,7 14,5 13,5 17,0 15,4 18,8 17,8 11,4 10,8 11,7 10,3 14,8 13,9 14,7 15,6 13,3 14,9 16,1 15,0 9,8 10,1 11,4 14,1 14,7 10,0 12,9 12,6 7,4 5,6 4,1 4,8 0,8 0,8 0,9 1,1 1,2 1,2 9,8 Excise Tax 1,3 1,4 1,4 1,6 1,6 1,7 2,0 2,2 3,3 4,6 5,0 5,2 5,6 5,6 5,8 6,1 9,3 10,1 10,4 9,8 9,8 9,5 9,7 10,0 10,6 10,5 10,3 10,0 9,8 9,6 Consumption tax 6,4 6,0 0,0 2012/2/29 (c) Takatoshi Ito ( 年度 ) 11

Demography

• • • • Demography matters – Pension system sustainability – Growth potential is adversely affected Contents of government expenditure changes – More medical; More pension How to affect debt dynamics – Social security payments increase – Effective kind of taxes change Intergeneration transfer becomes a key – Pay-as-you-go pension systems are quite unfair to younger generation – If relied on income tax, the baby boomer will escape taxation for sustainability  Unfair to the younger generation 2012/2/29 (c) Takatoshi Ito 12

Baby boomer generation is about to retire 2010 Female Population, 10,000 Second Baby boomer generation, sons and daughters of the first 2012/2/29 (c) Takatoshi Ito No third baby boom 13

Demographic deficits

• Both Japan and Italy faces – a sharp decline in the working age population ratio – A sharp increase in the retired population ratio • Japan will also faces the rapid decline in total population 2012/2/29 (c) Takatoshi Ito 14

Total population;

Italy

Total

and

Japan

130000 ITALY JPN 100000 70000 40000 1950196019701980199020002010202020302040205020602070208020902100 2012/2/29 (c) Takatoshi Ito 15

60,0% 50,0%

Working age population ratio: age 20-59 / total population

Italy

40,0%

Japan

30,0% 20,0% 10,0% 0,0% 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100 Source: Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2010 Revision 2012/2/29 (c) Takatoshi Ito 16

Retired population ratio: Ages 60 and over/Total population

45,0% 40,0% 35,0% 30,0% 25,0%

Japan Italy

20,0% 15,0% 10,0% 5,0% 0,0% 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100 Source: Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2010 Revision 2012/2/29 (c) Takatoshi Ito 17

How to restore fiscal

sustainability

• • Europe – Positive Element of the Euro Zone • Bond rate convergence (until October 2009) • Discipline by the Euro Area, the “troika” – Negative Element • Cannot depreciate the currency, difficult to restore growth • Discipline by the Euro Area, or the “troika” Japan – Long-time complacency motivated by • Low JGB interest rate • Room of maneuver – Taxes have to be increased, quickly • Intergenerational inequity, getting worse • Not much room for expenditure cut, except social security expenditure cut 2012/2/29 (c) Takatoshi Ito 18

Japanese Debt Crisis (to come)

• • • Very bad situation (worse than Italy and Spain) – – Deficit/GDP ratio Debt-to-GDP ratio, Puzzle: – Then, why no crisis yet? (JGB yield < 1%) Japanese residents hold 95% of JGBs – Japan has current account surpluses (although trade account turns negative recently) – Vast room for tax increases The sooner the better – Demographic change is very adverse 2012/2/29 (c) Takatoshi Ito 19

Puzzle, Debt and interest rate

JGBdebt JGBrate Trillion yen 700 600 500 400 300 200 100 0 % 6 5 8 7 1 0 4 3 2 2012/2/29 (c) Takatoshi Ito 20

A solution by Tax increase in Japan

• • • Increase VAT (consumption tax) rate from 5% to 25% will solve government deficit problem – New Bond issues: 44 trillion yen – 20% point increase in VAT will generate 45-50 trillion yen Personal income tax increase will miss baby boomer generation to be taxed. Corporate income tax increase will hasten hollowing out—bad for growth 2012/2/29 (c) Takatoshi Ito 21

Italy and Japan, common challenges fiscal crisis

• What did Italy learn from the European Sovereign debt crisis? – Is it just a bad spillover from Greece?

• Italy got hit despite its primary budget surpluses – Does it need “discipline” from outside? • Why it took so long and so much for Italy to convince investors that Italy is sustainable (assuming it is). – Can the “technocrats government” than politicians?

• do a better job Why do politicians fail to make right decisions? 2012/2/29 (c) Takatoshi Ito 22

Italy and Japan, common challenges fiscal crisis

• What can (should) Japan learn from the current European crisis?

– – When a crisis happens, it gets worse quickly What takes to calm the market once the crisis occurs requires much more austerity than restoring sustainable path during the non-crisis time – Hence, it is much more desirable to adopt austerity while the sovereign bond market is calm – Once the crisis occurs, political disputes (politicking) is very costly. Grand coalition or a technocrat government with broad mandate is the best 2012/2/29 (c) Takatoshi Ito 23

Italy and Japan, common challenges Growth Policy

• • Growth policy. Growth is better than austerity. – Where are growth engines? • • Japan: agriculture, bio-medical-health care, education?

Italy: What is a consensus among Italians?

– – Take advantage of “globalization”: Skill premium EU-Japan FTA will be a key for growth in both economies Low fertility rate – Japan , Korea, Hong Kong, Singapore and Italy ? – Will immigration be an answer?

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