The debt to GDP ratio of Japan is the largest in the world. It has been increasing over years, and the level has remained above 200%. Can a developed country ever safely carry this rate of debt to GDP, or will it contribute to very negative consequences in case of a downturn?
Japan’s geography, particularly its location in regards to tectonic plates, is one of the causes of high rate of debt to GDP. Japan is located at the intersection of four tectonic plates, in a frequent seismic activity zone.
The consequences of these factors cause Japan to have to spend a large portion of its budget ($9.86B in a supplementary budget) on disaster response and preparedness. Preparation for any possible missiles from the DPRK also causes increased spending. Lost productivity, along with the spending, creates a persistent spending problem that can’t be solved.
Japan’s age dependency ratio has increased by 18.73 percentage points from 2000-2016. Japan’s age pyramid has long passed the stable stage – now it is in a very clear declining stage. This causes increased spending in the form of retirement pay and services for seniors.
Attempts to keep seniors in the workforce have been been successful. However, there’s a limit on increasing the age of retirement. Even more worryingly, the old age dependency ratio in Japan is 46.03%.
Japan has ran up this debt ratio by issuing bonds. Yet, there are alternative ways from issuing bonds to finance necessary state expenses. The most straightforward way of increasing a state’s budget is the implementation of higher or new taxes. Of course, this solution is rarely popular with the voters.
A larger number of high income taxpayers could be the right solution to this increasing budget size. A larger number of these taxpayers is unlikely to become a reality, because of Japan’s population dynamics and social problems.
Slashing spending on initiatives of secondary importance would help to redirect money to the areas where it’s needed the most. Not all spending in Japan in the past few years has been well thought out. Some medical projects have been unnecessary. They will also continue to be state money drains in the future.
If spending on unnecessary projects would be slashed, Japan could take at least a small step to decreasing its $10 trillion debt.
This 237.5% rate of debt to GDP, in the worst case scenario, could make Japan default on it. It is a far-fetched scenario, but it is not entirely impossible. After all, Japan’s economy, in the past 10 years, has only experienced occasional boosts.
This worst case scenario would happen to Japan’s debt, if and only if, it met two circumstances at the same time: an economic downturn and an extreme depreciation of the yen. Additionally, a drop in the demand for Japan’s natural resources (e.g. aquaculture) and manufacturing exports would also have to occur. There is a sign that these problems could burden the Japanese economy in the future. GDP growth has been stagnating for the past 10 years. In contrast, the value of yen has been increasing for the same amount of time. Hence, it’s unlikely that these problems will happen at the same time.
The consequences of the default and restructuring of debt would take away money from social welfare, education and similar areas of the public sector. Japan has a growing population living in poverty or in near poverty – it’s not far-fetched to assume that a default would push even more into poverty. In a best case scenario, this amount of debt, could help to boost the Japan’s economy.
From the 1980s, Japan’s debt level has been on a steady increase. Japan shows that it is able to cope with it after a period of more than three decades of successful management. Past performance does not guarantee future results, but Japan’s example of debt management is a promising one.
Japan also has a long history of investing in its domestic high tech industries. Moreover, the East Asian country has a long history of manufacturing, and particularly, electronics manufacturing. The investment into high tech, coupled with a long and successful manufacturing history, makes Japan the prime candidate for being a strong competitor in specialized high tech manufacturing.
High level of debt does not necessarily always lead a country to doom. A high level of national debt requires that, for some of the projects, it’s used to fund things that generate returns, which will be able to pay off the debt and interest. It’s a serious commitment (even with the increase of low interest rates), and it can push a country to more responsible spending.
It’s possible to view the rising level of debt to GDP as an input source for Japan’s Keynesian multiplier (which is estimated to be at 1.5). Increasing debt then, if used correctly, could help to further the growth of the Japanese economy and its different stakeholders.
There have been countries which have run similar levels of debt. The consequences they have had to cope with took a toll on their economic growth and the welfare of citizens.
Argentina has a long history with high levels of fast growing debt. Iceland and Greece at different times have defaulted on their debt obligations. All of these countries still continue to offer their citizens a slightly worse, but similar, level of life quality as before the default.
Many developed countries are carrying debt at a similar level to Japan (Portugal, Greece). Also, Japan’s high debt to GDP ratio wasn’t caused by irresponsible spending. Thus, if the same trends of responsible spending will continue, the high ratio shouldn’t become a serious problem.
It’s important to note that the rising debt to GDP ratio can be partially attributed to some of the components of Japan’s GDP stagnating over the years (net exports, private investments). A fast growing debt ratio increases even more when some components of GDP negatively affect its size.
Japan has long carried a high debt to GDP ratio rather successfully. Some developed countries, mostly ones dealing with the consequences of defaults, also carry a similar ratio of debt to GDP. That’s a warning sign. Yet, Japan’s unique circumstances of acquiring this debt make it unlikely that this country will ever have a low debt ratio. The country’s strong industrial base and careful spending should prevent any worst case scenarios.