International Monetary Fund VOLUME 29 NUMBER 20

October 23, 2000 www.imf.org In this issue After recovery takes hold 337 Implications of aging population will pose Policy implications of ’s aging crucial policy issues for Japanese authorities population 337 n conjunction with its annual Article IV consultation with Japan, To˘sovsky ´ on lessons I IMF staff prepared a background (Japan—Selected Issues) on of transition a number of key topics. Two chapters of that paper dealt with the Annual Meetings macroeconomic and fiscal implications of Japan’s aging population. The 2000 authors—Hamid Faruqee, an Economist in the Research Department, 339 and Martin Mühleisen, an Economist in the Asia and Pacific Seminar program Department—speak with the IMF Survey about their findings. 341 Governors’ IMF SURVEY: Over the past decade, industrial countries have grown statements more aware of the significant macroeconomic implications of aging 346 populations, but Japan’s circumstances seem particularly urgent. Asset prices and FARUQEE: Population aging is a characteristic of most industrial monetary policy countries. Societies that achieve higher living standards customarily 348 see their mortality and fertility rates fall—something that is referred targeting in to as a demographic transition. emerging market Where Japan differs from other industrial countries is in degree. countries The rate of increase of Japan’s elderly dependents is much higher than A sharp demographic shift in Japan will 351 elsewhere. Ten years ago, Japan had the lowest share of elderly depen- have macroeconomic implications for the UN Millennium Summit dents among industrial countries; now it has the (Continued on page 343) young and the old. and...

Per Jacobsson address 342 To˘sovsky ´ reviews lessons learned from transition, Selected IMF rates 345 indicates process is still incomplete IMF Arrangements

n September 24 at the Annual nationalization, a mass privatization 346 OMeetings in Prague, Josef To˘sovsky, ´ program was needed to move quickly New on the web Governor of the Czech National Bank, to a market economy. At the same 350 delivered the 2000 Per Jacobsson address, time, these transitional economies Recent publications “Ten Years On: Some Lessons from the needed to create an adequate institu- 351 Transition.” His remarks are summarized tional framework to support the Use of IMF credit here; the full text is available on www. newly emerging private sector. This perjacobsson.org. second task, To˘sovsky ´ noted, turned Beginning with the premise that the Josef To˘sovsky ´ out to be far more demanding. transition process is still incomplete, To˘sovsky ´ said that most of the failures and continuing Distortions in the real economy difficulties that transition economies have encoun- Among the legacies of the old regime were the “deforma- tered are rooted in the past—the legacy left by 40 tions and distortions” in the real economy, including the years of central planning. exclusive geographic orientation toward eastern markets, Ten years ago, To˘sovsky ´ said, the transition econ- aggravated by a policy of economic self-sufficiency. omies of central and eastern Europe were mostly or The true extent of the distortions inherent in centrally completely nationalized. As a result of this near-total planned economies, as (Please turn to the following page) 337

