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Achieving progress on fiscal consolidation by controlling government expenditures.

With gross debt of 180% of GDP, further measures to reduce the large budget deficit are increasingly urgent. An improvement in the budget balance of between 4% and 5% of GDP Con a primary budget basis) is needed just to stabilise the government debt to GDP ratio, a first step towards the government's goal of lowering the ratio in the 2010s. The first priority is to further cut government spending, which has fallen by 2 1/2 percentage points as a share of GDP during the past five years, focusing on public investment and the government wage bill. Expenditure reductions should be accompanied by reforms to improve efficiency in the public sector. In addition, policies to limit the increase in social spending, in the context of rapid population ageing, are essential for fiscal consolidation. However, expenditure cuts alone are insufficient to achieve Japan's fiscal objectives, making it necessary to raise additional revenue.

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Japan has substantially reduced its fiscal deficit since the beginning of the economic expansion in 2002, despite the weak growth of nominal GDP in the context of persistent deflation. Spending cuts and revenue increases have each lowered the budget deficit by about 2% of GDP over the past five years. Nevertheless, much remains to be done to achieve fiscal sustainability in Japan. Indeed, the central government budget relies on borrowing to finance one-third of its spending, further pushing up public debt as a share of GDP, which is already the highest ever recorded among OECD countries. The government is committed to curbing the growth of expenditure to meet its target of a primary budget surplus for central and local governments combined by FY 2011. However, achieving large spending cuts in the major spending categories of social security, public investment and the government wage bill is becoming increasingly difficult. This chapter reviews the progress in fiscal consolidation, examines the government's medium-term fiscal objectives and discusses major spending issues. Policy recommendations are presented in Box 3.2.

How much progress has Japan made in addressing its fiscal problem?

The budget deficit declined from 8.2% of GDP in 2002 to 4% in 2007, excluding one-off factors (Table 3.1). Increased revenue accounted for 1.8% of the improvement (Panel B), driven primarily by buoyant corporate tax revenue, which in turn reflected record high corporate profits and shrinking loss carryovers as the economic expansion continues. In addition, the phasing out of the temporary personal income tax cut introduced in 1999 boosted revenues. Spending cuts, amounting to 2.4% of GDP, were concentrated in public investment, accompanied by a significant fall in the government wage bill. However, these reductions were partly offset by a rise in social welfare-related outlays amounting to 1% of GDP in the context of population ageing. Overall, fiscal policy measures accounted for about three-quarters of the decline in the deficit since 2002, with the remainder explained by cyclical factors. (1)

Despite rising debt, the government's net interest payments declined by about 1/2 per cent of GDP between 2002 and 2007, reflecting falling interest rates. (2) Indeed, the effective interest rate paid on government net debt dropped from an average of 5.5% in the 1990s to less than 2% during the current expansion. The effective interest rate has been kept low by a number of exceptional factors, including the Bank of Japan's quantitative easing policy between 2001 and 2006, the persistence of deflationary expectations and the risk aversion of investors and banks (2006 OECD Economic Survey of Japan).

Although the deficit is on a steady downward trend, government debt continues to increase. On a gross basis, it has been rising at an annual rate of 7% since 1991, boosting its share of GDP from 65% to around 180% in 2007, the highest in the OECD area (Figure 3.1). Similarly, on a net basis, government debt rose at a 13% rate over that period. (3) The decomposition of changes in the net debt to GDP ratio (Figure 3.2) shows that the dominant cause of rising debt is the primary budget deficit. In addition to 15 consecutive years of deficits, the slow growth of nominal GDP made it difficult to stabilise the upward trend in the government debt ratio, which requires that nominal GDP grow at least as fast as the stock of government debt. However, nominal GDP growth has been sluggish, at an annual rate of less than 1% since 1991 in the context of deflation. A positive factor for stabilising debt was the decline in interest payments, as noted above, thanks to lower interest rates. The challenge for Japan is to resolve the budget deficit problem before the period of low interest rate comes to an end and rising interest payments on the accumulated debt result in a further deterioration in the fiscal situation.

[FIGURE 3.1 OMITTED]

The government's medium-term fiscal plan

The government's Direction and Strategy, announced in January 2007, established three fiscal objectives: (4) i) curb the expansion in the size of the government; ii) achieve a surplus in the primary balance of the combined central and local government budgets by FY 2011; (5) and iii) stabilise the government debt to GDP ratio and decrease it in the mid-2010s. The plans calls for fiscal consolidation of around 1/2 per cent of GDP a year, the rate achieved between FY 2001 and FY 2006, in order to achieve the FY 2011 target. The Reference Projection provides a quantitative picture of how the policy goals in the Direction and Strategy can be achieved (Table 3.2). According to the latest version (January 2008), the combined central and local government primary budget deficit is estimated to have fallen from the 2.9% of GDP recorded in FY 2005 to 0.7% in FY 2007. (6) It is projected to fall further to 0.1% in FY 2011 without any tax increases, according to the "growth scenario" shown in Table 3.2, which assumes that the expenditure reductions included in the 2006 fiscal consolidation plan are implemented.

[FIGURE 3.2 OMITTED]

In addition, there is a plan for fiscal consolidation of the social security fund, which accounts for about 40% of total expenditure in the general government budget. First, the government will increase its contribution to the basic pension from one-third at present to one-half by FY 2009, at a cost of around 2.3 trillion yen (0.4% of GDP). Second, the rise in the pension contribution rate from 14.6% in FY 2007 to 16.1% in FY 2011 will generate an additional 1/4 per cent of GDP in revenue for the social security system. The additional revenue is projected to help improve the balance of the social security fund by 1/2 per cent of GDP, from a deficit of 1/4 per cent of GDP in FY 2007 to a surplus of a similar magnitude in FY 2011 (Figure 3.3). (7) Although the government's medium-term plan does not explicitly include the social security fund, it should be considered simultaneously with central and local government balances, given that the general government balance determines the evolution of government debt. It is important, therefore, to carefully monitor developments in the social security fund, which depends on demographic trends and other unpredictable factors, to ensure that the Direction and Strategy's target for a primary budget surplus for central and local governments combined is not achieved through a deterioration in the social security fund. Finally, the contribution rates for pensions, healthcare and nursing care should be taken into account in the government medium-term plan in determining the appropriate overall burden on households.

In sum, the government's medium-term plans would result in fiscal consolidation of around 1% of GDP by FY 2011, in terms of the primary general government balance, a pace that is only half as fast as the 1/2 per cent of GDP per year achieved during this expansion (on a cyclically-adjusted basis). (8) Moreover, the overall general government primary balance may remain in deficit in FY 2011 (Table 3.2). It is appropriate, therefore, to accelerate the pace of fiscal consolidation. Excluding one-off factors, the OECD estimates the general government primary deficit at 3.2% of GDP in calendar year 2007 (Table 3.1), suggesting that the pace of consolidation would have to accelerate to around 3/4 per cent of GDP a year to achieve a primary budget balance in calendar year 2011.

[FIGURE 3.3 OMITTED]

There is also a question of whether the 2008 Reference Projection is overly optimistic. In the "growth scenario", it projects that real GDP growth will accelerate from an average of 2% over the period 2002 to 2006 to 2.6% in FY 2011 (Table 3.2), thanks to positive supply-side factors, such as greater use of information technology, the implementation of free trade agreements and regulatory reform. However, this projection is higher than most other short-term projections, including those by the OECD, which expects that output will expand at an annual rate of less than 2% between 2007 and 2009 (Table 1.2). Moreover, the rate projected in the Reference Projection is well above Japan's potential growth rate, for the period 2007 to 2011, which is estimated by the OECD at 1 1/2 per cent (Table 1.4), a rate close to the current estimate by the government of Japan. Policies to boost potential growth are certainly necessary and desirable. But given uncertainty about the impact and timing of policy changes on potential growth, it is risky to assume a substantial and prompt rise in potential growth as a basis for the medium-term fiscal plan. This risk is acknowledged in the "risk scenario" of the 2008 Reference Projection, which projects that real GDP growth will decelerate to 1.1% in the absence of the reforms noted above (see Annex 3.A1). In sum, basing the fiscal consolidation plan on the assumption that economic growth does not accelerate would be more reasonable.

