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Tough lessons from Japan

July 02,2018
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Nahm Yoon-ho
*The author is the Tokyo bureau chief of the JoongAng Ilbo.

The Japanese economy has been booming thanks to a multi-layered stimulus package dubbed Abenomics. But that should not be envied, economic pundits say, as the government is running a colossal deficit. Japan has been faced with a large fiscal deficit since its epic economic bubble burst in 1992.

Since then, Japan has relied on debt-financed fiscal stimulus packages to revive the economy. It spent billions of dollars to bail out troubled financial institutions. According to the Organization for Economic Cooperation and Development (OECD), Japan’s national liabilities are 237 percent of its gross domestic product.

Even with the economy flourishing, Japan must worry about a fiscal breakdown. Japan has already been warned that it faces a 99.9 percent chance of fiscal insolvency by 2035 and 100 percent by 2040. To avoid this catastrophe, the government is being advised to bump its consumption tax rate to as high as 38 percent from its current 8 percent or cut the fiscal budget of 100 trillion yen ($903.96 billion) by 70 percent to 30 trillion yen. Both bombshell tax and extreme austerity options would scare the Japanese public.

A fiscal disaster does not mean the country will suddenly run out of money. First, government bonds will not sell well, sending their prices tumbling down and their yields (interest rates) soaring. The liquidity-short government will inevitably cut public services to save expenses. Key spending for defense and public safety also may have to be scaled back. The financial system could break down as well. Containing the crisis will only get more difficult as state authorities lose confidence. At the end of the day, the government may be forced to go on a stringent diet.

A disaster is not far away. The government could stray into it unknowingly, and it would not know before it is too late. This is why governments must extra take care to manage their public finances. Germany prohibits national liabilities from going above 0.35 percent of its GDP. Indonesia can even impeach the president if the fiscal deficit hovers above 3 percent of GDP.

Korea’s debt problems are mild compared with other developed economies. Its liabilities ratio against GDP stood at 38.5 percent last year. This is why the government thinks it can stretch the amount it spends to stimulate the economy, address unemployment and modernize underdeveloped areas.

The Keynesian prescription of increased government spending to aid the economy does not always produce the desired effect. It can be effective to save a patient carried into the emergency room after suffering a heavy blow, but it does not help grogginess due to regular and lengthy beatings. Our economy has withered — especially on the jobs front — more from structural problems and misguided policy applications than outside factors. Trying to fix the problem through spending instead of seeking fundamental solutions is both foolish and risky. Many empirical studies found increases in national debt can hamper economic growth by dampening corporate and consumer spending.

Korea’s debt will automatically pile up due to its quickly aging population. Korea has the fourth-fastest growth of national debt among OECD members. Debt increased by an average 11.6 percent annually from 2000 to 2016. That’s even higher than the 7 percent in Spain, 4.9 percent in Greece, and 3.4 percent in Italy — the trio that experienced a massive liquidity crisis. The OECD has warned that Korea’s net liabilities could exceed 200 percent of its GDP by 2060.

The ruling party and government seem to believe they can push the debt ratio against GDP to 40 percent from current 38 percent. But a one percentage point increase amounts to 19 trillion won ($17 billion). The government is making a unilateral compromise and is not defending financial integrity.

No market trusts a government that’s lax about bookkeeping. Investors could dump Korean assets, causing a downgrade in sovereign credit and a spike in international borrowing rates. Japan’s sovereign credit rating hovered below that of the African state of Botswana for five years from 2002 due to its fiscal deficit.

The Democratic Party has turned contradictory after it became the ruling party. In late 2016, 39 members of the then-opposition party submitted a bill aimed at capping national debts at 0.35 percent of GDP — which would amount to about 6.6 trillion won. Now, the ruling party does not care about ballooning national debt from its profligate spending on subsidies and welfare.

The government under Moon Jae-in also flip-flopped on its longstanding conservative position on public finance. The Finance Ministry had proposed limiting national liabilities to below 45 percent of GDP. It is bent on following the liberal administration’s lead. Its bill had a provision on government efforts to raise public awareness of the importance of fiscal integrity. It better get rid of that provision, as it goes against its own position on fiscal integrity.

JoongAng Ilbo, June 29, Page 31