©International Monetary Fund. Not for Redistribution (Continued from front page) well as the true magnitude of bad news about mounting macroeconomic imbalances. implicit, hidden indebtedness, came to light only with In addition, they end up getting the brunt of the blame the political changes that took place in 1989. According for slow growth, increasing unemployment, and social to Toso˘ vsky´, the growth of internal debt was a major unrest when they attempt to tighten monetary policy to problem. To avoid social unrest, ruling communist par- address the imbalances. This political pressure, Toso˘ vsky´ ties sought to provide an acceptable living standard. But said, has been “a fact of life” for central banks in most of since the productive capacities of the communist econ- the transition economies in the region, but he had hopes omies were eroded by inherent inefficiencies, the only that this “symptom of immaturity” would soon disap- way to achieve a decent living standard was to mortgage pear as these countries became members of the the future—that is, by living on hidden debt. The conse- (EU). quences of this long-standing allocation of resources Financial sector reform. Because it is the financial based on political priorities rather than profitability con- sector that undergoes the greatest changes in the tinued to haunt reformers during the 1990s, as massive course of an economic transition, the financial crises amounts of bad loans began to surface. that hit virtually all transition economies were proba- Human factors also accounted for many of the transi- bly unavoidable, Toso˘ vsky´ observed. The transforma- tion problems, Toso˘ vsky´ suggested. For one thing, the tion of a centrally planned financial sector to a market structure of education and the mix of skills in a com- economy calls for a systemic overhaul requiring the mand economy do not match the needs of a market development of a totally new infrastructure. The economy. In addition, living under socialism shaped peo- financial sectors of postcommunist countries still ple’s qualities, mentality, and morals into patterns incon- come in for a lot of criticism, he said, but it should sistent with the requirements of a market economy. not be forgotten that the task of creating from scratch Finally, the newly democratic economies emerged a strong, efficient, globally competitive financial sector into an environment of a rapidly moving globaliza- operating in an appropriate legal environment is a lot tion involving the widespread liberalization of goods to expect in only 10 years. and capital markets—in a word, competition. Although all developing countries had to accept and Results and conclusions adapt to these changes, the transition economies were Despite the highly unfavorable starting conditions, at a particular disadvantage; their “delayed start” gave combined with several mistakes along the way, them much less time to adjust, and they were forced to Toso˘ vsky´ said he considered the transformation of proceed with integration into the global economy and the Czech Republic and other countries at a similar international financial system quickly, regardless of the stage of transition as successful, even if the tradi- risks associated with such rapid integration. tional indicators, such as GDP, did not appear to support his conclusion. Radical economic transfor- Importance of market-friendly institutions mation is precisely the kind of situation where calcu- Many analysts agree, Toso˘ vsky´ said, that the current lated GDP is not necessarily the ideal indicator of a difficulties of some transition economies whose econ- country’s social well-being and quality of life, he omies have unexpectedly lagged behind other stronger stressed. A lot of mistakes were made, but in his view performers stem from their initial misunderstanding the countries of central and eastern Europe that have of the importance of institutions in a market economy. made the most progress in adapting themselves to One widespread and very damaging mistake, the conditions of a free market economy are incom- Toso˘ vsky´ observed, was the misconception that sys- parably better off than the countries that have post- temic measures—price and trade liberalization, a real- poned these reforms. istic exchange rate, and creation of market institu- In the past 10 years, Toso˘ vsky´ observed, the pitiful tions—could be implemented “overnight” in the economic conditions that prevailed in the closing days absence of the necessary supporting structural and of socialism have become a distant memory, and the institutional reforms. Such underestimation was com- most advanced transition economies are serious can- mon, for example, during privatization efforts that didates for EU membership. Their maturity is attested failed to establish the regulatory framework needed for to by the extent to which they satisfy the Copenhagen a privatized economy to function smoothly. criteria that—in addition to the political requirement Central bank independence. In general, transition that “the candidate state has achieved stability of insti- economies formally embraced most of the elements of tutions guaranteeing democracy, the rule of law, the European legal framework defining the position of human rights, and respect for and protection of central banks. But the principle of an independent cen- minorities”—emphasize the existence of “a function- tral bank has not yet been fully accepted by the public, ing market economy as well as the capacity to cope October 23, 2000 and especially by politicians, Toso˘ vsky´ noted. Central with competitive pressure and market forces within 338 banks have often had the unpopular task of announcing the Union.”

©International Monetary Fund. Not for Redistribution Annual Meetings seminar program Development, monetary and financial issues are focus of wide-ranging discussions

program of seminars addressing issues on the duction of the euro created the Ageneral theme of making the global economy prospect for a change from a dollar- work for everyone was held in Prague in conjunction denominated currency system to one with the Annual Meetings. The seminars, organized by in which power is shared by the dol- the IMF and the , served as a forum for lar, euro, and yen areas. He made the private sector leaders, government officials, and offi- case for a world currency in the cials of the international financial institutions to dis- longer run. Hans Tietmeyer, former cuss issues related to sustainable development and President of the Deutsche international monetary and financial relations. Bundesbank, argued that in a world of free capital movements, there was Challenges and opportunities no effective instrument for control- The opening “keystone roundtable” addressed both ling exchange rate movements. He Bono (left) with IMF the opportunities of globalization and the challenges also felt that creating a world currency was neither feasi- Managing Director Horst Köhler. involved in making the global economy work for ble nor desirable in anything but the very long run. everyone. Erna Witoelar, Minister for Housing and Yung Chul Park, professor at Korea University, stated Regional Infrastructure of Indonesia, cited the impact that interest in monetary and financial cooperation in of the Asian crisis on economic disparities in her east Asia had increased strongly in recent months, fueled country and said these disparities should be elimi- by frustration with being excluded from decisions on nated at every level. She called for renewed efforts to reform of the international financial architecture. The develop the productive capacity of poorer countries. east Asian economies, which hold a substantial fraction Stanley Fischer, First Deputy Managing Director of of the world’s international reserves, are particularly vul- the IMF, observed that globalization was not a new phe- nerable to swings in capital flows and in exchange rates nomenon and that more people had benefited from among the world’s three major currencies, he said. globalization today than in any previous period of his- tory. This, he said, was because of recent technological Dollarization and euro-ization advances, especially in communications technology; the In this seminar, moderated by Zanny Minto-Beddoes popular taste for more goods and more travel; and pub- of The Economist, Jacek Rostowski, Professor of lic policy initiatives. However, he noted that the recent Economics at the Central European University, intensification of globalization has also been associated , outlined the policy elements that the central with negative aspects, including income inequalities and European applicants for membership in the European environmental degradation, and stressed the necessity of Union should follow. These are to maintain a rapid acting to counter these problems. rate of economic growth, to be committed to free capi- Globalization has led to an unprecedented commu- tal movements, to recognize that the prices of nontrad- nity of values in human rights, equality of women, able goods will tend to rise as growth proceeded, and environmental protection, and an unprecedented gen- to satisfy the Maastricht criteria. eration of wealth, according to Olara Otunnu, the UN Drawing parallels between the central European Secretary General’s Special Representative for and Latin American experiences, Paulo Leme of Children and Armed Conflict. The remaining chal- Goldman Sachs saw a steady movement among lenges center on those who have been left out of the groups of countries toward single-currency systems. process, he said, citing persistent income gaps within He emphasized that high quality in the underlying countries and between regions and ethnic groups. policies, particularly open trade policies, is essential. Eduardo Borensztein of the IMF’s Research Currency areas Department said he was not persuaded that every coun- Opening a seminar on currency areas, Alexander try should either dollarize or set up a currency board. Swoboda of the IMF Research Department noted that, He saw costs as well as benefits from dollarization, say- together with financial integration extending to an ing that countries could lose a degree of policy freedom ever larger number of countries, the birth of the euro by tying their hands to gain credibility. represented a fundamental change in the organization Rudiger Dornbusch of the Massachusetts Institute of the international monetary system. of Technology essentially recommended that every Robert Mundell, Nobel Prize winner and professor of emerging market economy either adopt a currency October 23, 2000 economics at Columbia University, said that the intro- board or directly use a strong currency like the U.S. 339