In addition to overly optimistic economic assumptions, the FY 2011 objective of the Direction and Strategy is not likely to be sufficient to achieve the long-term goal of stabilising, and then reducing, the public debt ratio. (9) The size of the general government primary budget surplus necessary to stabilise the debt ratio depends on the level of the interest rate relative to the growth rate; the larger the gap between the interest rate and the nominal growth rate, the larger the necessary primary budget surplus. In the 2006 Reference Projection, the interest rate (3.9%) was substantially larger than the nominal growth rate (3.2%), suggesting that a primary budget surplus of 1% of GDP would be required. (10) This was revised in the 2007 Reference Projection, which projected an interest rate and nominal growth rate of around 4% in FY 2011. Finally, in the 2008 Reference Projection, the nominal growth rate is above the interest rate. Looking at recent trends, the net effective interest rate on government debt since 1995 has averaged 2.6%, well above the 0.3% average nominal growth rate. (11) Such a gap would require a primary budget surplus of around 2% of GDP. In sum, achieving the government's objective of stabilising the public debt ratio would require a general government surplus of between 1% and 2% of GDP--an improvement of 4% to 5% of GDP from the deficit in FY 2007. Reducing the public debt ratio would require an even larger improvement in the primary budget balance. This conclusion is consistent with long-term projections by the Japanese government and the members of the Council on Economic and Fiscal Policy (CEFP) (Box 3.1).
Box 3.1. Long-term fiscal projections by the Japanese government and
the CEFP

A projection by the CEFP examines the fiscal policy changes necessary
to stabilise the public debt ratio through 2025 (Table 3.3). It
concludes that an improvement in the primary budget balance of central
and local governments of between 1.5% and 4.9% of GDP is necessary.
The size of the needed improvement depends on the level of healthcare
and long-term nursing care spending and on the macroeconomic
assumptions. However, the lower end of this range assumes that real
growth will accelerate to a pace of 2.4% between 2007 and 2011.
Assuming growth of 1.6%--more in line with potential growth as
estimated by the OECD--implies that the necessary improvement in the
primary budget balance would be between 3.9% and 4.9% of GDP, in line
with the OECD estimate above. Even this large increase in the primary
budget surplus would not be adequate to reduce the public debt ratio,
as planned by the government during the 2010s.

Table 3.3. Long-term fiscal projections through 2025

Primary budget surplus needed to stabilise the debt to GDP ratio
(as a per cent of GDP) (1)

             Social security                                 Required
Expenditure  policy (2)                          Change in    change
cut between                          Growth       primary     in tax
FY 2006-11   Burdens   Benefits  assumption (3)   balance   burden (4)

   -1.9%     Increase  Constant       Low          4.9%        5.9%
                                      High         2.7%        3.1%
             Constant  Decrease       Low          4.3%        5.1%
                                      High         1.8%        1.9%

   -2.4%     Increase  Constant       Low          4.6%        5.5%
                                      High         2.4%        2.8%
             Constant  Decrease       Low          3.9%        4.6%
                                      High         1.5%        1.6%

(1.) Figures are derived endogenously based on the assumption that
the debt service ratios in FY 2011 and FY 2020 do not exceed the
level in FY 2025.

(2.) Social security policy includes healthcare and nursing care
services.

(3.) In the high-growth scenario, real GDP growth is 2.4% between
FY 2007-11 and 1.7% thereafter. In the low-growth scenario, real
growth is 1.6% and 0.9%, respectively. The gap between the interest
rate and the nominal growth rate ranges from 1.3 to 1.6 percentage
points. The high-growth scenario assumes an increase in labour
supply and regulatory reforms to boost productivity.

(4.) The required change in tax revenue is not equal to the change
in the primary balance due to macroeconomic changes. The increase
in tax revenue consists of greater consumption and income tax
revenues.

Source: Council on Economic and Fiscal Policy (2007c).

Another long-term projection, by the Financial System Council of the
Ministry of Finance in 2007, analysed fiscal sustainability through
the year 2050 (Table 3.4). With no fiscal reforms, the primary budget
deficit of central and local governments would rise to 4.5% of GDP by
mid-century due to increasing social welfare expenditures. As a result,
the debt to GDP ratio, currently estimated at 144% by the
government, (2) would reach nearly 400%. A primary budget surplus of
4.2% from FY 2007 onwards (compared to the deficit of 0.7% projected
that year in the Reference Projection shown in Table 3.2) would be
necessary to stabilise the debt ratio at its current level through
2050. Cutting the debt ratio in 2050 to 60%, the guideline set by the
Maastricht Treaty, would require a surplus of 5.5% of GDP in the
primary balance (shown under Estimate 1 of the baseline scenario in
Table 3.4). Delaying fiscal consolidation imposes a high cost,
according to this simulation. If the targeted budget surplus were only
achieved in FY 2012, the size of the improvement in the primary
balance to keep the debt ratio unchanged at around 140% would be about
4.8% of GDP--0.6 percentage point larger. This projection also examines
the effect of the government's fiscal consolidation plan. Even with the
budget cuts incorporated in the Reference Projection, a primary budget
surplus of 2.9% of GDP in FY 2007 would be necessary to stabilise the
government debt ratio through 2050. (3)

Table 3.4. Long-term fiscal projections through 2050

Primary budget surplus (as per cent of GDP) needed in FY 2007
to stabilise the debt to GDP ratio by 2050

                                             Baseline scenario (2)
Debt ratio (1)
target in 2050   Fiscal indicator       Estimate 1 (4)   Estimate 2 (5)

140%             Primary balance             4.2%             2.9%
                 Cost of delaying (6)        0.6%             0.4%
100%             Primary balance             4.8%             3.7%
                 Cost of delaying (6)        0.6%             0.5%
60%              Primary balance             5.5%             4.5%
                 Cost of delaying (6)        0.7%             0.6%

                                               MTO scenario (3)
Debt ratio (1)
target in 2050   Fiscal indicator       Estimate 1 (4)   Estimate 2 (5)

140%             Primary balance             2.9%             1.6%
                 Cost of delaying (6)        0.5%             0.2%
100%             Primary balance             3.5%             2.4%
                 Cost of delaying (6)        0.6%             0.4%
60%              Primary balance             4.1%             3.2%
                 Cost of delaying (6)        0.7%             0.5%

(1.) The coverage of debt is limited to central and local
government bonds and the borrowing by the special account for local
tax grants, and is thus below the OECD estimate based on a general
government basis, which was 1801 of GDP in 2007.

(2.) Baseline scenario assumes that current policies will continue
up to FY 2050.

(3.) The MTO (Mid-Term Objective) scenario reflects the current
reform plan included in the Reference Projection of the 2007
Direction and Strategy.

(4.) Estimate 1 uses the macroeconomic assumption in the Structural
Reform and Medium-Term Economic and Fiscal Perspectives--FY 2005
Revision for the period 2007-11. The nominal growth rate is assumed
to be 1.6% between 2012 and 2032--a gap of 1.4 percentage point
with the long-term interest rate. Nominal growth is assumed to be
1% between 2033 and 2050, a 2 percentage-point gap with the
long-term interest rate.

(5.) Estimate 2 increases the nominal growth rate by 1 percentage
point from Estimate 1 between 2012-2050.

