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Table 17. Replacement rates for different income bases and family situations

Table 17. Replacement rates for different income bases and family situations

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102



OECD Economic Surveys: Japan



In the event, this reform has proved inadequate. Until 2003, falling prices

were not allowed to reduce nominal pensions in view of the prevailing economic

circumstances, so temporarily undoing the move from wage to price indexation. As

a result, the level of pension spending, relative to national income, expected

for 2008 was reached in 2002 (Ministry of Foreign Affairs, 2002). Looking ahead, the

increase in the contribution rate scheduled for 2004 was postponed in view of the

economic circumstances. Moreover, the population growth projection has been

revised down. The authorities have announced a plan to set a ceiling on the

contribution rate and allow benefits to adjust to demographic and economic

trends. For a fixed contribution rate, the benefit level would depend on the

growth in both average earnings and the number of employees, thus insulating the

pension system from unexpected demographic developments. If the pension

contribution rate were capped at 20 per cent of earnings (close to the level

already planned for 2020 in 1999), the replacement rate would have to drop by

10 percentage points to 42 per cent of overall pay. Alternatively, capping the

contribution rate at its current level would stabilise spending relative to national

income at its 2002 level, with the replacement rate dropping to around 36 per

cent, reducing the income of a retired couple by just over a quarter. In order to

maintain their consumption level, such a household would have to increase the

speed at which their financial assets were run down from 2½ per cent annually to

6 per cent, without taking into account the possibility of realising some value

from their home.

In view of the likely reduction in public pensions in the future, the authorities

should ensure sound regulation of private provision for consumption in retirement.

Most employees have access to company-based pension or retirement saving

vehicles. The government has announced the progressive ending of one of these

funds – tax-qualified pensions – as they are subject to excessive risk. Under this

system (covering 18 per cent of employees), reserves are held on the balance

sheet of the company but are not secured by any specific asset and have been

limited to 40 per cent of liabilities by corporate tax law. As from 2002, no new

funds of this type can be created and existing reserves have to be transformed

into employee pension funds (or similar institutions) by 2012. Existing employee

pension funds (covering a further 28 per cent of employees) must be managed

independently or made into foundations not linked to the sponsoring company.

The government has not called for the pre-funding of the severance pay system,

which acts as further form of retirement saving. This benefit is provided mainly to

employees in larger companies and the government (Tachibanaki, 2000). These

liabilities have been estimated at 12 and 10 per cent of GDP for company and government employees respectively (Goldman Sachs, 1999 and Cabinet Office, 2001).

The government has introduced some reforms aimed at lessening the risk

that pension funds will default on their obligations. An accounting law reform,

introduced in 2001, obliges companies to declare pension liabilities on their



© OECD 2004



Achieving fiscal sustainability



103



balance sheet and, if there is a deficit, to put in place a 15-year programme to

restore the financial health of the plan. Many companies will need to do this.

In 1999, according to the Pension Funds Association, 37.8 per cent of employee

funds had a shortfall greater than 20 per cent of assets (Clark and Mitchell, 2002).

Such a shortfall occurred despite companies typically choosing to discount liabilities

at a comparatively high interest rate of 5.5 per cent, which is well above the yield

of 1½ per cent on government bonds, so significantly understating liabilities.

Without prompt corrective action by regulatory authorities, there is a danger that

there will be insufficient funds to pay these liabilities. In addition, legislation has

been introduced that permits the creation of defined contribution pension saving

systems, in which individuals are free to choose the desired level of investment

risk. The authorities hoped that such plans would prove popular among small and

medium-sized companies. However, their spread has been slow, with most new

schemes reflecting transfers from tax-qualified funds that are being wound up.

The public pension system has only limited disincentives to continued

employment once an old-age pension is drawn, although they are scheduled to

increase in a way that is inappropriate during a period of stress on future pensions. At the moment, the disincentives to continued work are concentrated on

people in the age group 60 and 64. If they continue to work while receiving an

employees’ pension, the marginal reduction in benefits is equivalent to a tax rate

of between 20 and 100 per cent depending on the level of an individual’s earnings. In 2002, all earnings above 370 000 yen (90 per cent of average earnings) were

deducted, yen for yen, from pension benefits. Until 2002, a person could work past

age 65 without any reduction in the employees’ pension. As a result, the cumulative loss of social security wealth between the earliest possible retirement age

and 69 relative to work income in Japan was among the lowest in major countries

(Gruber and Wise, 2002). About 30 per cent of those in the 60 to 64 age group who

work and are entitled to an employees’ pension, however, choose to work parttime in order to avoid losing their benefit. Since 2002, similar rules have been

applied to those aged 65 to 69 as were applied to those five years younger. Selfemployed workers, and people who have not been eligible for the earnings-related

pension, have an incentive to continue working as they have low benefits. Moreover,

a growing proportion of the self-employed (40 per cent in 1999) choose to not

contribute to the first-tier system, with non-compliance being particularly high

among young people (Oguchi and Hatta, 2001).

