The Japanese legislature on March 24 approved a record 92.3 trillion yen ($1 trillion) budget for fiscal year 2010. Prime Minister Yukio Hatoyama and his Democratic Party of Japan (DPJ) government hope that the budget will not only stimulate Japan’s notoriously stagnant economy but also boost the DPJ’s popularity ahead of Upper House elections in July.

Japan’s parliament on March 24 approved a record 92.3 trillion yen ($1 trillion) for the 2010 fiscal year, which begins April 1. The budget is 4.2 percent larger than the budget for fiscal year 2009. The Democratic Party of Japan (DPJ) government, led by Prime Minister Yukio Hatoyama, hopes the budget will stimulate Japan’s long-stagnated economy and show the DPJ’s ability to restore economic performance — particularly amid the global economic turmoil that began in 2008 — in hopes of bolstering its popularity ahead of Upper House elections slated for July.

  Among expenditures in the budget, the substantial increases came from social security and local allocation tax grants, which grew by 9.8 percent and 5.5 percent, respectively, from 2009. Of these expenses, a considerable portion is to cover Hatoyama’s ambitious agenda, outlined during his election campaign, to solve the longstanding deflationary problem of the world’s second-largest economy. Two newly enacted policies — one that gives allowances to households raising children and another that provides free tuition for public high school students — will cost 233.7 billion yen and 393.3 billion yen, respectively (0.7 percent of the total budget). Meanwhile, spending on public works projects will drop 18.3 percent to 5.8 trillion yen, the lowest level in 32 years.

  However, there is a sharp shortfall in tax revenue. Taxes only amount to 37.4 trillion yen — an 8.7 trillion yen, or 18.9 percent, decrease from fiscal year 2009. This decrease is primarily due to a lack of taxes from enterprises that have been losing profits and individuals experiencing lower income due to salary cuts. Because of this drop, the government has to issue a record 44.3 trillion yen in bonds (an 11 trillion yen increase from fiscal year 2009) to help finance the budget. This is the first Japanese budget in which bond issuance is greater than tax revenue. This, in turn, creates greater concerns about Japan’s fiscal health; Japan’s government debt reached 189 percent of its gross domestic product in 2009, the highest among industrialized countries.

 

 
In fact, this partially reflects a structural deficiency that would make it difficult for any policy effort to restore Japan’s economy. Since late 2009, Japan’s economy has been in a “mild deflationary phase” — something seen in the late 1990s and early 2000s when a fall in the general level of prices severely impeded the economy. The expectation of decreasing general prices discourages consumers from spending and defers business purchases. This in turn limits demand across the country, affecting the overall economic growth dynamics. The problem is particularly severe during economic recessions, when the government’s attempts to introduce stimulus packages could hardly revive consumption levels and boost prices. Japan is the only advanced economy suffering from entrenched deflation.

  The country’s population is aging and therefore less able to spend, and big lending by large enterprises due to the bubble collapse of the mid-1990s has reduced companies’ capabilities. Combined, these two factors make for a lack of spending incentives for Japan. Moreover, the Japanese government has relied heavily on public savings to make up for its increased expenditure, and more than 90 percent of government debt is financed domestically, making it even more difficult to manage public expectations. Add to this the fact that the government cannot spur spending by reducing interest rates, which have been at near zero for more than a decade, and deflation is expected to be a structural and endemic problem with no immediate resolution.

  Though the country’s export sector has rebounded since mid-2009 — which could help increase employment and fight deflation in the short run — the growth is primarily generated from stimulus spending in the outside world (such as the United States as well as China and other Asian countries) and most of these countries have gradually moved away from stimulus measures. Until the export sector becomes more stable, fighting deflation will not be easy.

  Given these circumstances, despite the increase of direct aid to households and the freeing of more household income, the new budget is not likely to achieve the expected goal of increasing domestic spending and reducing deflation. Moreover, the shift of expenditures from public infrastructure projects into aid might reduce investment — another important component of maintaining a country’s economic growth.

  Japan’s severe fiscal condition can be traced back to Tokyo’s fiscal policies and financial rescues during the “lost decade.” Massive stimulus spending and financial bailout programs resulted in huge budget deficits, and translated to surging government debt since the mid 1990s — the public debt was 189 percent of GDP in 2009 and is expected to reach 200 percent in 2010. Despite the DPJ-led government’s pledges to rein in government spending since it came to power in September 2009, the ongoing global financial turmoil has exacerbated the problem.

  The government responded by launching a 7.2 million yen stimulus package to help weather the financial crisis. This, in turn, further exposed the country to an extraordinary burden of budget deficits and public debts. In January, the ratings agency Standard & Poor’s (S&P) threatened to downgrade the country’s sovereign credit ratings if the government failed to curb the ever-growing public debts and budget deficits, which would make the debt more expensive and significantly reduce Tokyo’s ability to pay the debt. This would particularly affect the Japanese people, who have shouldered most of the government debt.

 

  In fact, the coalition government has seen intense debate over whether the administration will introduce another stimulus package, with Banking Minister Shizuka Kamei — also the head of The People’s New Party (PNP) coalition — calling for 11 trillion yen in fresh stimulus spending. Though the DPJ quickly responded by denying the proposal, such policy debates appear to be one of the main issues as Upper House elections approach and the DPJ wants to be seen as effective in spurring the economy. In addition, the DPJ government is also pressuring Japan’s central bank, the Bank of Japan, to take additional measures to ease monetary policy (particularly to expand its emergency lending program and to buy more assets from troubled companies) to combat deflation and bolster its slumped support, while the Bank of Japan is worried about the ongoing debt problem that threatens the nation in the long run.

  Japan is in a trap; stimulus spending and monetary loosening have been used so frequently for so long that they do not help to solve the structural deflationary problem, but exacerbate the country’s extraordinary government debt. This, in turn, shapes domestic policy debates and puts the government under further political and financial pressure.