(6.) The cost of delaying shows the additional primary budget
surplus required if fiscal consolidation is delayed five years,
i.e. from FY 2007 to FY 2012.

Source: Ministry of Finance, Financial System Council (2007).

(1.) While these simulations are useful to consider the necessary
amount of fiscal consolidation to stabilise the debt to GDP ratio in
the future, they are sensitive to the underlying assumptions. One of
the risks is a further rise in the borrowing rate of the government.
Although the Financial System Council assumes a gap of 2 percentage
points between the long-term interest rate and the nominal GDP growth
rate, a high level of debt and population ageing may lift the risk
premium. The higher cost of borrowing increases the amount of fiscal
consolidation needed to stabilise the debt ratio.

(2.) The government definition of debt is limited to central and local
government bonds and the borrowings of the special account for local
tax grants. It is thus less than the general government debt figure of
180% estimated by the OECD, which includes short-term borrowing and
other financial liabilities.

(3.) These estimates are sensitive to the rate of output growth. In
Estimate 2, nominal growth is boosted by 1 percentage point from the
rate assumed in Estimate 1 (the growth assumption used by the
Ministry of Health, Labour and Welfare in social security projections).
This reduces the needed improvement in the primary budget balance
by between 1% and 1.3% of GDP in the baseline scenario.


Continuing the downward trend in government spending

Expenditure cuts are the top priority for fiscal consolidation. Reducing spending would limit the amount of the additional tax burden necessary to achieve the fiscal objectives of the government, thus limiting the negative impact of taxes on growth. Moreover, empirical research indicates that deficit reductions achieved through spending cuts tend to be longer lasting than those resulting from tax increases. Furthermore, cross-country evidence suggests that expenditure reductions that focus on government wages and transfer spending have positive confidence effects that offset, at least in part, the contractionary impact of fiscal consolidation on economic activity (OECD, 2006a). This is particularly the case when government debt is high, as in Japan.

On the expenditure side, Japan has had some success: total government spending fell at an annual rate of 0.3% in nominal terms between 2002 and 2007, reducing it from 38.8% of GDP to 36.5%. In contrast, the spending target for FY 2007-11 in the 2007 and 2008 Reference Projections is less ambitious, as it allows government outlays to increase at an annual rate of between 1.2% and 1.7%. (12) Nevertheless, the high nominal growth rate of output assumed in the Reference Projection--2.7% over the period FY 2007-11--enables Japan to get close to the FY 2011 target of a primary budget surplus through expenditure cuts (as a share of GDP) alone. However, as noted above, this growth assumption appears overly optimistic. In contrast, the OECD projects that nominal output growth will pick up from an average of 0.9% between 2002 and 2007 to 1.7% between 2007 and 2009. If this pace of growth were extended to 2011, and expenditures expand at the 1.2% to 1.7% rate assumed in the Reference Projection, the decline in government expenditures over the period 2007-2011 would be 0.7% of GDP at most. Such a decline is well below the necessary improvement in the primary budget balance of 4% to 5% of GDP. This section focuses on the scope for spending cuts in some key areas, including pensions, healthcare, long-term nursing care, public investment and the government wage bill.

Social spending

Gross public social spending in Japan was 17.7% of GDP in 2006, well below the OECD average of 20.6%, according to the OECD Social Expenditure database. Indeed, Japan ranked eighteenth out of 24 OECD countries, despite its relatively aged population. Japan's Ministry of Health, Labour and Welfare reported the same level of social spending in FY 2006 (Table 3.5) as the OECD, although its more narrow measure excludes labour market and housing policies included in the OECD definition. Pensions, healthcare and long-term nursing care account for more than 90% of social expenditure in Japan. The government projects that social spending will grow at a 3% annual rate through FY 2015, boosting its share of GDP by less than I percentage point to 18.4%. With rapid population ageing, maintaining social expenditure well below the current OECD average is an ambitious target. Given that social spending accounts for 40% of total government outlays, containing expenditure increases in this area is a key to achieving fiscal consolidation in the medium term.

The 2004 reform of the public pension system was intended to ensure its sustainability for the next 100 years by introducing three measures (Table 3.6). First, the pension contribution rate is being gradually increased from 13.6% in FY 2004 to 18.3% by FY 2017. Second, pension spending will be limited through a system of "macroeconomic indexation", which adjusts pension benefits based on changes in the number of contributors and life expectancy. Macroeconomic indexation will be introduced once the consumer price index rises 1.7% above its 2005 level, (13) a condition that has not yet been met. Third, as noted above, the government contribution rate to the basic pension is to be increased from one-third to one-half by FY 2009. These reforms are projected to limit pension outlays to around 9% of GDP through FY 2015. However, it became known in 2007 that individual pension contributions have not been registered accurately. This problem has increased uncertainty about benefit entitlements, creating doubts about pension administration, as well as deep anxiety among current and potential pension recipients. Consequently, the reliability of projections for the pension system is difficult to assess. The government stated that the cost of correcting this mistake will be financed by a reduction of management costs, which suggests scope to streamline the pension management system.

The 2004 pension reform also requires that the average replacement rate remain above 50%, although the rates for relatively high-income persons are already below that lower bound. In the initial projection, the replacement rate was expected to fall to 50.2% in 2023, which would force an end to the system of macroeconomic indexation given the requirement that the replacement rate remain above 50%. (14) In 2007, the government recalculated the future replacement rates based on new population estimates and economic assumptions. In this new projection, the replacement rate falls from 59.7% in FY 2006 to 51.6% in 2026. The 1.4 percentage-point rise in the replacement rate compared with the previous projection is mainly explained by a positive impact from economic factors based on the optimistic growth scenario included in the 2007 Reference Projection. The economic effect partially offsets the negative impact from demographic factors--4.5 percentage points--based on the medium-case scenario for population changes, which has tended to be overly optimistic in the past. If the economic factors and demographic trends do not turn out as assumed in the projection, it will be difficult to maintain the replacement rate above the lower bound of 50%. One option is to change the law to allow the average replacement rate to fall below 50%. However, the scope for decline is limited as it may discourage contributions to the public pension scheme in favour of relying on social assistance, although the latter is subject to an asset test. A second option--a further hike in the contribution rate--should be avoided as it would have an adverse impact on the labour market. The best option would be to further raise the pension eligibility age in line with the increase in life expectancy. (15) This should be accompanied by reforms to increase the rate of return on accumulated assets in the social security funds.

Public healthcare expenditure in Japan, at 5.5% of GDP, was the ninth lowest among OECD countries in 2005. However, rapid ageing inevitably increases healthcare outlays; per capita spending for people aged from 65 to 74 was 3.2 times higher than for people under 65 in Japan. For those over age 75, the ratio is 5.1 times higher. Indeed, the changing age composition of the population alone would boost per capita healthcare expenditures by 1.3% per year until FY 2015. The government plans to reduce public healthcare spending from the 6.3% of GDP originally projected in PY 2015 to 5.8% through a number of reforms. First, the rate of co-payment by persons between the age of 70 and 74 with high incomes was increased from 20% to 30% and medical fees were cut by 3.2% in PY 2006. Second, a new medical insurance scheme for those over the age of 75 will be introduced in KY 2008. However, the hike in the standard co-payment rate for the 70 to 74 age group from 10% to 20% has been postponed for a year, although no new reforms to achieve the targeted cost reduction in FY 2008 have been proposed. Third, a large saving in the medium term is expected through a reduction in the average length of hospital stays, which is three to five times longer in Japan than in other OECD countries (OECD, 2007a). Fourth, healthcare costs are to be reduced through the prevention of lifestyle-related diseases. The government will further promote individual medical exams, (16) with the aim of reducing the number of persons with "metabolic syndromes" (17) by a quarter by FY 2015. However, the extent of savings that can be achieved by encouraging healthier lifestyles is uncertain. Moreover, the medical criteria underpinning this programme remain controversial even among healthcare professionals.

