[Public Lecture Record] Economics #14 Government Bonds and Public Finance
Hello everyone.
Last time, we learned about 'Types of Taxes and Tax Reform,' such as adjusting the ratio of direct to indirect taxes and raising the consumption tax. It was a theme about 'how to collect taxes.'
The sub-unit we are covering today is 'Construction Bonds and Deficit-Covering Bonds: Fiscal Crisis and Fiscal Reconstruction.'
Next time, we will return our perspective to history and enter 'Economic Democratization and Post-War Reconstruction,' so today, let's master the core part of 'the wallet situation of modern Japan that we are living in right now!'
'Before we start the class, I will throw one question at everyone.
[Question 1] 'If your family kept borrowing more than double their annual income every year, what would you think?'
'Huh, that's dangerous... they'd go bankrupt, right?' you would think. Actually, right now, the country of Japan is in exactly that state.
Why can Japan keep borrowing money?
In the first place, why does the government need to spend so much money (engage in fiscal activities)?
And how does this debt (government bonds) relate to all of you who will live in the future?
'If you think, "It has nothing to do with me," when you all become working adults, you will end up bearing an incredible burden in taxes and social insurance premiums. Today, I will reveal the mechanism behind that, including some behind-the-scenes stories!'
1. What are fiscal activities? Why does the government do them?
'Let's start with the basics. The economic activities carried out by the government are called public finance.
You might think, why not just leave everything to the market economy (private companies and consumers)? However, there are phenomena that are inevitably problematic if left only to the private sector. That is why the government fulfills three roles through public finance.'
Optimization of resource allocation Parks, police, roads, fire departments, etc., are called public goods. These have the characteristics that "it is difficult to exclude people who do not pay" and "everyone can use them at the same time." If left to the private sector, they would say, "It's not profitable, so we won't build it!" and society wouldn't function. That's why the government builds them with tax money.
Redistribution of income If you allow free competition, the gap between the rich and the poor will inevitably widen. Therefore, through progressive taxation, we take more taxes from the rich and circulate money to the poor through social security (pensions, welfare, etc.).
Stabilization of the economy This is the function of controlling the waves of the business cycle. This is an important point where trick questions are likely to appear on the Common Test!
[Important! Two mechanisms for economic stabilization]
Built-in stabilizer (automatic stabilizer): A systemic mechanism that automatically mitigates economic downturns without requiring special procedures, as tax revenue naturally decreases and expenditures such as unemployment benefits naturally increase when the economy worsens and individual income declines.
Fiscal policy (discretionary fiscal policy): A policy where the government observes economic trends and consciously increases public works or implements tax cuts to stimulate (or suppress) the economy.
Let's make sure to clearly distinguish between an 'automatically triggered mechanism' and a 'policy intentionally implemented by the government!'
2. Basic rules of debt (government bonds) and the 'two types of debt'
Now, the government needs money to fulfill its role. When revenue (tax revenue) is insufficient, the government borrows money. These debt certificates issued by the government are called government bonds (Japanese government bonds). Here, there is an important legal rule.
Article 4 of the Public Finance Act stipulates that, based on the historical lesson of the government borrowing money without limit and printing currency, which caused rampant inflation (soaring prices), 'in principle, borrowing through the issuance of deficit-covering bonds is prohibited.' However, in reality, there are two types of government bonds.
① Construction bonds (exception to the main clause of Article 4 of the Public Finance Act)
These are debts to cover the funding for
public investments that will remain as assets in the future such as roads, bridges, ports, flood control, disaster recovery, and public housing. These are permitted as an exception under Article 4 of the Public Finance Act. Since roads and facilities last for decades, this is based on the idea that 'it is fairer to have future generations also bear the construction costs little by little.' ② Deficit-covering bonds (special bonds)
On the other hand, these are debts issued for
current expenditures that disappear such as social security costs, local allocation taxes, education costs, and defense spending. Since this is not permitted under Article 4 of the Public Finance Act, a special law called the Special Public Bond Law
(Special Law) must be enacted in the Diet each time they are issued. Although it was originally intended to be a temporary measure, the fact that this law has been passed every year to continue issuing them is the cause of the rapid deterioration of Japan's public finances.
3. Trends in Japan's Expenditures, Tax Revenue, and Government Bonds: From the Bursting of the Bubble to the COVID-19 Pandemic
Now, let's look at an image of Japan's actual graphs.
Looking at the graph, you can see that since the 1990s, Japan's debt (borrowing) has been skyrocketing. What exactly happened? Let's follow the timeline.
① Recession countermeasures after the bubble burst (1990s–)
In the early 1990s, the bubble economy burst, and Japan entered a long, serious recession. To try to stimulate the economy, the government carried out massivepublic works projects(such as building roads and dams) across the country. Because expenditures were increased while tax revenues were falling, large amounts ofdeficit-covering government bonds(special bonds) began to be issued.
[Supplementary Note: Political Background] At the time, an "iron triangle of politics, bureaucracy, and business" was formed, where politicians, bureaucrats, and industry groups influenced each other, and criticism grew that pork-barrel politics were being conducted in local regions.
② The issue of road-specific revenue sources and the search for a "small government" (2000s)
Entering the 2000s, reforms aimed at asmall government(reducing government waste and leaving things to the private sector) were promoted, centered around the Junichiro Koizumi cabinet. A major topic of debate during this time was theroad-specific revenue source issue. The mechanism where "taxes such as the gasoline tax can only be used for road construction" was criticized for leading to unnecessary road building, and it wasconverted to general revenue sources in 2009(making it freely available for other uses).