©International Monetary Fund. Not for Redistribution dollar, thus “outsourcing” monetary policy and gain- Director Shigemitsu Sugisaki cited the emergence of a ing credibility and stability automatically. strong leadership in , the establishment of a basic macroeconomic framework and a credible judi- Challenges for EU accession countries cial system, and progress in foreign relations. He This seminar, moderated by Pedro Solbes, stressed, however, that the remaining tasks are monu- European Community Commissioner for Economic mental, particularly in the sound allocation of domes- and Financial Affairs, focused on key policy issues tic resources, building up indigenous managerial faced by accession countries on their road to capacity, and the efficient use of international aid. European Union (EU) membership. José Ramos Horta, Nobel Peace Prize winner and Charles Wyplosz of the Graduate Institute of representative of the East Timorese leadership, paid trib- International Studies in Geneva argued that removing ute to what he said were “exceptionally positive” rela- capital controls too rapidly would entail unnecessary tions with the IMF and the World Bank and the institu- risks and potentially lower long-term growth tions’ contribution to peace and stability in East Timor. prospects. György Surányi, Governor of the National Focusing on the lessons learned in East Timor, Luis Bank of Hungary, discussed the likelihood that strong Valdivieso of the IMF emphasized the need to closely capital inflows would at times push interest rates in coordinate international relief operations and recon- the candidate countries to levels lower than desirable struction efforts, and develop key institutions with for domestic monetary management. adequate resources and staffs. Marek Belka, economic advisor to the President of , stressed the key role that EU accession Time-series data management prospects had played in crystallizing domestic coali- Addressing a seminar on economic and financial time- tions for economic reform. Josef Kreuter of the Czech series data management, Warren Minami, Frank Ministry of Foreign Affairs also stressed the need for Maranto, and Sam Ouliaris of the IMF presented rec- the accession candidates to establish the right reform ommendations for collecting, managing, and reporting priorities—including in labor market reform. on large volumes of economic and financial statistical data. The main attraction of their approach is a Financial system stability dynamic link between the database and spreadsheets, Speaking at a workshop on improving financial system which would shift the work of analysts from time-con- stability, Andrew Crockett, General Manager of the suming data entry, management, and reporting to the Bank for International Settlements, noted that weak- more valuable manipulation and analysis of data, thus nesses in domestic financial systems and in financial “unlocking the hidden value of data in spreadsheets.” markets are most effectively addressed by strengthen- ing best practices and ensuring that markets are trans- Capstone roundtable parent, open, and efficient. It would be important to The seminar program was summed up at a roundtable at avoid undue complexity, he said, by prioritizing the which the opening speaker was the musician Bono, who large number of standards for the benefit of those said he represented a constituency of those who had lost countries that intended to use them. The chair of the confidence in institutions such as the IMF and the World workshop, Bimal Jalan, Governor of the Reserve Bank Bank. The only reasonable course, he asserted, was to of , recommended that the connection between completely cancel the debts of poor countries. Lauren standards and codes and financial stability be clarified. Lenfest of Oracle Corporation saw the challenge of the At a complementary workshop on the development coming years as making the global economy and techno- and assessment of international standards and codes, logical advances work for everyone. Carl Adams of Merrill Lynch observed that standards Elizabeth Tang of the Confederation of serve as the bricks and mortar to hold the global com- Trade Unions said that while workers and unions view munity together and that it is essential to provide details globalization as inevitable, they are concerned about los- of the work done in this area to the private sector. The ing their jobs. Trade unions, she said, are being weak- moderator, Alastair Clark, Executive Director of the Bank ened by liberalized trade and privatization policies. of England, called for a more determined effort to raise Boney Katumbo of the Ugandan National Chamber general awareness of the standards and codes process. of Commerce said that developing countries were poised to benefit from the digital revolution. He recom- East Timor mended that international negotiations focus on debt The pressing problems facing the people of East Timor relief or cancellation, free movement of labor, enhanced were the focus of a special workshop organized by the economic cooperation, and strengthened private sector IMF and the World Bank on the collaboration between institutions. Ian S. McDonald October 23, 2000 the Bretton Woods institutions in postconflict coun- Editor-in-Chief 340 tries. Opening the discussion, IMF Deputy Managing IMF Survey