The government should pursue additional reforms to limit the increase in healthcare expenditure. First, it is important to make greater use of market mechanisms by allowing private-sector companies to manage hospitals, which is currently allowed only in one special zone (see Chapter 5). This would be encouraged by changing the regulation that prevents public insurance from being partially applied in cases where non-covered and covered medical treatments are provided together. Second, incentive structures should be improved to encourage greater use of generic medicines, which is low in Japan. (18) Third, further increasing the use of information technology in the medical billing systems would boost efficiency and the scope for third-party oversight. The share of electronic forms has jumped from less than 2% of medical bills in 2003 to 24% in mid-2007, although there remains substantial scope for greater use of information technology. In an attempt to limit the increase in healthcare spending, the government is planning to establish regionally-based insurers, which may help to reduce management costs through economies of scale. However, this reform will not provide incentives to insurers to monitor hospitals, individual clinics and doctors on behalf of their members, as there is little competition among insurers.

Reforms are also needed to contain spending on long-term nursing care, which is also rising rapidly due to population ageing. At present, private-sector firms certified by the government are allowed to provide some services at prices set by the government. Weak competition results in a lack of innovation, a limited variety of services and pricing and dissatisfaction among consumers. Relaxing price controls would improve efficiency and quality. In addition, in the long-term care insurance scheme, the "care managers", who decide the services for individuals qualifying for care, are expected to choose the optimal care package and service provider. However, most care managers are employed by service providers, and thus have no incentive to curb costs for users. Although the law states the fiduciary obligation of care managers, the legal deterrent is too weak to resolve the principle-agent problem. Instead, economic incentives are needed to guarantee that the elderly receive the appropriate nursing care at the lowest cost. In sum, it is necessary to reform the current system and reduce aggregate costs through greater use of market forces.

Public investment

Public investment, including that by public enterprises, has fallen from a peak of 8.4% of GDP in 1996 to 4.4% in 2006, in line with the government's medium-term plan. However, Japan is still the fourth highest in the OECD area in this regard and above the OECD average of 3.1% of GDP. While the medium-term plan calls for continuing reductions in public investment, further declines would raise concerns about regional income disparities and the need to maintain existing public infrastructure.

Traditionally, public investment has been used to promote regional equality. Indeed, the level of public investment by prefecture is negatively correlated with income levels (Figure 3.4). Not surprisingly, the size of the construction sector tends to be larger in low-income areas. However, between FY 1998 and FY 2004, the share of public investment fell in all prefectures and the negative correlation between per capita income and public investment weakened. Nevertheless, the regional variation in the unemployment rate declined between FY 1998 and FY 2004, suggesting that the sharp decline in public investment over that period had little impact. The regional variation in unemployment did widen between FY 2004 and FY 2006, but this is largely explained by the unbalanced nature of economic growth since 2004, with strong exports and sluggish domestic demand (see Chapter 1). (19) Consequently, areas where manufacturing is important have benefited the most from this expansion (Figure 1.6).

Public investment has not been an efficient tool for reducing regional inequality in Japan. In fact, the large disparity in levels between regions is explained primarily by differences in labour inputs and productivity, which is in turn determined by the industrial structure (Cabinet Office, 2004). Labour productivity growth in manufacturing has risen at an annual rate of around 4% since the 1970s, while that in the service sector slowed from 3.5% in the period 1976-89 to less than 1% between 1999 and 2004 (see Chapter 5). Consequently, regions focused on manufacturing have tended to experience faster per capita income growth. Policies to boost productivity growth in services are thus essential to narrow regional income gaps. While public investment can create some additional demand and improve local infrastructure so as to attract private investment, past experience suggests that the marginal gains are small relative to the cost. Indeed, the marginal productivity of public capital in the Tohoku region is only 5% of that in the southern Kanto region, which includes Tokyo (2006 OECD Economic Survey of Japan). As public infrastructure is an important intermediate input for the corporate sector, its allocation should be driven more by economic criteria. In addition, it has an important impact on social welfare, making it unfair to provide insufficient infrastructure in the major urban centres. Instead, regional inequality should be addressed through other measures, including well-targeted social welfare programmes, tax transfers among prefectures and policies to boost productivity growth in the service sector.

[FIGURE 3.4 OMITTED]

The rising share of public investment needed to maintain and renew existing infrastructure is another constraint on further reducing spending. According to the Ministry of Land, Infrastructure and Transport (2005), expenditure on maintenance and renewal will exceed the amount of new investment by 2011 and will totally crowd out new investment by 2022, if the current pace of spending cuts is maintained. However, this assumes that the existing stock of infrastructure is maintained, which is not an economically efficient choice in the context of a falling population, internal migration and a changing age composition. Indeed, the government projects that Japan's working-age population will fall by 16% by 2025, with the extent of the decline in Japan's 47 prefectures ranging from 4% to 32%. Meanwhile, the population over 65 years old will rise by 41% nationwide, with the rate of increase by prefecture varying between 12% and 73%. Such significant changes in total population and in its composition at the prefectural level over the next 18 years imply that the type and quantity of public infrastructure will need to adjust rapidly. Maintaining the existing stock of infrastructure in areas with large population declines would limit the scope for new infrastructure needed for an ageing population. In sum, the government must decide to maintain infrastructure required to satisfy demographic and economic trends, while eliminating unnecessary infrastructure.

[FIGURE 3.5 OMITTED]

Further cuts in public investment should be accompanied by measures to increase its efficiency to ensure the adequate provision of public goods and services. Reforms to improve bidding, contracting and selection systems for public investment, in addition to strengthening the enforcement of competition policy, (20) have reduced the unit cost of public construction from 227.9 thousand yen (per square metre) in FY 1999 to 197.1 thousand yen in FY 2005 (Table 3.7). (21) However, it was still 18% higher than in the private sector in FY 2005, implying scope to further reduce construction costs. The gap is largest in the construction of factories, hospitals and offices. Although public construction accounts for only about 10% of total public investment, reducing costs should be a priority as it allows cuts in public expenditure without reducing the quantity or quality of public investment.

Reducing the size of the government and increasing its efficiency

The current administration aims to create a "small and efficient government", as stated in the Basic Policies 2007, by reducing the government wage bill by more than 2.6 trillion yen (0.5% of GDP) over a decade. The reduction will be achieved by simultaneously cutting employment and reforming the wage system. This will help achieve the government's target of halving the total compensation of central government workers (including employees of central government corporations) as a share of GDP in ten years. (22) There is public support for reducing government compensation before cutting other public expenditures or raising taxes, reflecting the fact that public wages have not experienced the marked decline recorded in the private sector (Figure 3.6). Indeed, wages of government employees are 14% higher than in 1990 compared to only a 1% rise in the private sector. However, the impact of higher wage growth on total compensation was partially offset by a sharp decline in government employment beginning in 2004 (Panel B).

[FIGURE 3.6 OMITTED]

The scope for cutting the central government wage bill is limited by the fact that employment is already small. In 2006, there were only 2.6 central government workers per 1 000 population in Japan, compared to 4 in the United States and 33 in the United Kingdom (Figure 3.7). Given that central government workers account for only about 8% of public-sector employees in Japan, efforts to reduce the government wage bill should include local governments, public enterprises and other government-related organisations in accordance with the Law for the Promotion of Administrative Reform and other related reform plans. However, overall government employment is also low in Japan. Nevertheless, privatisation and the market-testing initiative, which was fully implemented in 2006, should be used to cut public employment by outsourcing government activities to private-sector firms (see Chapter 5). Reductions in the government wage bill should be accomplished by policies that enhance productivity and efficiency in the public sector, in particular by increasing labour mobility. In this regard, the priority should be to further reform aspects of the rigid and closed government wage and employment system, such as the steep seniority-based wage curve and the retirement pay structure that discourages job changes. The introduction of more flexible career paths and wage structures, combined with active personnel exchanges with the private sector, would enhance productivity and thereby reduce the government wage bill.