Government policy has become more oriented to keeping people in

employment as long as possible. There has been considerable use of short-term

unemployment as a route into retirement, with over a third of the people who

completely retire from the labour force have previously been drawing unemployment

benefits (Oshio and Oishi, 2002). This route was made less attractive in 2001, when

the maximum period that older people can draw such benefits was reduced from

one year to six months. In addition, a number of incentives to continued work are



© OECD 2004



104



OECD Economic Surveys: Japan



in effect. A re-employed worker (aged over 60) can continue to receive 30 per cent

of the unemployment benefit under the Employment Acceleration Allowance

introduced in May 2003. As well, older workers who are re-employed after age 60

at a lower wage than they earned at 60 are eligible for the Employment Continuation

Benefit. The number of workers aged 60 to 64 who receive this benefit tripled

between 1996 and 2001 to 3.1 per cent of the labour force in that age group. On

the demand side, employers are now more likely to hire older workers as they

have been able to offer them five-year fixed-term contacts since 1998, although

these can only be renewed for a one-year period. Unlike some other OECD

countries, disability benefits do not seem to provide an alternative pathway into

early retirement in Japan. Strict medical criteria are used to determine eligibility

for disability benefits and the number of these pensions is very low.

If further reductions in replacement rates are to be made, it will be important

to introduce reforms that lower the disincentives for married women to work

full-time so that they can build up pension rights. As noted above, the labour

force participation of Japanese women is similar to the OECD average but an

unusually high proportion of women work part-time and consequently they are not

eligible for second-tier pensions. The combination of income and social security

tax plays a considerable role in increasing the attractiveness of part-time work.

Spouses can earn 1.03 million yen without paying income tax and up to 1.3 million

yen without paying social security contributions and this leads to a clustering of

incomes at the 1.0 million yen level (Ono and Rebick, 2003). Moreover, women

earning over the social security limit pay the same contribution rate as men but obtain

a much lower replacement rate, reflecting differences between the career paths of

men and women. Policies to improve the ability of women to combine work and

bringing up children appear to be effective in Japan (Higuchi et al., 1997). Further

implementing such policies could lead to women accumulating increased pension

rights and eventually lower the extent of poverty amongst elderly single women.

Assessment

The deterioration of the fiscal situation is due to a large extent to the

weakness of the economy and continued deflation. Fiscal policy is not sustainable

in the sense that the current stability in financing public debt depends on the

continuation of exceptionally low interest rates, weak private demand and the lack

of risk-taking by households and the corporate sector. However, given the urgency

of fiscal consolidation, any increase in revenue resulting from buoyant activity

should be used primarily to reduce the budget deficit. Moreover, the expected

½ per cent of GDP decline in the structural budget deficit in 2004, assuming no

supplementary budget in FY 2003, is a welcome development. However, a more

significant tightening of fiscal policy could undermine the current recovery, further

delaying a significant reduction in the budget deficit over the longer term. In



© OECD 2004



Achieving fiscal sustainability



105



addition, accelerated bank and corporate-sector restructuring is likely to have a

negative impact on employment and activity in the short term. Temporary hikes in

spending should be allowed to address structural problems, particularly in the

financial sector. Such outlays may be necessary to unblock the credit transmission

channel, which would help end deflation and facilitate reductions in the budget

deficit. At the same time, efforts to improve the efficiency of public expenditures

need to continue in order to enhance growth prospects and to establish the credibility of medium-term fiscal consolidation. Given the precarious state of public

finances, a solid framework for fiscal consolidation over the medium term needs to

be established to maintain credibility and ensure fiscal sustainability. Following

through on the planned reduction in the budget deficit in 2004 is a key to building

confidence. It should be accompanied by specific measures to reduce the deficit

further in 2005 and over the medium term. Once the economy attains a more normal

growth path, strengthening the credibility of fiscal consolidation is the key to limiting

an increase in the risk premium on interest rates, which would slow the pace of

deficit reduction.

A key to ensuring fiscal sustainability is reform of the pension system.

