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Japan in bankruptcy? Well, not quite. Countries don't go under like dot-com startups. After all, they control the money-printing presses. But expect to see plenty of headlines in the coming days about the magnitude of Japan's world-class debt trap. A new balance sheet just drawn up by the Finance Ministry reveals that Japan is showing a negative net worth to the tune of $7 trillion.
It's the legacy of a decade-long spending spree by Tokyo to put some oomph back into the economy. And just how successfully Japan can cut back its budget deficits to reasonable size will be a major story here for years to come.
The Finance Ministry arrived at $7 trillion by calculating the value of assets, such as government-funded roads, bridges, and other public works projects, and then factoring in depreciation or current market value (in the case of marketable securities). On the liability side of the balance sheet are government bonds held by private investors, deposits by ordinary Japanese in the savings accounts run by the nation's postal system, and IOUs in the form of future pension obligations in rapidly aging Japan.
UNDER THE VOLCANO. If you throw in the liabilities from local governments, which the Finance Ministry does not, things are even worse. Right now, prefectures such as Tokyo, Osaka, and others are bleeding red ink. Some Japan debt specialists, like Massachusetts Institute of Technology's David L. Asher, think Japan faces obligations closer to 200% of output rather than the 136% of gross domestic product the government contends, still among the worst levels in the rich world. Unless things change, Asher sees the makings of a "financial Mt. Fuji" eruption that would dwarf previous financial crises in Mexico and East Asia.
With any luck, it won't come to that. After all, Japan does have a deep savings pool at home and is a net creditor abroad. Most of its government debt is denominated in yen and owned by domestic investors. So Japan doesn't have to worry much about an exodus of foreign capital that would send interest rates soaring and crush its fragile recovery. Indeed, long-term bond yields are all of 2%. It's hard to see Japan facing any kind of liquidity crunch that would rile the global markets in the short term.
But that could change unless the ruling Liberal Democratic Party starts coming up with a sensible round of spending cuts, makes some tough decisions on pension benefits, and loses its penchant for ineffective public-works projects. Nobody is really talking about that sort of fiscal reconstruction. Indeed, the betting is that Prime Minister Yoshiro Mori's government will cobble together a $38 billion supplementary budget this year to give the economy another fix.
It's typical of the unimaginative policies that have been around Tokyo since Japan's bubble burst in the early 1990s. More than $1 trillion already has been spent on traditional civil engineering projects -- bridges, highway extensions, you name it -- since 1992. It has certainly been a boon to the LDP's loyal followers in the construction industry, but it hasn't done much for the broader economy.
SAVERS AND SPENDERS. Trouble is, it has probably made things worse. Japanese consumers, whose spending typically accounts for 60% of Japan's output, have been in a defensive crouch for years. They're frantic savers because they know instinctively that someday the government's IOUs need to be paid off. That will come in the form of tax hikes and maybe even pension-benefit cuts.
Until consumers know the score, and see how fiscal reconstruction will affect their household budgets, they have no incentive to spend. In fact, it's a very rational response to a political class that has all the fiscal discipline of a Las Vegas high-roller.
The good news is that Japan is finally getting truthful about the dimension of the problem. Moves are afoot to cut back on traditional public spending on roads and bridges in the provinces -- or at least redirect it into more promising investments on information technology infrastructure and job training for displaced workers. Reform-minded LDP bigwigs such as Junichiro Koizumi and Koichi Kato are trying to keep the profligate spenders in the party in line.
They know the true way to economic prosperity is to burn off the excess capacity in Japan's sunset industries, recycle workers into faster-growth venues, and remove regulations and barriers that discourage foreign investment while needlessly raising the cost of living in Japan. True, none of this is easy, and it's quite painful in the short-term. But it's better than a huge government deficit crowding out private investments and saddling future generations with the tab for today's reckless spending.
TOUGH CHOICES. However flawed, drawing up a national balance sheet of the central government's books, a practice common in the Group of Seven industrialized nations, is a move in the right direction. The tough part will come once the economy, now showing signs of life, is on the full-recovery track. Somebody is going to have to deliver the news that it's time to pay off the debts -- and come up with a plan to get there.
It has been done before. Look at the U.S., which once seemed like the poster child of runaway deficits and political gridlock. Deficits can turn into surpluses when a strong economy, led by information technology and fiscal prudence, carry the day. Japan isn't there yet, but the IT sector is generating job growth and already starting to improve Japan's dismal labor productivity.
For a country that sensibly lectured U.S. Administrations in the 1980s about spending beyond its means, the irony is rich. Global investors and policymakers abroad now wonder whether Japan has the kind of political and economic stewardship to get out of its debt trap before it does some harm to the global economy. It's going to be a fascinating story to watch in the coming years.
Bremner, Tokyo bureau chief for Business Week, offers his views in Eye on Japan every week for BW Online Edited by Beth Belton
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