[FIGURE 3.7 OMITTED]

Moreover, there is scope to reduce the wages of local government workers as part of the objective to cut the government wage bill. First, the estimates of the average wage of workers in local governments range from roughly equal to about 12% higher than those in the central government despite the lower living costs in regional areas. Unless there is clear evidence of higher productivity at the local level, there is room to reduce wages of local government workers relative to the central government. Second, the variation in public-sector wages across regions does not appear to accurately reflect differences in the cost of living (Figure 3.8). In particular, the gap between public and private-sector employees in low-income areas is large compared to high-income areas. (23) This suggests some scope for reduction in the local government wage bill, which in addition might boost productivity by making the private sector more attractive to talented individuals.

[FIGURE 3.8 OMITTED]

Conclusion: additional revenues are needed to achieve Japan's medium-term fiscal objectives

Japan still has some scope to reduce government outlays. In particular, cutting public investment to a level closer to the OECD average and lowering the government wage bill could reduce expenditures by around 1 1/2 per cent of GDP. However, it will be more difficult to achieve significant savings in social spending, given its relatively low level at present and the impact of rapid ageing. Nevertheless, measures to slow the growth of social expenditure are crucial to the success of Japan's medium-term fiscal plan as it accounts for 40% of total spending. In sum, further reducing government expenditures as a share of GDP is still the top priority for fiscal consolidation. The cuts by specific spending programmes that were incorporated in the 2007 Direction and Strategy are an important addition to the medium-term plan, although the size of the reductions should be made more ambitious.

In any case, expenditure cuts alone are inadequate, given the size of Japan's fiscal deficits. Projections by the government show that an improvement in the primary budget surplus of between 4% and 5% of GDP (24)--a range in line with OECD estimates discussed above--is needed to achieve the government's objective of balancing the public debt ratio. Achieving such an improvement will require increased government revenue. Indeed, the same government projection expects that between 4.6% and 5.9% of GDP in additional tax revenue is needed for this goal, while an even larger amount is required to reduce the debt ratio beginning in the mid-2010s. However, the government's medium-term fiscal plans do not suggest any concrete measures to raise revenue. While this may have been an appropriate strategy to focus attention on expenditure cuts during the initial stage of fiscal consolidation, the serious fiscal situation now requires a comprehensive tax reform to achieve the government's fiscal objectives. Chapter 4 analyses Japan's tax system and proposes a comprehensive reform plan.
Box 3.2. Summary of recommendations for medium-term fiscal
consolidation

Improve the framework for fiscal consolidation

* Make the spending cut targets in the Direction and Strategy more
ambitious by aiming at a further reduction in the share of government
spending relative to GDP.

* Make sure that the economic assumptions underlying the Reference
Projections are not overly optimistic.

* Ensure the sustainability of the social security fund, which is not
included explicitly in the Direction and Strategy. The government's
budget target for central and local governments should not be achieved
through a deterioration in the balance of the social security fund.

* Set targets for the primary balance of general government that are
large enough to stabilise, and eventually reduce, the debt to GDP
ratio in the mid-2010s, in line with the government's stated
objective.

Pursue policies to contain spending

* Focus future reforms of the pension system on raising the pension
eligibility age rather than on cutting benefits or increasing
premiums, which are already set to rise significantly.

* Strengthen market forces and incentive mechanisms in healthcare and
long-term nursing care to limit cost increases.

* Reduce healthcare costs by increasing the use of generic medicines,
and nursing care costs by providing care managers with incentives to
curb the expenditures of their clients.

* Make greater use of information technology in medical bills to
reduce management costs and strengthen oversight.

* Further reduce public investment, while emphasising a more efficient
allocation to boost its impact on economy-wide productivity.

* Develop a comprehensive plan to close inefficient public
infrastructure in the context of population ageing and urbanisation to
limit renewal and maintenance costs that would crowd out important new
public investment.

* Expand the plan to cut the central government wage bill to include
the entire public sector and make it more binding on local
governments.

* Focus on reducing the government wage bill by increasing
productivity in the public sector rather than on across the board cuts
in employment.

* Promote greater use of market testing to outsource government
activities to the private sector.

ANNEX 3.A1

"Growth scenario" and "risk scenario"
of the 2008 Reference Projection (1)

Fiscal year                                     2005  2006  2007  2008

A. Macroeconomic indicators (per cent change from proceeding year)

  Real GDP                               2008a   2.4   2.3   1.3   2.0
                                         2008b   2.4   2.3   1.3   2.0
  Nominal GDP                            2008a   1.1   1.6   0.8   2.1
                                         2008b   1.1   1.6   0.8   2.1
  GDP deflator                           2008a  -1.3  -0.7  -0.5   0.1
                                         2008b  -1.3  -0.7  -0.5   0.1
  CPI                                    2008a  -0.1   0.2   0.2   0.3
                                         2008b  -0.1   0.2   0.2   0.3
  Nominal long-term interest             2008a   1.4   1.7   1.6   1.7
    rate (per cent)                      2008b   1.4   1.7   1.6   1.7

B. Fiscal Indicators (per cent of GDP)

  General government fiscal balance      2008a  -4.3  -3.3  -2.8  -3.0
                                         2008b  -4.3  -3.3  -2.8  -3.0
  of which:
    Central government                   2008a  -4.1  -3.4  -2.8  -2.9
                                         2008b  -4.1  -3.4  -2.8  -2.9
    Local government                     2008a  -0.4   0.2   0.2   0.5
                                         2008b  -0.4   0.2   0.2   0.5
    Social security fund (2)             2008a   0.3  -0.1  -0.2  -0.6
                                         2008b   0.3  -0.1  -0.3  -0.6
    Primary balance of the general       2008a  -3.6  -2.7  -1.9  -2.1
      government (2)                     2008b  -3.6  -2.7  -1.9  -2.0

  of which:
    Central and local government         2008a  -2.9  -1.7  -0.7  -0.5
                                         2008b  -2.9  -1.7  -0.7  -0.5
    Social security fund (2)             2008a  -0.7  -1.0  -1.2  -1.6
                                         2008b  -0.7  -1.0  -1.2  -1.5

Fiscal year                                     2009  2010  2011

A. Macroeconomic indicators (per cent change from proceeding year)

  Real GDP                               2008a   2.3   2.5   2.6
                                         2008b   1.6   1.3   1.1
  Nominal GDP                            2008a   2.5   2.9   3.3
                                         2008b   1.8   1.6   1.6
  GDP deflator                           2008a   0.2   0.4   0.7
                                         2008b   0.1   0.3   0.5
  CPI                                    2008a   0.6   1.0   1.4
                                         2008b   0.6   0.9   1.1
  Nominal long-term interest             2008a   2.1   2.4   2.9
    rate (per cent)                      2008b   1.9   2.1   2.3

B. Fiscal Indicators (per cent of GDP)

  General government fiscal balance      2008a  -2.7  -2.4  -2.2
                                         2008b  -2.8  -2.7  -2.7
  of which:
    Central government                   2008a  -3.0  -3.0  -2.9
                                         2008b  -3.0  -3.2  -3.2
    Local government                     2008a   0.3   0.4   0.5
                                         2008b   0.3   0.4   0.4
    Social security fund (2)             2008a   0.0   0.2   0.2
                                         2008b   0.0   0.1   0.1
    Primary balance of the general       2008a  -1.6  -1.2  -0.9
      government (2)                     2008b  -1.7  -1.5  -1.5

  of which:
    Central and local government         2008a  -0.6  -0.4  -0.1
                                         2008b  -0.7  -0.7  -0.6
    Social security fund (2)             2008a  -1.0  -0.8  -0.8
                                         2008b  -1.0  -0.8  -0.9

(1.) The figures are from the scenarios 1-A (2008a) and 2-A
(2008b). While both scenarios assume that the fiscal consolidation
programme announced in 2006 is implemented, the macroeconomic
assumptions are different. In the case of the "growth scenario"
(shown in 2008a), the positive effects of supply-side reforms and
favourable global economic conditions will boost growth (this
scenario is also shown in Figure 3.2). However, in the absence of
these positive factors, growth will be lower in the "risk scenario"
shown in 2008b.