③ Fiscal year 2020 and beyond, and COVID-19 (Modern era)
And now, the modern era. Since fiscal year 2020, due to the spread of the COVID-19 infection and economic countermeasures, the government has repeatedly compiledthe largest supplementary budgets in history. Much of this massive expenditure was also covered by the issuance of government bonds, which accelerated the deterioration of Japan's public finances.
4. Fiscal Crisis and Fiscal Reconstruction: What is the Horizon to Aim For?
If we compare Japan's current situation to a household, it is like a "household with an annual income of 6 million yen that spends 10 million yen every year, borrows the missing 4 million yen through a card loan, and has a total debt exceeding 100 million yen."
[Caution!] Of course, unlike a household, the government has thepower to taxto collect taxes independently and has a relationship with the monetary system, so it cannot be said to be "exactly the same as a household." However, please grasp this as an image to understand the feeling that "if you continue to spend more than your income, your debt will pile up."
Currently, a large proportion of the national expenditure (spending) is accounted for bygovernment bond expenses.Government bond expensesarethe costs allocated for the redemption (repayment) of the principal of government bonds and interest payments. Because about one-fourth of expenditures disappears into these repayment costs, it has become difficult to spend money on other policies.
So, what should be done to rebuild public finances?
Primary Balance
An important keyword as an indicator for fiscal reconstruction is the Primary Balance (PB).
[Primary Balance Formula] Income such as tax revenue - Policy expenditures (expenditures excluding government bond expenses)
Simply put, it is an indicator that shows, "Are the expenses for social security, public works, etc., for that year being covered only by that year's tax revenue, without relying on new borrowing?" If this becomes positive (a surplus), it means that "at least, excluding the repayment of past debts, we are managing without increasing new debt."
The Japanese government has set a goal of "achieving a PB surplus," but the reality is that the target date has been postponed many times due to the expansion of social security costs accompanying the aging population.
5. [Common Test Frequent Topic] Mechanisms of the National "Wallet" You Should Know
Here, let's grasp three supplementary pieces of knowledge that are likely to be targeted in the Common Test!
General Account and Special Accounts The national purse is not singular. What we usually call the 'national budget' is the General Account (basic revenue and expenditure), but there also exist Special Accounts (pensions, government bond consolidation funds, etc.) for specific projects or fund management.
Fiscal Investment and Loan Program (The Second Budget) This is a mechanism that uses funds collected through national credit rather than taxes (such as postal savings and public pension reserves) to lend to public institutions for infrastructure development and support for small and medium-sized enterprises. It is a funding route separate from government bonds.
Government Bonds and Local Government Bonds Bonds issued by the national government are government bonds, while debt issued by local public entities such as prefectures and municipalities are local government bonds. It is also common to evaluate Japan's fiscal situation using the 'outstanding balance of national and local debt,' which combines both.
6. The Principle of Market Digestion and the Reality of the 'Fiscal Collapse Theory'
When the government issues government bonds, there is a principle of market digestion (prohibition of direct underwriting by the Bank of Japan) which states that the Bank of Japan (the central bank) must not be allowed to purchase them directly. If the Bank of Japan were allowed to print money indefinitely to buy government bonds, the value of the currency would plummet, leading to hyperinflation. Therefore, the rule is to first have private banks and investors (the market) purchase them.
[Question 2] 'So, will Japan, with its debt having increased this much, collapse (default) in the near future?'
[Expert Perspectives and Viewpoints] This remains a subject of debate among economists.
The Cautious Stance: They point to the risk that if interest rates rise in the future, massive interest payments will occur, making public finance unsustainable, and the danger that inflation will become uncontrollable, advocating for fiscal reconstruction through tax increases and expenditure cuts.
The Pro-Fiscal Expansion Stance (MMT, etc.): MMT (Modern Monetary Theory) is a theory that argues that a government capable of issuing government bonds denominated in its own currency should prioritize inflation rates over the fiscal deficit itself. It asserts that government bonds denominated in one's own currency are extremely unlikely to lead to default compared to foreign-currency-denominated bonds.
From the perspective of the Common Test, it is important to maintain a neutral understanding from both sides, such as: 'While there is a view that government bonds denominated in one's own currency are less likely to lead to default than foreign-currency-denominated bonds, there is also a risk that excessive issuance of government bonds can cause problems such as inflation and rising interest rates.'
Today's Summary and Review
'Let's organize the key points of today's lesson!
The Role of Public Finance: Resource allocation, income redistribution, and economic stabilization (distinguish between built-in stabilizers and fiscal policy!').
Types of government bonds: construction bonds based on Article 4 of the Public Finance Act, and deficit-covering bonds (special bonds) based on the Act on Special Measures for Government Bond Issuance.
Historical changes: recession countermeasures after the bubble burst, the conversion of road-specific revenue sources into general revenue in 2009 and the search for small government, and from fiscal year 2020 onwards COVID-19 countermeasures.
Fiscal reconstruction: Reducing the burden of government bond expenses (principal repayment and interest payments) and improving the primary balance are the challenges.
When you see terms like 'supplementary budget,' 'government bond issuance,' 'primary balance,' and 'fiscal reconstruction' in the news, please remember the mechanisms we learned today and think about how they will affect your future.
Next time, we will cover 'Economic Democratization and Post-war Reconstruction.' We will trace how post-war Japan rose from despair.
Yes, that is all for today's class. Thank you for your hard work.