©International Monetary Fund. Not for Redistribution Governors’ statements seen as greatest challenge of new century despite improved global environment onditions in the global economy are encouraging, ment the necessary reforms in their financial, corpo- Cand prospects for continued economic growth are rate, and government sectors. generally favorable. Nonetheless, poverty remains the sin- Several governors, however, cautioned that the task gle greatest challenge of the century. Speaking at the ple- ahead would be to make this growth more sustainable nary sessions of the 2000 Annual Meetings of the IMF and to spread its benefits more widely. For example, and the World Bank, held on September 26–28 in if oil prices were to continue to rise, said de Rato Prague, Czech Republic, the governors representing the Figaredo, the rosy outlook for world growth could be IMF’s 182 members acknowledged that, although global- jeopardized. Didier Reynders, Minister of Finance of ization has brought opportunities for growth and devel- , agreed. “It is in our collective interests,” he said, opment to both rich and poor countries, not everyone “including those of the oil producing countries, to pre- has been able to take advantage of the opportunities. The vent a slump in world growth; it is therefore essential to task facing the international community, the governors ensure that the market is supplied in a manner more in agreed, is to build a successful, truly global economy that line with economic circumstances.” A number of gover- works well for all people and addresses the widespread nors, supporting this position, called on the oil producing poverty that remains “the unacceptable face of the global countries to increase oil production to bring prices down. economic situation,” according to Yannos Papantoniou, However, Mohsen Nourbakhsh, Governor of the Central Minister of National Economy and Finance of Greece. Bank of the Islamic Republic of Iran, characterized the In addition to poverty reduction—a dominant mes- present attempts to shift responsibility to oil producers as sage of the 2000 meetings—governors addressed a num- “patently unfair.” When the price of oil collapses, he said, ber of interrelated topics. These included the current producers are asked to adjust their economic policies to high price of oil—and the implications for, in particular, offset lower prices. When prices recover, the industrial developing countries that depend on imported oil; sup- countries do not adjust their economic policies, but port for the goal of bringing to 20 heavily attempt to push producers to adjust oil production. indebted poor countries by the end of the year; the need Paraguay’s Minister of Finance, Federico for a further strengthening of the international financial Zayas Chirife, also spoke of the risks of architecture; and various issues related to reforms of the globalization, which he said poses an Bretton Woods institutions and the division of labor increasingly serious challenge to the ingenu- between the IMF and the World Bank. ity and creativity of IMF and World Bank members. He hoped that the industrial Growth of the world economy countries would help to “achieve global eco- At the 1999 Annual Meetings, the general opinion nomic growth that is truly beneficial to all among governors was that the worst of the interna- nations of the world” by opening their mar- tional financial crisis was already over. “We were correct kets, providing more aid, and providing then,” said Rodrigo de Rato Figaredo, Second Vice debt relief to the poorest countries. President and Minister of Economy of , “but we Rod Kemp, Assistant Treasurer of the were far from realizing that we would now find our- Commonwealth of Australia, noted that selves in a global economic boom.” This boom is sustained growth required sound domestic expected to carry over to 2001 in all geographical policies and institutions, better lending regions of the world. Robust growth in the United and investment assessments, and better DAI Xianglong called for “a win-win States is contributing to this performance, he noted, as performance from the international institutions. He, globalization is growth in Europe and much of Asia. After recovering too, argued that the industrial countries could boost characterized by from their recent financial crisis, the Latin American the prospects of the poorest economies by lowering equality.” economies are expected to join in that growth. trade barriers. CHEA Chan To, Governor of the National Bank of DAI Xianglong, Governor of the People’s Bank of Cambodia, and KEAT Chhon, Cambodia’s Senior , called for “a win-win globalization character- Minister of Economy and Finance, noted that the ized by equality.” He said it was therefore necessary to underlying fundamentals of the world economy have create a fair and reasonable world economic order strengthened and a more sustainable pattern of involving all countries—to the extent possible and on growth has been created. They applauded the coun- an equal basis—in international economic decision tries for their successful performances and praised the making and rule setting, and establishing a new and October 23, 2000 international community for helping countries imple- fair international financial and trading system. 341