(2.) The figures are calculated by the OECD based on the figures in
the Reference Projection and the OECD Economic Outlook, No. 82
Database.

Source: Cabinet Office (2008) and OECD calculations.


Bibliography

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Cabinet Office (2006), Reference Projection, January, Tokyo (in Japanese).

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Cabinet Office (2008), Reference Projection, January, Tokyo (in Japanese).

Carlin, Wendy and David Soskice (2005), Macroeconomics: Imperfections, Institutions and Policies, Oxford University Press.

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Fatas, Antonio (2005), "Is there a case for sophisticated balanced-budget rules?", Economics Department Working Paper No. 466, OECD, Paris.

Fiscal System Council (2007), On the Analysis of Fiscal Sustainability, a paper submitted by members of the drafting committee, 26 October 2007, Ministry of Finance, Tokyo (in Japanese).

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Ministry of Finance (2007b), On the Wage Bill of Central Government Employees, a reference paper submitted to the Fiscal System Council on 26 October 2007, Tokyo (in Japanese).

Ministry of Finance (2007c), On the Wage Bill of Local Government Employees, a reference paper submitted to the Fiscal System Council on 26 October 2007, Tokyo (in Japanese).

Ministry of Finance (2007d), On Social Security, a reference paper submitted to the Fiscal System Council on 5 November 2007, Tokyo (in Japanese).

Ministry of Health, Labour and Welfare (2005), Actuarial Revaluation in 2004, Tokyo (in Japanese).

Ministry of Health, Labour and Welfare (2006), Projection on Social Security Payments and Contributions, May 2006, Tokyo (in Japanese).

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OECD (2006a), OECD Economic Survey of Germany 2006, OECD, Paris.

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OECD (2006c), "Projecting OECD Health and Long-term Care Expenditures: What are the Main Drivers?", Economics Department Working Paper No. 477, OECD, Paris.

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Van den Noord, Paul (2002), "Automatic Stabilisers in the 1990s and Beyond", in The Behaviour of Fiscal Authorities: Stabilisation, Growth and Institutions, edited by M. Buti, J. Von Hagen and C. Martinez-Mongay, European Communities.

Notes

(1.) On a cyclically-adjusted basis, the general government deficit adjusted for one-off factors declined by 3.1% of GDP during the period 2002-07, some three-quarters of the 4.1% fall in the deficit (Table 3.1).

(2.) Given shrinking interest payments, the primary budget deficit--which excludes interest payments--has fallen by less than the overall budget deficit over the period 2002-2007. In 2007, it was around 3% of GDP on a general government basis, excluding one-off factors.

(3.) While net debt may provide a better indicator of the economic burden, there are several factors that make gross debt a more appropriate measure. First, government assets are largely held by the social security system and are thus earmarked for future obligations. Second, the quality of some government assets, such as credits to Fiscal Investment and Loan Programme institutions, is doubtful. Only about a third of government assets are in the form of liquid instruments, such as bonds or cash. Third, both net and gross measures of debt exclude contingent liabilities, such as loan guarantees for quasi-government institutions, and may thus understate the government's eventual obligations. Gross debt, which is higher as it excludes government assets, may thus provide a more realistic picture of the government's obligations. Indeed, the government's medium-term fiscal objectives are framed in terms of stabilising gross debt relative to GDP.

(4.) The Direction and Strategy replaces the Reform and Perspective, which had earlier set the target of a primary budget surplus in the early 2010s. Like its predecessor, the Direction and Strategy will be revised annually based on a Cabinet decision. One of its key features is a formal review mechanism to check outcomes with the target.

(5.) This target was first set by the Basic Policies 2006, which included the Integrated Expenditure and Revenue Reform, published in July 2006 (see the 2006 OECD Economic Survey of Japan).

(6.) The gap between the primary deficit of 3.2% of GDP for the general government in calendar year 2007 estimated by the OECD (Table 3.1) can be reconciled with the 0.7% primary deficit for central and local governments in the 2008 Reference Projection as follows: i) the OECD estimate excludes a one-off factor of 0.6% of GDP. The overall deficit was thus 2.5% of GDP; ii) the Reference Projection excludes the social security fund, which had a primary deficit estimated at 1.2% of GDP in FY 2007 (Table 3.2). Including social security thus raises the deficit estimated by the Reference Projection to 1.9% of GDP. The remaining gap of 0.6% of GDP is explained by the difference between calendar and fiscal years, which begin in April of each year. Over the past ten years, the primary budgets of calendar and fiscal years have differed by an average of 0.4% of GDP.

(7.) The 0.4 percentage improvement in the social security fund is projected to reduce its deficit, on a primary budget basis, by a similar amount, from an estimated 1.2% of GDP in FY 2007 to 0.8% in FY 2011.

(8.) This includes the 0.6% of GDP decline in the primary budget deficit of central and local governments (from 0.7% of GDP to 0.1%) and the 0.4% of GDP improvement in the social security fund.

(9.) The 2008 Reference Projection for FY 2011 (based on the "growth scenario") shows a primary budget deficit of 0.1% of GDP for central and local governments in FY 2011 (Table 3.2). Given the projected deficit in the social security fund as well, as noted above, the primary balance in the general government is likely to be negative.

(10.) A 1% surplus would stabilise gross debt--the government's objective--at its current level of around 144% of GDP, according to the government's definition.

(11.) An effective interest rate that is higher than the nominal growth rate is also the norm in the OECD area (see the 2006 OECD Economic Survey of Japan).

(12.) The 2007 and 2008 Reference Projections assume the expenditure path in the Integrated Reform of Expenditure and Revenue of July 2006, which targets cuts relative to a baseline of 3% nominal output growth. Consequently, it has a smaller amount of expenditure cuts than the 2006 Reference Projection.

(13.) In addition, there was a temporary change in the indexation of pension benefits to prices. During the years 1999 to 2001, the decline in the consumer price index (CPI) was not reflected in pension benefits. To bring benefits back into line with the CPI, it was decided to adjust the growth of pension benefits in line with changes in the CPI when it declines but not when it rises. When the cumulative increase in the CPI relative to 2005 reaches 1.7%, the adjustment of pension benefits in line with increases in the CPI would resume.

(14.) Without macroeconomic indexation, the sustainability of the pension system over 100 years (as shown in Table 3.6) cannot be assured.

(15.) In FY 2008, the eligibility age for receiving the flat-rate portion of the pension was 64 for men and 62 for women, respectively. It is to be raised to 65 years in 2013 for men and in 2018 for women.

(16.) The government requires all insurers to support medical exams for their insurees above age 40.

(17.) These are identified as obesity, high blood pressure and elevated levels of cholesterol and insulin.

(18.) The share of generic medicine in Japan is 17% in terms of quantity and 5% in terms of value. In contrast, the shares are 56% and 13% in the United States, 49% and 21% in the United Kingdom and 41% and 23% in Germany. The Ministry of Finance estimates that greater use of generic medicines could save 1.3 trillion yen per year.

