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Japan Stands Up

(Version in  日本語)

As a Japanese proverb has it: “Knocked down seven times, get up eight.”

In a display of its resilience, Japan is getting up once again after the devastating earthquake and tsunami of a year ago.  But the world’s third largest economy still faces multiple challenges, and in our latest assessment of the country’s economy, the Japanese mission team at the International Monetary Fund has proposed a range of mutually reinforcing policies to strengthen confidence, raise growth and help restore Japan’s economic vitality.

A year and four months ago, Japan was reeling from the Great East Japan earthquake and accompanying devastation.  As well as the tragic loss of life, the economy was badly shaken.  Supply chain disruptions brought production in parts of Japan to a virtual halt. Yet, since then, the country has shown its resilience, with reconstruction contributing to strong first quarter growth of 4¾ percent.

But despite this hopeful sign, all is not well.

A contentious debate over how to address the large and growing public debt has occupied the political center stage. Deflation continues to affect economic activity, euro Area turmoil is casting clouds on growth prospects, and the appearance of an army of office workers in “cool biz” attire is a reminder of continuing energy shortages. Against this backdrop, the IMF conducted its regular health check of the world’s third largest economy.

Following that annual checkup, and in response, Fund staff are proposing a virtuous circle of positive, integrated policies: well-designed fiscal adjustment plans to strengthen confidence, and structural reforms to raise growth and support central bank actions to end deflation. Indeed, an end to deflation would help fill fiscal coffers and support activity, and so on.

Rising debt

The first order of business is to put Japan’s fiscal house in order. Net debt has increased ten-fold since 1990 and—at 130 percent of GDP—is the highest of any advanced economy. Over the same period, social security spending has risen from 10 to 22 percent of GDP while associated revenues have remained flat.

These developments threaten fiscal sustainability, but also place an enormous burden on the young. A typical household with head aged between 20 and 29 can expect to make net resource transfers to the government of 16 years of their income over a lifetime.

So, how should Japan address this rising debt burden? The crisis in Europe offers two critical lessons.

Lessons from Europe

Once investor confidence is lost, regaining it is no simple task. So, while bond yields are low and there is no imminent threat of a crisis, it is critical for Japan to put in place as soon as possible, a credible medium-term adjustment plan.

The recent passage by the lower house of parliament of a doubling of the consumption tax to 10 percent by 2015 is an important step. More will be needed, but this is a strong statement of purpose.

Secondly, adjustment is necessary, but adjustment without growth is unlikely to work. Japan’s potential growth has been depressed by a shrinking labor force and weak investment.  Furthermore, adjustment may weigh on near-term growth. Failure to raise potential growth will make it all the more difficult to reduce the debt burden on the economy.

A more dynamic Japan

So how to raise growth? Some potentially fruitful directions to consider:

All this is easier said than done, of course, but Japan’s history emphasizes its ability to reinvent and revitalize itself. It can do so again.