Notwithstanding extensive reforms in recent years, public pensions will become

unsustainable under existing rules in the face of an ageing society. Bringing the

system back to financial sustainability through sharp increases in contributions

should be avoided, as this might adversely affect the productive capacity of the

economy by weakening work and saving incentives. Indeed, the authorities’ plan

to set a ceiling on contribution rates and allow benefit levels to adjust to

economic and demographic trends appears to be appropriate. This plan should

involve re-valuing the past earnings used to calculate benefits by the growth of

total wages in the economy rather than by the growth of per capita wages and

should ensure that the policy of indexing pensions, once granted, to prices is

adhered to, even if prices are falling. Some reform of the tax system would also

help to encourage married women to work full-time – a move that would also

reduce the risk of poverty among elderly women by improving their pension entitlements. However, labour market practices, such as the age limits in recruitment,

also need to be addressed to reduce obstacles to the participation of married

women in the labour force. While employment of the elderly is high in Japan, the

rules that lower pension benefits for older workers should be reviewed in order to

increase the attractiveness of full-time work. In the context of a possible fall in

public provision, individuals may have to save more for retirement. The authorities need to facilitate private saving by establishing an adequate regulatory and

supervisory framework for pension funds. In this context, the solvency of each

employee pension fund, using market interest rates to value liabilities, should be

examined by the pension regulator and the period allowed for moving to solvency

reduced from the current 15 years. Adequate information on solvency should be

sent to all fund members.



© OECD 2004



IV.



Product market competition

and economic performance



The OECD Growth Study and other empirical work have shown that the

strength of competition in product markets is likely to play an important role in

the process of economic growth. In Japan, policies promoting product market

competition have long been compromised by ministerial guidance and explicit

exemptions from the competition law. Intense competition is thus lacking in many

domestic sectors. As a result, these sectors are characterised by comparatively

high prices, weak innovative activity and low levels and growth of productivity.

The current allocation of resources thus seems inefficient, partly explaining why

the Japanese economy has failed to come out of its quasi-stagnation of the past

decade. From a positive perspective, however, this means that potential gains

from more pro-competition policies are probably quite large. To realise such

gains, the Japanese government has made the promotion of competitive markets

one of the cornerstones of its policy to promote economic growth. For example,

the resources of the Fair Trade Commission have been increased, and greater

impetus has been given to regulatory reforms. However, the legacies of past

policies appear difficult to dismantle and progress has been uneven.

This chapter begins with a short review of Japan’s disappointing growth performance over the past decade and its possible links to weak competitive pressures.

Attention is then turned to indicators of product market competition to gauge the

strength of competitive pressures as well as the implications of barriers to trade and

foreign direct investment. This is followed by an assessment of the general competition

policy framework and its role in promoting competition. The chapter then examines a

number of sectors where regulatory policies can be expected to have particularly large

impacts. The chapter concludes with a set of policy recommendations.

Macroeconomic performance and indicators of competition

The economic performance has been weak over the past decade

Starting from a high level of GDP per capita, the economic performance of

Japan over the past decade has been comparatively poor (Table 18). GDP growth

has been less than half of the OECD average, with stagnant employment levels



© OECD 2004



108



Table 18. Output, employment and productivity



Average GDP growth: 1992-2002

of which:

Productivity

Employment

of which:

Unemployment1

Labour force

Demographics,2 1990-2001

Participation rates,3 1990-2001

Labour productivity growth

in selected industries:4

Total manufacturing

Electricity, gas and water supply

Construction

Wholesale and retail trade,

restaurants and hotels

Transport, storage

and communication

Memorandum items:

MFP growth,5 1992-2001

GDP per hour worked, 2001



United

States



Japan



3.2



1.1



1.4



1.9



1.5



2.6



3.2



2.6



2.0



1.8

1.4



1.1

–0.1



1.3

0.1



1.1

0.8



1.3

0.2



2.0

0.6



1.5

1.7



1.2

1.4



1.4

0.6



0.1

1.3

1.2

0.0



–0.3

0.3

0.7

–0.1



–0.2

0.3

0.2

0.2



–0.1

0.7

0.7

–0.1



–0.1

0.2

0.1

0.0



0.3

0.3

0.2

0.0



0.3

1.4

1.3

0.0



–0.1

1.4

1.7

–0.1



0.0

0.6

0.8

0.3



3.9

1.0

0.2



2.4

2.1

–3.0



2.4

4.9

0.0



3.8

1.8

–0.3



2.2

3.9

– 0.1



2.5

9.7

2.5



2.5

1.3

0.2



n.a.

n.a.

n.a.



n.a.

n.a.

n.a.



3.8



0.9



–0.6



0.6



1.1



2.4



2.3



n.a.



n.a.



2.7



1.2



7.2



3.1



3.5



4.9



3.4



n.a.



n.a.



1.1

100.0



0.1

75.1



0.6

98.2



0.6

109.9



0.8

102.6



1.2

85.1



1.2

87.6



n.a.

83.1



n.a.

94.9



Germany



France



Italy



United

Kingdom



OECD



European

Union



© OECD 2004



OECD Economic Surveys: Japan



1. A positive sign indicates that unemployment has declined and contributed to higher output growth.

2. The contribution of demographics includes changes in the size and age composition of the working-age population.

3. Measures the effect from changes in age-specific participation rates.

4. 1991-2001, except for France, which is 1991-2000.

5. Total economy.

Source: OECD.



Canada



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