(19.) Indeed, domestic demand growth slowed from 2% in 2004 to 1% in 2007, while export growth remained buoyant at more than 8% over that period.

(20.) The FTC has been engaged in a strong effort against bid-rigging, which accounted for six of 13 legal measures taken in FY 2006 (see Chapter 5).

(21.) The successful bid rate--the bid price as a per cent of the assumed price--for public investment by the Ministry of Land, Infrastructure and Transport dropped from a simple average of 97% in FY 2000 to 90% in FY 2006.

(22.) This objective was included in the 2006 Law for the Promotion of Administrative Reform, which includes: i) scaling back public financial institutions; ii) reforming independent administrative agencies; iii) reforming the special accounts; iv) cutting the total compensation of public-sector workers, including a 5% cut in the number of central government employees over five years; and u) sales of government assets.

(23.) This may also reflect the fact that the skills of public-sector workers are similar across regions while there are large differences in the private sector.

(24.) Assuming economic growth of 1.7%, a rate somewhat above the OECD's estimate of potential growth of 1.4%.
Table 3.1. The evolution of the fiscal situation in Japan between
2002 and 2007

A. Fiscal situation (per cent of GDP)

Calendar years                          2002   2003   2004   2005

A. Total
Net lending                             -8.0   -7.9   -6.2   -6.4
Primary balance                         -6.6   -6.6   -5.0   -5.6
Cyclically-adjusted net lending         -7.0   -6.9   -5.6   -6.0
Cyclically-adjusted primary balance     -5.7   -5.6   -4.4   -5.2

B. Excluding one-off factors

Net lending                             -8.2   -8.3   -7.3   -5.6
Primary balance                         -6.8   -6.9   -6.2   -4.8
Cyclically-adjusted net lending         -7.2   -7.2   -6.7   -5.2
Cyclically-adjusted primary balance     -5.8   -5.9   -5.6   -4.4
One-off factors (3)                      0.1    0.4    1.2   -0.8

C. Spending and revenue levels

General government expenditure          38.8   38.4   37.0   38.2
General government revenue              30.6   30.2   29.7   32.5

                                                              Change
Calendar years                        2006 (1)   2007 (1)   2002-07 (2)

A. Total
Net lending                              -2.9       -3.4         4.6
Primary balance                          -2.1       -2.5         4.1
Cyclically-adjusted net lending          -2.8       -3.5         3.6
Cyclically-adjusted primary balance      -2.0       -2.6         3.1

B. Excluding one-off factors

Net lending                              -4.9       -4.0         4.1
Primary balance                          -4.1       -3.2         3.6
Cyclically-adjusted net lending          -4.8       -4.1         3.1
Cyclically-adjusted primary balance      -4.0       -3.2         2.6
One-off factors (3)                       2.0        0.6

C. Spending and revenue levels

General government expenditure           36.6       36.5        -2.4
General government revenue               31.7       32.4         1.8

B. Contribution to fiscal change by item (calendar years)

                                      Per cent of GDP
                                                            Change
                                      2002     2007 (1)   2002-07 (2)

Revenue items
Direct taxes on households             5.2         5.6        0.4
Direct taxes on business               2.9         4.0        1.2
Social security contributions
  received                            10.5        10.9        0.4
by government
Indirect taxes                         8.4         8.4       -0.1
Interest receipts                      1.6         1.7        0.0
Others                                 2.0         1.9       -0.2
Total revenues                        30.6        32.4        1.8
Expenditure items
Government wage expenditure            6.7         6.1       -0.7
Government consumption on social
  benefits (4)                         3.7         4.2        0.5
Other government consumption           7.5         7.6        0.1
Social security benefits paid by
  government                          11.1        11.6        0.6
Government fixed capital formation     4.8         3.2       -1.6
Interest payments                      3.0         2.5       -0.5
Other expenditures                     2.0         1.2       -0.7
Total expenditure                     38.8        36.5       -2.4
Budget balance                        -8.2        -4.0        4.1
Primary budget balances               -6.8        -3.2        3.6

(1.) OECD estimates.

(2.) Difference in percentage points.

(3.) Major one-off factors include the transfer of the basic part
of corporate pension funds to the government, the transfer of debt
from the highway corporations to the newly established Expressway
Holding and Debt Repayment Agency, and the transfer of the reserve
fund from the Fiscal Loan Fund Special Account to the central
government.

(4.) Mainly healthcare and long-term nursing care.

(5.) Includes subsidies, other current payments, capital transfer
payments and consumption of fixed capital.

(6.) Excludes net interest payments.

Source: Cabinet Office and OECD, OECD Economic Outlook, No. 82
Database, OECD, Paris.

Table 3.2. Evolution of the medium-term plan of the government (1)

                                     Year of
Fiscal year                           plan    2005  2006  2007  2008

A. Macroeconomic indicators (per cent change from proceeding year)

Real GDP                              2006     2.7   1.9   1.8   1.8
                                      2007     2.4   1.9   2.0   2.1
                                      2008     2.4   2.3   1.3   2.0

Nominal GDP                           2006     1.6   2.0   2.5   2.9
                                      2007     1.0   1.5   2.2   2.8
                                      2008     1.1   1.6   0.8   2.1

GDP deflator                          2006    -1.1   0.1   0.7   1.1
                                      2007    -1.3  -0.4   0.2   0.7
                                      2008    -1.3  -0.7  -0.5   0.1

CPI                                   2006     0.1   0.5   1.1   1.6
                                      2007    -0.1   0.3   0.5   1.2
                                      2008    -0.1   0.2   0.2   0.3

Nominal long-term interest            2006     1.4   1.7   2.4   2.9
  rate (per cent)                     2007     1.4   1.8   2.1   2.6
                                      2008     1.4   1.7   1.6   1.7

B. Fiscal Indicators (per cent of GDP)
General government fiscal balance     2006    -5.4  -5.0  -4.0  -3.7
                                      2007    -5.8  -3.6  -3.0  -2.8
                                      2008    -4.3  -3.3  -2.8  -3.0

of which: Central government          2006    -5.0  -4.5  -3.4  -3.2
                                      2007    -5.9  -3.5  -2.7  -2.6
                                      2008    -4.1  -3.4  -2.8  -2.9

          Local government            2006    -0.4  -0.2  -0.4  -0.3
                                      2007    -0.2   0.1   0.3   0.4
                                      2008    -0.4   0.2   0.2   0.5

          Social security fund (2)    2006     0.0  -0.2  -0.2  -0.2
                                      2007     0.3  -0.2  -0.6  -0.6
                                      2008     0.3  -0.1  -0.2  -0.6

Primary balance of general            2006    -4.7  -4.2  -3.1  -2.6
government (2)                        2007    -5.1  -2.8  -2.1  -1.9
                                      2008    -3.6  -2.7  -1.9  -2.1

of which: Central and local           2006    -3.3  -2.8  -2.0  -1.5
  government                          2007    -2.9  -1.7  -0.6  -0.4
                                      2008    -2.9  -1.7  -0.7  -0.5

          Social security fund (2)    2006    -1.4  -1.4  -1.1  -1.1
                                      2007    -2.2  -1.1  -1.5  -1.5
                                      2008    -0.7  -1.0  -1.2  -1.6

General government expenditure        2006    36.1  35.6  34.9  34.8
                                      2007    n.a   n.a   n.a   n.a
                                      2008    n.a   n.a   n.a   n.a

                                     Year of
Fiscal year                           plan    2009  2010  2011

A. Macroeconomic indicators (per cent change from proceeding year)

Real GDP                              2006     1.7   1.7   1.7
                                      2007     2.2   2.4   2.5
                                      2008     2.3   2.5   2.6

Nominal GDP                           2006     3.1   3.1   3.2
                                      2007     3.3   3.7   3.9
                                      2008     2.5   2.9   3.3

