IMES DISCUSSION PAPER SERIES Will a Growth Miracle Reduce Debt in Japan? Selahattin mrohorolu and Nao Sudo Discussion Paper No. 2011-E-1 INSTITUTE FOR MONETARY AND ECONOMIC STUDIES BANK OF JAPAN 2-1-1 NIHONBASHI-HONGOKUCHO CHUO-KU, TOKYO 103-8660 JAPAN You can download this and other papers at the IMES Web site: http://www.imes.boj.or.jp Do not reprint or reproduce without permission.
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IMES Discussion Paper Series 2011-E-1 January 2011 Will a Growth Miracle Reduce Debt in Japan? Selahattin mrohorolu* and Nao Sudo** Abstract Japan has the highest debt to GDP ratio among the developed nations. In addition, the population is projected to age rapidly over the next few decades, which will significantly increase the ratio of government expenditures to GDP. In this paper, we explore the effect of economic growth driven by total factor productivity on Japanese debt in the face of higher future social security expenditures. Our main finding is that a decade of unprecedentedly fast growth of total factor productivity, at an average of 6% per year, is needed in order for Japan to eliminate its debt. Since this is very unrealistic, what is needed is a significant reduction in government expenditures together with an increase in the consumption tax rate, to eliminate debt in forty years. Keywords: Government Debt; Productivity; Fiscal Policy JEL classification: E00, H20, H50 * Professor, Department of Finance and Business Economics, Marshall School of Business, University of Southern California (E-mail: simrohor@marshall.usc.edu) ** Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: nao.sudou@boj.or.jp) This paper is prepared for Keizai Kenkyu, released from Institute of Economic Research, Hitotsubashi University. The authors would like to thank Yukinobu Kitamura, Yasushi Hamao, Fumio Hayashi, Hideaki Hirata, Itsuo Sakuma, Toshiaki Watanabe, seminar participants at Hitotsubashi University, and the staff of the Institute for Monetary and Economic Studies (IMES), the Bank of Japan, for their useful comments. Views expressed in this paper are those of the authors and do not necessarily reflect the official views of the Bank of Japan.
110 100 90 Japan U.S. U.K. Germany France Italy Net Debt to GDP Ratio 80 70 60 50 40 30 20 1995 2000 2005 2010
Population (Normalized) 3 Technology Level (Normalized) 1.1 1 0.9 0.8 2.5 2 1.5 0.7 1 0.18 Transfer Payments to GNP Ratio 0.26 Government Purchases to GNP Ratio 0.16 0.24 0.14 0.12 0.1 0.22 0.2 0.08 0.18 0.06 0.16
60 55 50 45 40 35 Consumption 30 Model Data 25 1980 1985 1990 1995 2000 2005 2010 28 26 24 22 20 18 16 14 Investment 12 1980 1985 1990 1995 2000 2005 2010 110 Real GNP 3 Capital-Output Ratio 100 2.8 90 80 70 2.6 2.4 2.2 2 60 1.8 50 1980 1985 1990 1995 2000 2005 2010 1.6 1980 1985 1990 1995 2000 2005 2010
3 Tax Revenue from Consumption Tax 22 Tax Revenue from Income Tax 2.5 20 2 18 1.5 16 1 14 0.5 Model Data 0 1980 1985 1990 1995 2000 2005 2010 12 10 1980 1985 1990 1995 2000 2005 2010 0.06 0.04 0.02 0-0.02-0.04-0.06-0.08-0.1 Primary Balance -0.12 1980 1985 1990 1995 2000 2005 2010 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 Government Debt over GNP 0.1 1980 1985 1990 1995 2000 2005 2010
200 150 Consumption = 1.00 = 1.02 = 1.04 = 1.06 140 120 100 80 Investment 100 = 1.08 60 40 50 20 0 400 350 300 250 200 150 100 Real GNP 50 Primary Balance over GNP 0.2 0.15 0.1 0.05 0-0.05-0.1-0.15-0.2-0.25
0.25 Transfer Payments to GNP Ratio = 1.00 = 1.02 0.35 0.3 Government Expenditure to GNP Ratio 0.2 0.15 = 1.04 = 1.06 = 1.08 0.25 0.2 0.15 0.1 0.1 0.05 0.34 Tax Revenue to GNP Ratio 10 Government Debt to GNP Ratio 0.32 8 0.3 6 0.28 4 0.26 2 0.24 0 0.22-2 0.2-4
1.1 1.08 = 1.00 = 1.02 = 1.04 = 1.06 = 1.08 1.06 1.04 1.02 1 0.98 0.96 1980 1985 1990 1995 2000 2005 2010 2015 2020
200 150 Consumption = 1.00 = 1.02 = 1.04 = 1.06 140 120 100 80 Investment 100 = 1.08 60 40 50 20 0 400 Real GNP 0.3 Primary Balance over GNP 350 0.2 300 250 200 150 0.1 0-0.1 100-0.2 50
0.25 0.2 0.15 Transfer Payments to GNP Ratio = 1.00 = 1.02 = 1.04 = 1.06 = 1.08 0.35 0.3 0.25 0.2 Government Expenditure to GNP Ratio 0.15 0.1 0.1 0.05 0.4 Tax Revenue to GNP Ratio 8 Government Debt to GNP Ratio 0.35 6 4 0.3 2 0.25 0-2 0.2-4
200 150 Consumption = 1.00 = 1.02 = 1.04 = 1.06 140 120 100 80 Investment 100 = 1.08 60 40 50 20 0 400 350 300 250 200 150 100 Real GNP 50 Primary Balance over GNP 0.2 0.15 0.1 0.05 0-0.05-0.1-0.15-0.2-0.25
0.25 0.2 0.15 Transfer Payments to GNP Ratio = 1.00 = 1.02 = 1.04 = 1.06 = 1.08 0.35 0.3 0.25 0.2 Government Expenditure to GNP Ratio 0.15 0.1 0.1 0.05 0.34 Tax Revenue to GNP Ratio 20 Government Debt to GNP Ratio 0.32 0.3 15 0.28 10 0.26 0.24 5 0.22 0 0.2