Merryn's Blog

Why the Japanese state is more solvent than you think

As the debt crisis in Europe grows, some analyst-eyes are on Japan. With gross debt at 200%, some think it will be the next to feel the pressure. They are probably wrong.

Is Japan bust? Will it be the next Greece? The next Italy? I looked at this very briefly last week(How the euro-crisis could affect your investments) but I think the answer is a pretty clear no. There is a view that it won't be long before Japan- rather like Greece- buckles under the weight of its enormous debts and defaults via a huge money printing splurge. The result will be hyper-inflation and the total collapse of the Japanese economy. This is, of course, perfectly possible.

After all, Japan's gross debt is running at around 200% of GDP (yikes), it barely raises enough in tax revenues to cover its financing expenses and at some point, that problem is going to have to be confronted. However, the first thing that makes it less possible than the bald number suggests is that Japan's net debt is only around half that. Nicholas Smith of CLSA (who does not think that Japan is remotely bust) notes that the asset side of Japan's balance sheet has a lot going for it.

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It has huge foreign exchange reserves, but it is also home to the world's biggest bank Japan Post, an organisation that is "bigger than the world'sfour orfive biggest banks put together." And Japan Post isn't the only vast state asset that could easily be sold to pay down debt. There is also Japan Tobacco (which is 50% government owned), NT (33%), Inpex and the Tokyo Metro. It all adds up to a tidy sum- one that could provide a relatively large sum of cash to stave off an immediate disaster.

However, Japan has several other avenues open to it. A senior Japanese banker told me earlier this year that all the country really had to do was double consumption tax and disaster would be averted. The general view is that wouldn't work- that it would push consumption down too far too fast (as it did back in 2007). Butas Japan's consumption is about as low as one can expect in a developed country, that's far from a given. Consumption tax in Japan is 5% - that's amazingly low in international terms. That said, there are probably easier ways for Japan to increase tax revenues.

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Then there is corporation tax. This is very high in Japan- 40%. But it also demonstrates one of the truisms of tax: make the rate too high and no one will pay it. Japan has one of the lowest corporate tax takes in the OECD- despite the fact that corporate profits regularly hit new highs. And the percentage of firms that don't pay any tax? 75%. That's partly because so many profitable companies don't pay at all (is it a coincidence, asks Smith, that "small companies just happen to be the biggest source of political donations for almost all factions of most parties?").

But it is also because the banks, pressured not to create bankruptcies, are keeping hordes of the "small company undead" going when they should be shutting them down. So companies with no ability to make economic returns are "clogging the arteries of corporate Japan", says Smith. They need to go, leaving space for Japan's many great companies to get on with making great returns.

So what should Japan do? Crack down on avoidance and evasion; dump zombie companies; and lower the corporate tax rate to encourage compliance- 25% would make it competitive in Asia. Better that more pay less and that an environment in which economic growth is possible is created.

Finally, Japan can, just as we should in the UK (see this week's magazine), have a go at cutting its spending properly. Its pension system was put together post-war. Life expectancy was 65. People also retired at 65. It wasn't an expensive system. Now Japanese men live to 80 and women to 87 and it is an expensive system. Hike the retirement age to 70 or more and not only do you cut the cost of pensions but you up the size of the workforce (useful in itself given Japan's shrinking population). Japan has defaulted once in its history- in 1942. It has no need to do so again. Britain, by the way, has not defaulted on its debts in over 200 years.




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