GDP deflator                          2006     1.3   1.4   1.5
                                      2007     1.1   1.3   1.3
                                      2008     0.2   0.4   0.7

CPI                                   2006     1.9   2.1   2.2
                                      2007     1.7   1.9   1.9
                                      2008     0.6   1.0   1.4

Nominal long-term interest            2006     3.3   3.7   3.9
  rate (per cent)                     2007     3.3   3.7   4.0
                                      2008     2.1   2.4   2.9

B. Fiscal Indicators (per cent of GDP)

General government fiscal balance     2006    -3.4  -2.9  -2.8
                                      2007    -2.4  -2.0  -1.8
                                      2008    -2.7  -2.4  -2.2

of which: Central government          2006    -3.3  -3.2  -3.4
                                      2007    -3.0  -3.0  -3.0
                                      2008    -3.0  -3.0  -2.9

          Local government            2006    -0.2  -0.1   0.1
                                      2007     0.5   0.6   0.7
                                      2008     0.3   0.4   0.5

          Social security fund (2)    2006     0.1   0.4   0.4
                                      2007     0.1   0.4   0.5
                                      2008     0.0   0.2   0.2

Primary balance of general            2006    -1.8  -0.9  -0.5
government (2)                        2007    -1.3  -0.6  -0.2
                                      2008    -1.6  -1.2  -0.9

of which: Central and local           2006    -1.0  -0.4   0.0
  government                          2007    -0.5  -0.1   0.2
                                      2008    -0.6  -0.4  -0.1

          Social security fund (2)    2006    -0.8  -0.5  -0.5
                                      2007    -0.8  -0.5  -0.4
                                      2008    -1.0  -0.8  -0.8

General government expenditure        2006    34.6  34.4  34.4
                                      2007    n.a   n.a   n.a
                                      2008    n.a   n.a   n.a

(1.) The Reference Projection is revised in January of each year.
The figures for 2006 are from the "Base Case" in which the budget
surplus is achieved in FY 2011. The figures for 2007 and 2008 are
from the "growth scenario" (1-A), in which: i) output growth is
sustained by supply-side reforms to improve potential growth and a
favourable global environment; and ii) the spending reductions
scheduled in the fiscal consolidation programme announced in July
2006 are implemented. The Reference Projection also includes a
"risk scenario", shown in Annex 3.A1, in which growth is lower in
the absence of reforms and a favourable growth environment.

(2.) The figures are calculated by the OECD based on the figures in
the Reference Projection and the OECD Economic Outlook, No. 82
Database.

Source: Cabinet Office (2006, 2007c and 2008) and OECD
calculations.

Table 3.5. Projection of social spending to FY 2015

                                         FY 2006

                         Before reform           After reform (1)

                       Trillion     Share      Trillion     Share
                         yen      of GDP (2)     yen      of GDP (2)

Total outlays            91.0       17.7         89.8       17.5
Pensions                 47.3        9.2         47.4        9.2
Healthcare               28.5        5.5         27.5        5.4
Welfare                  15.2        3.0         14.9        2.9
of which:
Elderly nursing care      6.9        1.3          6.6        1.3

                                         FY 2011

                          Before reform           After reform (1)

                       Trillion     Share      Trillion     Share
                         yen      of GDP (2)     yen      of GDP (2)

Total outlays           110.0       18.4        105.0       17.6
Pensions                 56.0        9.4         54.0        9.1
Healthcare               34.0        5.8         32.0        5.4
Welfare                  20.0        3.3         18.0        3.1
of which:
Elderly nursing care     10.0        1.7          9.0        1.4

                                         FY 2015

                         Before reform           After reform (1)

                       Trillion     Share      Trillion     Share
                         yen      of GDP (2)     yen      of GDP (2)

Total outlays           126.0       19.9        116.0       18.4
Pensions                 64.0       10.1         59.0        9.3
Healthcare               40.0        6.3         37.0        5.8
Welfare                  23.0        3.6         21.0        3.2
of which:
Elderly nursing care     12.0        2.0         10.0        1.6

(1.) Includes the impact of the 2004 pension reform, 2005 elderly
nursing care reform and 2006 healthcare reform.

(2.) GDP growth rate until FY 2011 is based on the 2006 Reference
Projection (Table 3.2). The Ministry of Health, Labour and Welfare
assumes an annual growth rate of 1.6% after FY 2011.

Source: Ministry of Health, Labour and Welfare (2006).

Table 3.6. Long-run projections for the public pension system (1)

Trillion yen

                                                     Ratio of
         Revenue    Outlays   Balance               the Fund to
Year       (A)        (B)      (A-B)    Fund (C)   outlays (C/B)

2005       32.3      36.1      -3.8      174.7          4.9
2006       34.1      37.4      -3.3      171.4          4.7
2007       35.8      38.6      -2.8      168.7          4.4
2008       37.8      39.9      -2.1      166.5          4.2
2009       41.5      41.5       0.0      166.5          4.0
2010       43.2      42.6       0.6      167.0          3.9
2015       50.5      47.3       3.2      176.3          3.7
2020       56.5      49.7       6.8      204.2          4.0
2025       61.8      52.5       9.3      246.3          4.5
2030       67.4      57.5       9.9      295.8          5.0
2040       77.4      73.5       3.9      368.8          5.0
2050       86.6      87.8      -1.2      377.0          4.3
2060       95.3      97.7      -2.4      356.3          3.7
2070      103.1     107.3      -4.2      324.1          3.1
2080      111.9     117.8      -5.9      273.1          2.4
2090      123.1     130.0      -6.9      207.4          1.6
2100      136.7     143.9      -7.2      136.7          1.0

(1.) The National Pension Scheme and Employees' Pension System.

Source: Ministry of Health, Labour and Welfare (2005).

Table 3.7. Comparison of the unit cost of public and private
construction

Thousand yen per square metre (1)

                                           FY 1999

                            Public (A)   Private (B)   Ratio (A/B)

Residences                    177.2         165.6         1.07
Offices                       255.3         197.3         1.29
Shops                         194.6         110.8         1.76
Factories and workplaces      242.2         103.0         2.35
Warehouses                    121.1          79.2         1.53
Schools                       219.2         210.4         1.04
Hospitals                     346.0         207.1         1.67
Other                         252.7         167.6         1.51
Average (2)                   227.9         157.4         1.45
Average (3)                   227.9         175.4         1.30

                                           FY 2005

                            Public (A)   Private (B)   Ratio (A/B)

Residences                    167.3         161.3         1.04
Offices                       265.1         175.1         1.51
Shops                         153.5         102.5         1.50
Factories and workplaces      188.1         109.3         1.72
Warehouses                    111.5          72.3         1.54
Schools                       168.3         197.2         0.85
Hospitals                     338.9         209.4         1.62
Other                         213.7         143.0         1.49
Average (2)                   197.1         148.3         1.33
Average (3)                   197.1         167.1         1.18

                              Change
                             in ratio

Residences                    -0.03
Offices                        0.22
Shops                         -0.26
Factories and workplaces      -0.63
Warehouses                     0.01
Schools                       -0.19
Hospitals                     -0.05
Other                         -0.01
Average (2)                   -0.12
Average (3)                   -0.12

(1.) Original data is from Table 17 in the Yearbook of Building
Construction Started and New Dwellings Started, Ministry of Land,
Infrastructure, and Transport.

(2.) Public and private construction are each weighted by their
individual composition.

(3.) Public and private construction are both weighted by the
composition of public construction for comparison purposes.

Source: Council on Economic and Fiscal Policy (2007a) and OECD
calculations.
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Title Annotation:Chapter 3
Publication:OECD Economic Surveys - Japan
Date:Apr 1, 2008
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