Kan's Megaproblem

Article excerpt

Byline: Paul J. Scalise

Japan's debt is too big to manage.

Japan's former finance minister, Naoto Kan, has become the nation's fifth prime minister in just four years--and the predictable cycle of high expectations followed by mild cynicism has begun anew. How long he will remain in office is anyone's guess, but one thing is certain: trying to solve government finances could be for this premier the same kind of career killer that the Futenma base-relocation issue was for the last one.

The inescapable math of an aging society that has been promised huge retirement and welfare benefits, which are not fully covered by taxes, could make Kan's tenure a true test of government and party leadership. Japan's gross debt-to-GDP ratio is second only to Zimbabwe, at almost 200 percent. Even if double counting the debt (what government agencies owe each other) were deducted, net debt is still 113 percent of GDP. That's about the same ratio as Greece, which ignited a continentwide financial meltdown earlier this year.

No one can predict if or when the Japanese bond market will collapse, of course, but rating agencies, the Organization for Economic Cooperation and Development, and the International Monetary Fund have all publicly expressed concern. Aging populations exacerbate pension costs and pay fewer taxes. In Greece, the 65-and-over population is projected to increase from 18 percent of the total in 2005 to 25 percent in 2030. For Japan, the swell is worse, from 19.9 percent to 30 percent.

Until recently, Japan's debt--the total of all annual budget deficits--was allowed to build thanks to the country's unique market conditions. With 95 percent of the national debt held by Japanese, increased government borrowing from its own citizens was arguably nothing more than a domestic transfer--a shift of funds from the right hand (taxes to pay off the debt) to the left hand (interest income for bond holders). As long as interest rates remained artificially low and competing investment opportunities in the private sector limited, the government could manage the bond market without depending on the kindness of foreign lenders. It could tap into the country's savings surplus until the economy recovered.

Except for one unforeseen glitch: the economy never recovered. Throughout two "lost decades," Japan applied small Band-Aids to festering fiscal wounds that drained the country of its dynamism and prolonged the recession. …