©International Monetary Fund. Not for Redistribution Strengthening the monetary system exhorted the two institutions to reinforce their part- Governors generally welcomed the IMF’s recent nership with each other as well as to coordinate their efforts to strengthen the international financial sys- activities with regional financial institutions, such as tem, including the formulation of standards and the Chiang Mai Initiative, which several Asian gover- codes, measures to improve surveillance, and efforts to nors described as a further step toward economic increase transparency. Bangladeshi Minister of cooperation in the Asian region. Finance Shah A.M.S. Kibria emphasized, however, that Igor Mityukov, Ukraine’s Minister of Finance, urged to be sustainable, the new financial architecture had to the IMF and the World Bank not to “sideline their core be based on equity, “where both developing and responsibilities in promoting sound development poli- industrial countries have equal opportunity for partic- cies, strengthening the international monetary and ipation.” Dato’ Shafie Mohd. Salleh, Malaysia’s Deputy financial system, and helping to sustain momentum Minister of Finance, suggested that IMF surveillance for the acceleration of international trade.” He stressed had to be more evenhanded. Surveillance would be the importance of preserving the cooperative nature of more effective, he explained, if the IMF focused more the international financial institutions at the turn of attention on developments in the major industrial the century of the information revolution. countries, which have systemic implications for the Another issue that attracted a considerable amount rest of the world. Pavel Mertlik, Deputy Prime of attention from governors was the IMF’s quota for- Minister and Minister of Finance of the Czech mula and revisions that would reflect the changing Republic, characterized the need for transparency as circumstances of the global economy. Several gover- particularly important in transition economies. “The nors for developing countries—including Kinikinilau lack of transparency,” he said, “increases the costs of Tutoatasi Fakafanua, Tongan Minister of Finance; transition and slows down economic growth.” Dato Haji Selamat Haji Munap, Deputy Minister of Finance of Brunei Darussalam; and Tantely R.G. Support for HIPC Andrianarivo, Prime Minister and Minister of Finance Poverty can more easily be addressed during times of and Economy of on behalf of the Joint strong economic performance, according to Papan- African Group—said they felt that their countries toniou, who emphasized that the international commu- should have a greater say in defining development pri- nity should take advantage of the present favorable orities, especially in light of the new emphasis on conditions. Along with the majority of governors who country ownership of programs. Nyum Jin, Minister spoke, he expressed support for the Poverty Reduction of Finance and Economy of Korea, agreed that the and Growth Facility and the Heavily Indebted Poor IMF’s quota and representation systems needed to be Countries (HIPC) Initiative. “The developed world,” he adjusted. In his view, “the IMF’s current policy does said, “should intensify its efforts to combat poverty not properly weigh the economic influence of Asian through the systematic application of relief and assis- emerging economies,” including that of Korea. Kemp tance policies.” concurred but said he would not want to see the rep- Kemp welcomed the progress made in bringing 10 resentation of smaller developing countries reduced. heavily indebted countries to their “decision points,” Australia, he said, supports a simplification of the cur- but warned against complacency. He urged the IMF rent quota formula system, “which lacks both logic and the World Bank to maintain their current efforts and transparency.” and continue to collaborate closely “to get a further 10 countries to this point by the end of the year.” The heavily indebted poor countries themselves, he said, Selected IMF rates

must address circumstances that prevent an early deliv- Week SDR interest Rate of Rate of ery of relief, including armed conflicts in some coun- beginning rate remuneration charge tries. Prijadi Praptosuhardjo, Minister of Finance of October 9 4.76 4.76 5.52 Indonesia, was also encouraged by the progress October 16 4.73 4.73 5.48 The SDR interest rate and the rate of remuneration are equal to a achieved in implementing the HIPC Initiative but weighted average of interest rates on specified short-term domestic expressed concern that its financing remained unre- obligations in the money markets of the five countries whose cur- rencies constitute the SDR valuation basket (as of May 1, 1999, the solved. He urged all bilateral and multilateral donors to U.S. dollar was weighted 41.3 percent; euro (), 19 percent; euro (), 10.3 percent; Japanese yen, 17 percent; and U.K. “provide the necessary financial supports to avoid set- pound, 12.4 percent). The rate of remuneration is the rate of return on members’ remunerated reserve tranche positions. The rate of backs in providing debt relief to poor countries.” charge, a proportion (115.9 percent) of the SDR interest rate, is the cost of using the IMF’s financial resources. All three rates are com- puted each Friday for the following week. The basic rates of remu- Bretton Woods institutions neration and charge are further adjusted to reflect burden-sharing arrangements. For the latest rates, call (202) 623-7171 or check the Cooperation emerged as a catchword of this year’s IMF website (www.imf.org/cgi-shl/sdr.pl). October 23, 2000 meetings, arising, notably, in discussions of the roles Data: IMF Treasurer’s Department 342 of the IMF and the World Bank. Several governors

