There are some reasons why a high level of public debt can be dangerous. Interest rates are currently rather low in Japan. But government borrowing can push up interest rates. First, it could oust more productive private-sector investment. Second, Japan can get involved in the so-called “debt trap” (i.e. a situation when total debt continues to grow even if the government is not overspending), because of the potential build-up of a huge budget deficit. A third concern is that Japan is suffering from deflation. Yet it would be better if there was a modest positive rate of inflation. Borrowers throughout the ages have generally liked inflation as they wanted to bring down the real amount of its debt burden. And under current conditions, modest inflation would be a good thing for Japan. Besides, if the government runs a primary budget deficit and interest rates exceed nominal GDP growth, the debt will increase indefinitely relative to GDP. Unfortunately, the economic situation in Japan is very similar to that. All these factors give evidence that a public-sector debt crisis can really take place in Japan.
Under current conditions, balancing the budget wouldn’t be enough to stop the debt ratio from growing, the government needs to aim for a considerable primary budget surplus, but it is a dangerous thing when the economy is fragile and that’s why the government shouldn’t reduce its budget deficit. A similar story already took place in 1997 and the economy fell into a deep recession. But once the recovery in Japan is strong, the government should take some measures to prevent a debt crisis. Among such measures there are cuts in public spending and increase in tax rates. It may result in social conflict as health, pension and education costs are reduced. However, economists suppose that Japan has considerable scope for increasing tax revenues and for cutting spending on public works, as Japan’s current levels of tax revenues and public investment are almost the lowest among the developed economies.
So Japan has a big advantage over other former big public-sector debtors, such as Sweden, Italy, Ireland or Belgium. And if the Japanese government makes right changes in its policy, the country has a chance to escape a public-sector debt crisis.
But even if there is a small chance for the Japanese economy to rebound, we see, that there are plenty of features which give evidence that a situation in the country gets worse. The path of Japan’s debt looks unsustainable. The outlook is not encouraging at all. Many rating agencies predict that by 2007 Japan’s gross public debt will increase to 200% of GDP. I guess that the Japanese government should implement some rather dramatic economic and financial reforms as soon as possible in order to get out of the recession. If it is slow, not only a public-sector debt crisis can occur, but also the whole economy can collapse.