Fiscal Sustainability of Local Governments in Japan†

• Author: Motonori Yoshida
• DOI: http://doi.org/10.1111/asej.12210
• Published date: 01 June 2020
• Date: 01 June 2020

Fiscal Sustainability of Local Governments in

Japan†

Motonori Yoshida

Received 9 February 2018; Accepted 15 May 2020

Graduate School of Economics, Osaka Prefecture University, Osaka, Japan

The total amount of Japan’s local government (LG) expenditures exceeds its cen-

tral government (CG) expenditures. Japan’s LG and CG are responsible for the

worst general government’s debt situation among the G7 countries. The paper elu-

cidated the fiscal reactions of Japan’s prefecture governments (PGs) based on

Bohn’s (1998a, 2005) method with a panel dataset (44PGs, fiscal years 1974–

2016), addressing nonstationary and endogeneity issues. In my model, a positive

reaction of the primary surplus/gross regional product (GRP) ratio to the PG debt/

GRP ratio (d) constitutes a sufficient condition for sustainability. The results of

the study demonstrate the following: (i) the PG in any fiscal condition are

assumed to provide sustainable fiscal management; (ii) the PGs in sounder or

more dire fiscal conditions probably manage their finances more firmly; (iii) the

fiscal transfers from the CG generally ease the PG fiscal conditions; (iv) although

primary regressors dand dsq (the square of d) are assumed to be I (1) with some

accuracy, they become stationary through cointegration with other regressors.

Keywords: Bohn, endogeneity, fiscal sustainability, panel cointegration, panel

unit root, prefecture governments.

JEL classification codes: E61, E62, H11, H72, H77.

doi: 10.1111/asej.12210

Introduction

Japan is a global top-class economic power. Its economy has maintained its cur-

rent account surplus for the past 39 years and its external financial asset balance

*Motonori Yoshida (corresponding author): Graduate School of Economics, Osaka Prefecture

University, 1-1 Gakuen-cho, Naka-ku, Sakai-city, Osaka 599-8231, Japan. Email: myoshida@eco.

osakafu-u.ac.jp.

†An earlier version of this paper was presented at the 16th International Convention of the East

Asian Economic Association hosted by the National Taiwan University, Taipei on 27–28 October

2018. I would like to thank all the participants of this convention, the anonymous referees, and the

Editor of the Journal for helpful suggestions and insightful comments. I also acknowledge financial

support from the Japan Society for the Promotion of Science (Grant-in-Aid for Science Research C,

25380309 and 19 K01720).

© 2020 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2020, Vol.34 No. 2, 127–162 127

is the highest in the world (as of 2016) (Tables 1 and 2). However, Japan’s pub-

lic sector has been mired in a relatively dire fiscal situation for decades. The

ratio of Japan’s general government

1

debt to its GDP was 237.1 percent in 2018:

the worst figure among the G7 countries.

2

Although Japan’s central (national)

government (CG) continues to experience a poor fiscal condition, its local public

finance (LPF) situation is relatively stable. Since the 1940s, the total amount of

expenditures by Japan’s local governments (LGs) has also exceeded that by its

CG, and the former’s ratio to the total sum has generally hovered around 60 per-

cent. Yet scrutiny of the fiscal conditions of Japan’s LG tiers reveals the follow-

ing facts. Japan’s prefecture governments (PGs), which are at a higher tier of the

Japanese LG system, are only at capacity when they implement just ordinary

administration and have a relatively high ratio of outstanding deficit-covering

local government bonds (LGBs) to total outstanding LGBs. Moreover, the total

amount of all PG expenditures is around half the total amount of all LG expen-

ditures (Section II).

Many prior studies have examined the sustainability of government finances,

i.e. whether the concerned government finances satisfy its intertemporal budget

constraint (IBC), based on previous financial management stances, using

Bohn’s (1998a, 2005) method. However, to the best of my knowledge, those

studies suffer from the following weaknesses: (i) their objects are weighted to

the general government or to the CG in their objective countries; (ii) most fail to

completely test and examine nonstationarity and cointegration relationships on

variables despite using time-series data; (iii) apart from Fujii (2010), they fail to

deal with the endogeneity problem of variables; (iv) apart from Mahdavi (2014),

they fail to consider the effects of fiscal transfers from the concerned CG to

LGs; and (v) studies examining Japan’sLGfinances are quite scant, and the pri-

mary studies are limited to Mochida (2015) and Yoshida (2016, 2017).

