Abenomics will fail if Japan doesn’t address its debt problem. Here’s the crucial way forward

June 17, 2013
Obsession
abenomics
June 17, 2013

Japan’s government debt is so excessive that, one way or another, many think it will eventually default. But there’s a way Japan can begin sloughing off its debt and growing its economy: by privatizing government assets. In fact, the nature of its debt means that it can’t fix its debt problem without doing that, says Michael Pettis, a finance professor at Peking University’s Guanghua School of Management.

Pettis likens it to the US railroad boom in late the 1800s. “Most of it was very, very wasteful and the companies eventually went bankrupt. The railroads shifted to new owners who bought at a significant discount. That meant they could lower prices immediately,” he tells Quartz. “That’s painful, but it’s economically very efficient.”

That never happened in Japan. In fact, this is why Japan’s GDP appears not to have grown in so long, says Pettis—wasteful government spending in the 1980s meant GDP “was significantly overstated.”

“Let’s say you build two bridges. One bridge is useful, one’s not. Both show up immediately in same way in terms of GDP impact,” says Pettis. “What happens over time is that second bridge doesn’t contribute [to the economy], and that debt has to be paid off. So it’s written down over long period of time.”

Here’s a look at how Japan’s GDP as a percentage of global GDP has declined compared with the US and China:

Japan-GDP-World-GDP-US-GDP-World-GDP-China-GDP-World-GDP_chart (1)

That means that what looks like the collapse of Japan’s GDP since 1990 probably hasn’t been as bad as it seems. Meanwhile, much of the rest of Japan’s excessive debt comes from the government’s absorption of private-sector debt throughout the 1990s. Here’s the historical trend of public and private debt:

JapanDebtToGDP

There’s some good news and some bad news in all this. First, the good. The government has a lot of inefficiently run assets it can “reflate”—i.e. sell to more efficient private enterprises that can wring more value out of those assets—as Naomi Fink, Japan Strategist at Bank of Tokyo-Mitsubishi UFJ argues. For instance, it owns chunks of Japan Post, which it also protects via regulation, and nearly half of Japan Tobacco. Then there are highways and other infrastructure that could be privatized, as well, the way Japan Rail once was. The government also owns unusually high levels of land and other hard assets (pdf, p.24), according to an IMF report. Here’s how Japan stacks up compared with other advanced economies:

reported nonfin assets percentage gdp-japan

In addition to generating proceeds from the sale that could go toward paying down its debts, the government boosts its corporate tax base, as well. True, it sacrifices whatever profits might come from those assets. But if privatizing allows those wasteful assets to start generating real growth, rising productivity would boost the economy in a sustainable way.

The bad news—at least part of it—is that privatizing is politically tricky, and will probably involve mass layoffs. Prime Minister Shinzo Abe should have championed privatization along with his other proposed structural reforms. And that’s the rest of the bad news: he didn’t. But with Abenomics teetering, finding a way to get privatization onto the table might soon be a necessity.

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