©International Monetary Fund. Not for Redistribution Japan has options in addressing large deficit

(Continued from front page) highest. Some studies have to rise considerably as the population ages. While the suggested that a relative lack of child care facilities has largest pension system for private employees is partly exacerbated the impact on family size of rising female funded, it will run out of funds if Japan doesn’t do participation rates in the labor force. Whatever the something in the next couple of years. So the question is cause, the decline in fertility rates has been much more what the Japanese authorities can do with the least dramatic in Japan. The country expects to see a com- harmful consequences for growth. paratively faster rate of aging and a greater increase in elderly dependents. The country can also expect an IMF SURVEY: What methodology did you use? overall decline in its population—something that sets FARUQEE: We extended the IMF’s own multicoun- Japan apart. Among the industrial countries, only try macrosimulation model—MULTIMOD—to comes close to Japan’s experience. bring in the impact of population aging and intro- duced a pension system with revenues generated IMF SURVEY: Why is the IMF looking at the macro- from different avenues, including wage and con- economic implications of aging in Japan now, and sumption taxes. Conceptually, we tried to quantify what concerns were your studies designed to address? the impact by looking at how various age groups MÜHLEISEN: Japan has long been known for its strong fis- differed, notably in wage earning. In Japan, as in cal position. Like its people, the Japanese government has most countries, you see young workers with rising been fiscally conservative and traditionally has had little income, middle-aged workers at an earnings peak, debt and relatively low expenditures. But the fiscal situa- and senior workers and retirees with declining or Faruqee: “We tion, like the demographic situation, has seen a marked little labor income. The age-earnings profile helped us wanted some sense of how large the reversal over the past decade. Japan has had to run very characterize labor supply and productivity differences economic impact high deficits—including several large stimulus pro- between age groups. And that feature helped us to of aging would be grams—to keep its economy afloat after the bubble period quantify the impact of the changing composition of the and then use that information to help in the late 1980s. Within a few years, Japan recorded virtu- population. The model then used this information to frame pertinent ally the highest level of gross debt within the Organization determine demand- and supply-side implications of policy questions for Economic Cooperation and Development. population aging. and strategies.” Japan still has formidable assets, especially in its social security system, but it cannot continue indefinitely with- IMF SURVEY: What did the data tell you about the out raising concerns about the sustainability and financ- broader implications of Japan’s aging population? ing of these deficits. The economy is still fragile, so this is FARUQEE: On the supply side, Japan will have a shrink- not yet the time for fiscal consolidation. But a thinking ing workforce, with implications for investment. An process must begin; it is hoped this will lead to a strategy aging population needs to shed capital as the size of for addressing the fiscal problem before the aging prob- the workforce declines. On the demand side, we found lem really kicks in. A public debate is going on now, and that saving levels also tend to decline with the overall the government has said that it wants to return to a size of the economy, but per capita saving rates tend to more sustainable fiscal path as soon as the economy stay fairly stable. The fact that we did not find large allows. Our are meant to contribute to this think- declines in saving rates is a little different from the ing process and help lay the basis for a strategy to findings of previous studies on aging populations. In address these issues. Japan, the aging comes from a fall in fertility rates and FARUQEE: The broader macroeconomic study, which I an increase in longevity. The elderly tend to save less prepared, sought to quantify the impact of population than other age groups, but increasing longevity tends aging on key macroeconomic variables. We asked our- to raise saving rates across age groups, because the selves what might happen to Japanese saving and planning horizon is lengthened. Also, Japan’s sharp investment rates and growth over the next half-century. decline in fertility rates has led to a decline in youth We wanted some sense of how large the economic dependency rates, which helps lessen the negative impact of aging would be and then use that informa- impact on saving rates. tion to help frame pertinent policy questions and The other main finding was that given a contracting strategies. workforce and a contracting population—and barring MÜHLEISEN: My paper looked more specifically at the fis- some change in productivity growth—Japan’s overall cal side. Besides the question of how Japan could move GDP growth could decline by about 1/2 of 1 percentage away from its huge deficits in the coming years, we asked point over the next several decades, compared to a sce- ourselves how Japan could address its long-term aging nario with a stable population and workforce. In per problem. Japan’s pension and health care systems are to capita terms, this is not necessarily a large decline, October 23, 2000 a large extent publicly financed, with expenditures slated because income is declining in line with the number of 343

