Rejoinder to the Groundless Criticism against "Restrictive Fiscal Policy"

Heizo TAKENAKA (Minister of Economic and Fiscal Policy)

This year's budgeting season has arrived. Every policy needs financial backing. Therefore, any budgetary argument is nothing but a policy argument. On the other hand, huge vested interests are generated, as the government as a whole spends as much as 80 trillion yen a year.

The Koizumi reform is intended to save the government budget from bankruptcy, while administering policies to revitalize the economy by eliminating old vested interests. For this purpose, it has adopted a new way of budgeting, which is fundamentally different from the past. This means not only that budget items are reorganized, but also that the budgetary process itself is altered.

Last year, our Council of Economic and Fiscal Policy tried for the first time to formulate our budget in an effective fashion, while maintaining the compatibility of macroeconomic policy and fiscal normalization. This year, we are preparing a new framework in which a "comprehensive budget picture" is discussed to further pursuing our objective.

In the midst of such reform, there are constant voices to criticize the current fiscal policy as "restrictive" and to call for more fiscal spending. In this paper, I wish to make it clear that such criticisms are groundless and quite irresponsible.

Neutrality with modest pace for fiscal improvement

Since the beginning of the Koizumi Administration, there have been repeated criticisms that "the government has adopted restrictive fiscal policy in spite of the recession." This argument has been reinforced by the intuitive analogy with the deterioration of the Japanese economy after the rise in the consumption tax under the Hashimoto Administration in 1997.

However, it is not clear at all what "restrictive" fiscal policy means, and it is not easy to judge whether the current fiscal policy is restrictive or not. The important thing is that so far there has been no argument that evaluates the current fiscal stance rigorously as a basis for criticizing the government's fiscal policy.

How should the fiscal stance of the Koizumi Administration be understood as a matter of fact?

First, regarding spending, the initial budget in the general account for this fiscal year is 81.2 trillion yen, that is only 2 percent less than that for last fiscal year. If we take deflation into consideration, it is more or less stable in real terms, and may well be neutral—very difficult to call it restrictive.

Next, regarding the evaluation of the fiscal stance from the viewpoint of the savings-investment gap, we can think of the size of newly issued government bonds as an approximation of this gap. As is well known, the total amount of new government bonds for this fiscal year is 30 trillion yen, that is the same amount as that for last fiscal year. This means two important things:

First (about the level), the government is continuing stimulus fiscal spending, that is approximately 6 percent of GDP, highest in the world. Second (about the change), this year's budget that is the first the Koizumi administration has organized maintains the same amount of the deficit as last fiscal year, and it is just about neutral in terms of budgetary balance—at least not restrictive in any sense.

The Koizumi Administration has decided to restore basic "primary" fiscal balance in the next ten years as a minimum objective to achieve for normalizing the fiscal condition that would be no longer sustainable. The primary balance for last fiscal year was in red and the deficit size was 4.3 percent of GDP. We need to improve its balance by 0.4 – 0.5 percent per year in order to achieve primary balance in the next ten years.

In cases of advanced countries that successfully normalized their fiscal condition in the 1990s, they continued to reduce their fiscal deficit by about 0.5 – 1.0 percent of GDP every year. In this sense, the pace of fiscal improvement that the Koizumi Administration is assuming is just right and modest enough to take Japan's economic condition into account. In other words, the basic stance of the current fiscal policy is "almost neutral with modest fiscal normalization."

No scenario for fiscal normalization

Therefore, criticisms against the current fiscal stance as "restrictive" are groundless. However, some people might be opposed to even the modest pace for fiscal normalization around 0.4 percent of GDP per year. They would say that expansionary fiscal policy should be adopted in times of recession and taxes should be raised after the economy recovers.

This may sound reasonable, but actually some irresponsibility is hidden in such an argument. First of all, we should not forget that the existing balance of public debt, amounting to 700 trillion yen is a result of these arguments in the past.

Such a deficit-reinforcing mechanism is embedded in our democratic society, as Nobel laurite Professor Buchanan and others have consistently warned. Such warnings have been heard and various devices to exclude short-term discretionary fiscal policy are being set up in advanced countries.

In Japan, such policy stance was clearly established in our "reform and prospects," officially decided by the Cabinet in January, 2002. It has not yet been understood by the public, however. The groundless criticism against "restrictive" fiscal policy is aggravating public confusion over this issue.

The important thing is the fact that those who advocate a temporary fiscal expansion never presented a clear scenario as to how (or if) fiscal normalization is made possible in later years. Actually, that is also the case with those economists, think tanks, and opposition party members who criticize the current fiscal policy. We need to graduate from this kind of low-level policy argument.

New approach to spending cuts

The actual budgeting process has changed substantially for the past year, and is evolving further this fiscal year. The important thing is that we are about to administer a comprehensive policy to achieve economic revitalization and fiscal normalization simultaneously. Our policy argument has moved from the "entry" stage, where fundamental directions are changed, to the "exit" stage, where concrete policy changes are presented.

We must maintain our scenario to restore the primary balance in accordance with our "reform and prospects," officially decided by the Cabinet in January, 2002. There is no realistic choice but our approach to be "neutral with modest pace for fiscal normalization" around 0.4 – 0.5% of GDP a year on the average. We need to follow a "narrow path" to achieve both economic revitalization and fiscal normalization by mixing tax reform and "special zone" policy, for example.

The Koizumi government is going to adopt a further innovation in fiscal management at the beginning of next fiscal year's budgeting process. That is to show a "comprehensive budget picture" for consistent management of Japan's macro-economy and fiscal policy as well as for effective formulation of the government budget in the stage of establishing criteria for initial budget requests. We are searching for a framework to reduce government spending in the process and cut taxes for economic revitalization. This is nothing but the basic philosophy of the Koizumi reform that is to rationalize the government sector thoroughly and to enhance the vitality of the private sector.

(Translation of the original Japanese article that appeared in the May 14, 2002 issue of "Economist" published by Mainichi Newspaper Co.)