The Sovereign Debt Crisis: Similarities and differences between Italy and Japan

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"The Sovereign Debt Crisis Similarities and
differences between Italy and Japan"

• Takatoshi ITO
• University of Tokyo
• Presentation at Banca dItalia, Rome
• March 2, 2012

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Outline

• Introduction
• European Debt Crisis
• Japanese Debt Crisis (in future?)
• Demographic problem
• Puzzle. Why is the interest rate so low?
• Japans fiscal consolidation efforts
• Italy and Japan common challenges

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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

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Gross Government Debt-GDP ratio Japan used to be
respectable, not anymore. Japan is much worse
than Italy now
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Net Debt-GDP ratioSimilarly, in the Net measure
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European Debt Crisis

• Started with the Greek crisis
• Critical points of time October 2009 May 2010
  May 2011 July 2011 and December 2011
• Why couldnt 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 couldnt 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?

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General Government, primary surplus (Euro Area
countries with large debts)
Projection
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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

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Revenue and expenditure
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Tax Revenues by category, VAT is a best bet
Individual income tax
Corporate income tax
Excise Tax
Consumption tax
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Demography turns against Japan

• Long history of low fertility Lengthening life
  expectancy
• Increasing population cohort of age 65 and over
• Shrinking working age population
• Why have young couples not producing babies? ?
  Next slide
• Implications
• Increasing social security related expenditures
  under PAYGO plus tax subsidies to the system
• Growth rate declines, holding constant labor
  productivity measured by output per working-age
  population
• Demography and Economic Growth

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Declining Birth Rate
Healthy Elderly
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1950
Male
Female
Population, 10,000
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1980
Male
Female
Population, 10,000
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Baby boomer generation is about to retire
2010
Male
Male
Female
Population, 10,000
Second Baby boomer generation, sons and daughters
of the first
No third baby boom
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2040
Male
Male
Population, 10,000
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2060
Male
Female
Population, 10,000
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Economic Effects of Demographic transition

• 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

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Table 4. History Demographic Dividend
?rGDP ?rGDP ?POP ?POP ?POP ? (wPOP)/(POP) ? (rGDP/wPOP)
1955-1970 9.70 9.70 1.00 1.00 1.00 1.03 7.77
1971-1980 4.46 4.46 1.22 1.22 1.22 0.01 3.46
1981-1990 4.64 4.64 0.55 0.55 0.55 0.21 3.75
1991-2000 1.19 1.19 0.27 0.27 0.27 0.09 1.16
2001-2010 0.75 0.75 0.02 0.02 0.02 -0.49 1.34

But demography turns against growth in the
future, due to the low and declining fertility
rate and the lengthening longevity
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Table 5. Implication of 2 growthwhich is the
current government estimate
?rGDP ?POP ?(wPOP)/(POP) ?(rGDP/wPOP)
2011-2020 2.00 -0.35 -0.65 3.00
2021-2030 2.00 -0.63 -0.13 2.76
2031-2040 2.00 -0.86 -0.76 3.62
2041-2050 2.00 -1.05 -0.49 3.53
Unrealistic per-worker productivity growth
Government forecasts
Means ?
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Table 6. Growth per worker productivity at 1.25
to future
?rGDP ?POP ?(wPOP)/(POP) ?(rGDP/wPOP)
2011-2020 0.26 -0.35 -0.63 1.25
2021-2030 0.37 -0.63 -0.25 1.25
2031-2040 -0.36 -0.86 -0.75 1.25
2041-2050 -0.26 -1.05 -0.46 1.25
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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

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Total population Italy and Japan
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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

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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 lt
  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

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Puzzle, Debt and interest rateHigh debt but high
prices (low yield)
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Defying gravity

• More JGBs have been absorbed by domestic
  residentsbanks, insurance companies, and other
  financial institutionswithout raising the
  interest rate.
• Possible because
• Corporate deposits are increasing
• Household deposits are stable
• Bank loans to corporations are decreasing
• If any of these changes, then the debt becomes
  unsustainable

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Defying gravity in Tokyo
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When will gravity finally pulls the JGB price
down to the earthThe absolute ceiling of private
saving and increasing debts
Government Debt
Amount
Private Saving
Time
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Figure 6. Government Debt and Private Sector
Financial Assets 2010-2050 (1.25 GDP per worker
growth)
Source T. Hoshi and T. Ito, Defying Gravity
How Long Will Japanese Government Bond Prices
Remain High? To be published as NBER Working
paper, March 2012
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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 outbad for growth

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Figure 12. Sustainable Tax Policy (Increase from
33 to 41 starting in 2012)
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Italy and Japan, common challengesfiscal 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 do a better job
  than politicians?
• Why do politicians fail to make right decisions?

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Italy and Japan, common challengesfiscal 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

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Italy and Japan, common challengesGrowth Policy

• Not just fiscal austerity, but growth, we need
• 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?