©International Monetary Fund. Not for Redistribution people. But because the workforce becomes more contribution rates of 30 percent, which would serve as an elderly, you might also expect some decline in per capita even larger disincentive for labor force participation. incomes compared to a case where no aging took place. We also looked at the fiscal implications of rising gov- ernment transfers on the pension and health insurance IMF SURVEY: The second study looked at the fiscal sit- systems. We found that once expenditure cuts and mea- uation in greater detail. sures to broaden the tax base are implemented, additional MÜHLEISEN: The most important question for the near adjustments will still be required on the consumption tax term is whether Japan’s fiscal position is sustainable. side. This is a politically sensitive issue, but in the end it is The simulations tell us that the problem is manage- the main tool the authorities have to adjust the fiscal side. able but will require serious consolidation in the Right now, Japan has a relatively low tax rate of 5 percent. next few years and a tight fiscal policy over the next Under our baseline projections, the consumption tax rate couple of decades when the aging process kicks in. would have to rise to 25 percent by the year 2050, when But having said that, there is still some concern the age dependency rate is the highest. This estimate is over the immediate future, since debt levels are going not very precise, of course, since different assumptions to rise even if Japan takes steps to turn its fiscal on, say, the fertility rate or total factor productivity deficit of 8–9 percent of GDP into a primary surplus. growth could lead to considerable variations in the end On the basis of a realistic policy scenario that incor- point for the consumption tax rates. Our estimates are in porates already approved social security reforms, we the range of 18 to 30 percent. figure that net debt (excluding the social security sys- The main long-term question for Japan is really how tem) is not going to stabilize until it reaches 120 per- it should finance the growing pension and health care cent of GDP by the end of the decade. burden. There are basically three options: maintain ben- Mühleisen: “The most important The options come in when we talk about the com- efit levels roughly where they are, but raise contribution question for the position of adjustment measures. Japan has one of the levels; keep the current level of benefits, but finance the near term is whether largest public investment ratios among the Group of gap through government transfers instead of contribu- Japan’s fiscal position is Seven countries, so there is some room to cut public tions; or cut both benefits and contributions. These sustainable.” investment. Moreover, while there is comparatively lit- options have different growth and welfare effects. The tle room to cut current expenditure, Japan’s tax rev- baseline option of keeping benefits at current levels and enue ratio is rather small, and the authorities would raising contribution levels produces the worst results, need to either broaden the income tax base or raise because it discourages workforce participation. It is also the consumption tax rate. proves to be the least equitable option, because pension Our policy analysis looked at the growth and wealth costs would be entirely financed by the young, who are a effects of these policy options. For example, cutting pub- shrinking proportion of the population. lic investment a strong positive effect on growth over the Cutting both benefit levels and contributions pro- longer term but would have sharply negative effects over duces the most positive effects. It offers an incentive for the short term, since it reduces demand directly. It is not higher saving through private pension arrangements, something we would recommend doing on a big scale has the least distortionary effects in terms of payroll right away, because Japan’s recovery remains weak. taxes, and is the most equitable. The third option— The other two options for stabilizing debt—a con- higher benefit levels funded by consumption taxes paid sumption tax increase or a broadening of the tax by the elderly as well as the rest of the population— base—tend to have somewhat lower long-term positive offers higher growth than the baseline scenario over effect on growth but create fewer macro problems in the long term, but the welfare effects measured by real the short term. Realistically, however, these measures consumption and real private wealth tend to disappear would also need to be phased in gradually to avoid over time. The main reason is that the model incorpo- strong taxpayer resistance. So the policy response will rates welfare losses caused by higher consumption need to be a balanced mixture. taxes, owing to the wedge between consumer and pro- ducer prices. Our simulations conclusively indicate that IMF SURVEY: Once the fiscal situation has stabilized, cutting benefits and raising contributions is the pre- what are the fiscal implications of the aging process? ferred option, albeit a politically difficult one. MÜHLEISEN: In our simulations, we looked first at the finances of the social security system. The Japanese IMF SURVEY: What are the key issues, then, for Japan Ministry of Health and Welfare projects that under its in the near term? currently envisaged pension reform plan, contributions to MÜHLEISEN: Let me emphasize that the first priority is the major pension system would need to increase from a ensuring a solid recovery. Debt reduction should be pur- current level of 171/2 percent on wages to 25 percent over sued in ways that least endanger the recovery. Our find- October 23, 2000 25 years. We found, using our own macroeconomic ings underscore the detrimental effects on growth that 344 assumptions, that this would not be enough. We projected would initially result from severe public investment cuts.

©International Monetary Fund. Not for Redistribution FARUQEE: Certainly, Japan’s current macroeconomic necessitate a larger, more difficult adjustment. This climate and persistent cyclical weakness argue that its paper hopes to encourage early action as soon as the short-term priorities lie elsewhere, but the prospects strength of the recovery makes that feasible. for population aging are well in place and thus pose serious policy challenges. Acting early, rather than Copies of Japan—Selected Issues will be available shortly for later, gives the authorities the greatest degree of flexi- $10.00 each from IMF Publication Services (see page 350 for bility in the options they can consider. Acting only ordering details). The two chapters discussed in this article are also being revised and will be released as an IMF Working Paper. after the aging hits with full force would probably also

