Afternoon Discussion Topics – Lecture #4 Problems with the Chinese Economy

1. Afternoon Discussion Topics – Lecture #4 Problems with the Chinese Economy 1. Excessive Government Debt in Japan 2. Aging of the Japanese Population 3. Rising Value of the Yen against the USD 4. Japan's Rising Conflict with China 5. Problems of Stagnating Japanese Innovation 6. Japanese Deflation

2. 1. Excessive Government Debt in Japan Japan's government has been able to continue funding its deficits because of deflation. Over 90% of Japanese government debt is held domestically. When consumer prices are falling steadily, those ever-lower yields still look like an attractive guaranteed return. But with demographics deteriorating, this ready market for JGBs will shrink. Ominously, the Government Pensions Investment Fund, which holds around 11% of government debt, became a net seller of JGBs over the last year for the first time in nine years. Ultimately, I think it's likely that the government will have to push the Bank of Japan (BOJ) to buy up much larger volumes of bonds – i.e. monetise its new debt issuance. The BOJ currently operates a self-imposed cap on JGB holdings, but is under pressure to lift this. Some politicians – including Ozawa – are calling for the law that makes the BOJ independent of government to be changed (in practice, the central bank's independence is already relatively weak). Japan's government debt is mostly serviced by the large domestic population of savings. These savers invest their money with the government and receive a very low increase rate in return. This rate is derived from the high demand for Japanese debt, but this trend might will change over time. As Japan's population ages, they will run down their savings and in turn, have less money to purchase Japanese debt. This decrease in demand will increase the interest rate paid by Japanese government. As interest rates increase, so will the threat of a fiscal crisis in Japan. S&P cut its outlook on Japan's long-term sovereign debt rating of AA to negative from stable, saying that the government's diminishing policy flexibility may lead to a downgrade "unless measures can be taken to stem fiscal and deflationary pressures." As more and more Japanese citizens retire in the next few years, they are likely to start selling their government bonds to pay for their retirements. This means that Japan will need to start borrowing from the rest of the world, and the government may have a hard time convincing foreign lenders to let it borrow at such a low interest rate.

3. 2. Ageing of the Japanese Population First came the grisly discovery this summer that Tokyo’s oldest man, 111-year-old Sogen Kato, was in fact one of the city’s best-preserved mummies, having taken his last breath 32 years ago. He still lay in the bed where he died back in 1978, and his family had been collecting his pension cheques since that time. Japan is already the second-oldest society in the world, and its fastest aging. The government expects that within five years, more than a quarter of its 127 million citizens will be 65 or older. In 1989, only 11.6% of the population was 65 years or older, but projections were that 25.6% would be in that age category by 2030. However, those estimates now seem low given that 21.2% (as of April 2007) are already 65 and over, now the world's highest.  While the country introduced a nursing-care system in 2000 that covers 90 per cent of costs, most seniors are eligible to receive only five hours of care a day, putting the expectation on relatives to provide care the rest of the day. Indeed, a 2005 national census found that 3.86 million elderly were living alone, up from 2.2 million a decade earlier. A more recent government survey found that 24.4 per cent of men and 9.3 per cent of women over the age of 60 had no neighbors, friends or relatives they felt they could rely on in difficult times. A number of factors contributed to the trend toward small families: high education, devotion to raising healthy children, late marriage, increased participation of women in the labor force, small living spaces, education about the problems of overpopulation, and the high costs of child education. A study by the UN Population Division released in 2000 found that Japan would need to raise its retirement age to 77 or admit 1 million immigrants annually between 2000 and 2050 to maintain its worker-to-retiree ratio. The U.S. Census Bureau estimates Japan will experience an 18% decrease in its workforce and 8% decrease in its consumer population by 2030. Most Japanese companies require that employees retire upon reaching a specified age. During most of the postwar period, that age was fifty-five. Because government social security payments normally begin at age sixty, workers are forced to find reemployment to fill the five-year gap. However, in 1986 the Diet passed the Law Concerning the Stabilization of Employment for Elderly People to provide various incentives for firms to raise their retirement age to sixty. Many Japanese companies raised the retirement age they had set, partly in response to this legislation. And despite mandatory retirement policies, many Japanese companies allow their employees to continue working beyond the age of sixty, although generally at reduced wages As Japan's population ages, the financial health of the public pension plan deteriorates. To avoid massive increases in premiums, the government reformed the system in 1986 by cutting benefit levels and raising the plan's specified age at which benefits began from sixty to sixty-five.