Hence, the paper scrutinize the fiscal sustainability of Japan’s PG using

Bohn’s (1998a, 2005) method to overcome the above weaknesses in the existing

research and elucidate the general fiscal management tendencies in Japan’sLPF.

The following are the main findings of this study. First, the PG in any fiscal condi-

tion are assumed to basically conduct sustainable fiscal management. Second, the

PGs in the relatively more sound or more dire fiscal conditions probably manage

their finances more firmly than other PGs. Third, PGs suffer from primary balance

deterioration ifthey expend more than their expenditure trends. Fourth, larger fiscal

transfers from the CG to PGs generally help their finances become even sounder.

The rest of this paper is organized as follows. Section II explains Japan’s gen-

eral government finance and LPF states. Section III reviews the related literature

and explains this study’s position and aim. Section IV presents the backbone of

1

The general government consists of a central government, local governments and social security

funds.

2

Italy had the second worst figure of 132.1 percent. These figures are from the Ministry of Finance:

https://www.mof.go.jp/tax_policy/summary/itn_comparison/j01.htm.(Accessed in March 2020.)

ASIAN ECONOMIC JOURNAL 128

Bohn’s method. Section V explains the empirical models and datasets. Section

VI presents the results of the analysis and Section VII concludes.

Fiscal State of Japan’s Public Sector

Although Japan’s economy retains its status as a global economic power, its pub-

lic sector remains in a terrible fiscal condition. Tables 3 and 4 describe the CG’s

miserable state. The LPF finds itself in a relatively good position. First, let me

outline Japan’s LG structure. Japan’s LGs are comprised of the following two

tiers. In the first tier, PGs preside over the 47 prefectural regions, including

Table 1 State of Japan’s economy: Net lending (+)/Net borrowing (−) of Japan’s sectors

FY 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Sector

1. Households 7.5 3.6 4.2 4.5 2.2 0.9 4.2 3.1 6.0 3.5 1.4 4.5 2.0 3.9

2. Financial

corporations

0.4 2.0 1.3 2.6 0.5 2.1 3.8 0.6 2.8 −0.3 −0.4 −0.8 −0.7 −0.3

3. Non-financial

corporations

−1.6 2.0 2.2 −0.1 3.8 4.0 4.9 8.3 1.6 5.4 5.9 3.4 4.9 2.9

Subtotal 6.3 7.6 7.7 7.0 6.5 7.0 12.9 12.0 10.4 8.6 6.9 7.1 6.2 6.5

4. General

government

−4.4 −5.1 −4.1 −2.9 −1.9 −5.0 −9.5 −8.4 −8.7 −7.8 −6.6 −5.5 −2.8 −2.5

5. Rest of world −1.8 −2.4 −3.6 −4.0 −4.5 −2.0 −3.3 −3.6 −1.7 −0.8 −0.4 −1.6 −3.3 −4.0

Notes: Households include private non-profit institutions serving households.

Source: By author using FY2018’s SNA (Cabinet Office).

Table 2 International investment position (in descending order, 2016)

(Unit: US

dollars, millions)

Japan 2 879336 Canada 304 050 Austria 15 426 Ireland −519 151

Mainland China 1950 368 Korea 281 098 UK 7735 Mexico −532 298

Germany 1 698 441 Belgium 247 241 Sweden −9160 Brazil −566 633

Hong Kong 1 153 824 Russia 219 666 Italy −182 048 Australia −701 225

Switzerland 813 293 Denmark 157078 Poland −274 206 Euro Area −942 728

Norway 735 996 Argentina 48 048 France −306 280 Spain −1 004 275

Singapore 721 040 Luxembourg 31 552 Indonesia −333782 US −8 192 158

Saudi Arabia 597271 South Africa 22 336 India −362 830

Netherlands 458 091 Finland 19 584 Turkey −368 938

Source: By author using ‘IMF Principal Global Indicators’(http://www.principalglobalindicators.

org/?sk=E30FAADE-77D0-4F8E-953C-C48DD9D14735). (Accessed in March 2020).

FISCAL SUSTAINABILITY OF LOCAL GOVERNMENTS IN JAPAN 129