Stand-By, EFF, and PRGF Arrangements as of September 30

Date of Expiration Amount Undrawn Member arrangement date approved balance (million SDRs) Stand-By Arrangements March 10, 2000 March 9, 2003 5,398.61 5,398.61 Bosnia and Herzegovina May 29, 1998 March 31, 2001 94.42 30.15 Brazil1 December 2, 1998 December 1, 2001 10,419.84 2,550.69 Ecuador April 19, 2000 April 18, 2001 226.73 113.38 March 1, 2000 August 31, 2001 29.34 29.34 Korea1 December 4, 1997 December 3, 2000 15,500.00 1,087.50 December 10, 1999 April 9, 2001 33.00 33.00 March 8, 2000 June 7, 2001 61.80 61.80 Members drawing on Mexico July 7, 1999 November 30, 2000 3,103.00 1,163.50 Nigeria August 4, 2000 August 3, 2001 788.94 788.94 the IMF “purchase” Panama June 30, 2000 March 29, 2002 64.00 64.00 March 29, 2000 May 28, 2001 85.54 75.54 April 1, 1998 December 31, 2000 1,020.79 237.56 other members’ Romania August 5, 1999 February 28, 2001 400.00 260.25 Russian Federation July 28, 1999 December 27, 2000 3,300.00 2,828.57 currencies, or SDRs, December 22, 1999 December 21, 2002 2,892.00 2,226.84 Uruguay May 31, 2000 March 31, 2002 150.00 150.00 with an equivalent Zimbabwe August 2, 1999 October 1, 2000 141.36 116.62 Total 43,709.37 17,216.29 amount of their own EFF Arrangements Bulgaria September 25, 1998 September 24, 2001 627.62 156.92 currency. Colombia December 20, 1999 December 19, 2002 1,957.00 1,957.00 Indonesia February 4, 2000 December 31, 2002 3,638.00 2,786.85 Jordan April 15, 1999 April 14, 2002 127.88 91.34 Kazakhstan December 13, 1999 December 12, 2002 329.10 329.10 Pakistan October 20, 1997 October 19, 2000 454.92 341.18 Peru June 24, 1999 May 31, 2002 383.00 383.00 Ukraine September 4, 1998 September 3, 2001 1,919.95 1,207.80 Yemen October 29, 1997 March 1, 2001 105.90 65.90 Total 9,543.37 7,319.09

PRGF Arrangements Albania May 13, 1998 May 12, 2001 45.04 9.41 Benin July 17, 2000 July 16, 2003 27.00 20.20 Bolivia September 18, 1998 September 17, 2001 100.96 56.10 Burkina Faso September 10, 1999 September 9, 2002 39.12 27.94 Cambodia October 22, 1999 October 21, 2002 58.50 41.79 Central African Rep. July 20, 1998 July 19, 2001 49.44 32.96 Chad January 7, 2000 January 7, 2003 36.40 26.00 Côte d’Ivoire March 17, 1998 March 16, 2001 285.84 161.98 Djibouti October 18, 1999 October 17, 2002 19.08 13.63 Gambia, The June 29, 1998 June 28, 2001 20.61 10.31 Ghana May 3, 1999 May 2, 2002 191.90 120.85 Guinea January 13, 1997 January 12, 2001 70.80 15.73 Guyana July 15, 1998 July 14, 2001 53.76 35.84 Honduras March 26, 1999 March 25, 2002 156.75 64.60 Kenya August 4, 2000 August 3, 2003 150.00 136.40 Kyrgyz Republic June 26, 1998 June 25, 2001 73.38 28.69 Madagascar November 27, 1996 November 30, 2000 81.36 9.48 Mali August 6, 1999 August 5, 2002 46.65 33.15 Mauritania July 21, 1999 July 20, 2002 42.49 30.35 Mozambique June 28, 1999 June 27, 2002 87.20 42.00 March 18, 1998 March 17, 2001 148.96 53.82 Pakistan October 20, 1997 October 19, 2000 682.38 417.01 Rwanda June 24, 1998 June 23, 2001 71.40 28.56 São Tomé and Príncipe April 28, 2000 April 28, 2003 6.66 5.71 Senegal April 20, 1998 April 19, 2001 107.01 42.80 Tajikistan June 24, 1998 June 23, 2001 100.30 40.02 Tanzania March 31, 2000 March 30, 2003 135.00 95.00 Uganda November 10, 1997 March 31, 2001 100.43 8.93 Yemen October 29, 1997 October 28, 2000 264.75 114.75 Zambia March 25, 1999 March 28, 2003 254.45 234.45 Total 3,507.62 1,958.46 Grand total 56,760.36 26,493.84

1Includes amounts under Supplemental Reserve Facility. EFF = Extended Fund Facility. PRGF = Poverty Reduction and Growth Facility. Figures may not add to totals owing to rounding. October 23, 2000 Data: IMF Treasurer’s Department. 345

©International Monetary Fund. Not for Redistribution