4. 3. Rising Value of the Yen against the USD The yen has maintained a rising trend against the U.S. dollar despite the government's intervention in September and previous steps by the BOJ to add liquidity. The U.S. currency hit a 15-year low of Y80.88 on Oct. 14, and in early afternoon trade Wednesday stood at around Y81.38. There is a risk that the yen's appreciation will lower consumer prices not only through worsening economic activity but also through changes in import prices The yen has been rising even as the economic outlook for Japan has deteriorated. On Tuesday, the government officially lowered its view on the economy in its monthly economic report for October, the first downgrade in over a year and half. Reports this week that Toyota is considering moving its production of Corollas overseas is another worrying sign that, with no end in sight for the appreciation of the yen, Japanese manufacturers will speed up their shift to overseas production. The head of Mitsubishi Motors slammed the government on Thursday for not understanding the burden the high yen was having on manufacturers. Some hopes are pinned on the upcoming meeting of G20 finance ministers and central bankers starting Friday in South Korea. Can they come up with some basic currency intervention guidelines or ideas for cooperation? That’s what Prime Minister Naoto Kan is hoping for, according to a report in the Asahi Shimbun, one of Japan’s main dailies. But when the dollar starts trading below 80 yen, surely Japan will have to intervene again.  Japan doesn't need a stronger yen. Japan needs deregulation of its labor and capital market, privatization of state-owned industries, and a more pragmatic, pro-growth domestic industrial policy focused on excising vested interests and the rigidities of domestic service industries.

5. 4. Japan's Rising Conflict with China Yoichi Funabashi, editor-in-chief of the Asahi Shimbun, said consequences of China's aggressive response would have a larger impact in Japan than US president Richard Nixon's secret meeting with Chairman Mao in 1971. ''Japan and China now stand at ground zero, and the landscape is a bleak, vast nothingness,'' wrote Mr Funabashi, in a letter sent to dozens of high-ranking friends in China. Tens of thousands of Chinese students took part in mass demonstrations in several cities over the weekend. Some damaged Japanese cars and others brandished placards of racially inflammatory slogans. The Chinese government has taken measures to contain those protests and has recently toned down its propaganda onslaught. But Japanese anger appears unabated. Former prime minister Shinzo Abe this week likened China's growing territorial ambitions to those of Nazi Germany and Lebensraum - Adolf Hitler's philosophy that the German people needed more ''living space'' in which to grow.

6. 5. Problems of Stagnating Japanese Innovation Japan’s stagnation in the 1990s and the first years of the 21st century has been driven by an equally potent set of forces, in large measure derived from the same factors contributing to the economic miracle of the 1970s and 1980s. These factors include: • An industrial system principally driven by considerations of economies of scale, increasing market share, and export growth, with profitability viewed as less important in determining resource allocations and the development of particular industries and firms. • A banking system pervaded by huge non-performing loans and weak balance sheets resulting from Japan’s distorted industrial base and the credit misallocations associated with it. • A regulatory system marked by the heavy hand of government and protectionism, limiting free entry and market access both within Japan and from potentially competitive firms outside, in the process stifling entrepreneurship and innovation. (Recent RAND work on economic “openness” found that Japan ranked far below the economies of both the U.S. and Germany, and about on a par with China and Korea, in its profusion of nontariff restrictions permeating the economy and impeding market access by foreign businesses.) If the Japanese are so innovative, why can’t they solve these basic problems with their economy?

7. 6. Japanese Deflation Try to list the various problems which deflation poses for the Japanese economy