But about half of the gross debt in Japan consists of debts that one government agency owes to another, debts that in fact cancel each other out. Another substantial portion of the debt consists of surpluses in the social security account.

Selling assets does not solve the problem, except in a very short-term slipshod accounting sense. The government will gain some immediate cash, but it has lost the right to all the revenues that would accrue to it in the future from owning that asset. So, for the sake of a quick buck, it has reduced its future non-tax revenue. There are some very good economic reasons to get the government out of the business of selling cancer sticks and running a huge bank and insurance company. But the notion that it solves the problem that annual revenue falls short of annual spending is not one of them.

Naomi Fink, Japan Strategist, Global Marketing & Trading Division, Bank of Tokyo-Mitsubishi UFJ, Ltd.

It is not more important to keep in mind net than gross debt when looking at the adverse impact of a massive government balance sheet upon growth. That the government carries much intra-governmental debt with little to show for it is not a recommendation for the efficiency of their asset allocation. However, if we are to discuss the probability of a fiscal crisis, canceling out intra-governmental assets and liabilities is relevant. The MOF’s (Ministry of Finance) ability to borrow from the social security system reduces the need for fund-raising from the private sector. It is also important to keep in mind, when discussing the probability of financial crisis, the country’s external surplus/deficit position. Much less of Japan’s current account surplus is being ‘recycled’ abroad via direct and portfolio investments and instead is coming back to sit in banks as savings. Then, instead of lending banks are buying the government debt? These ‘risk free’ assets gain a higher capital weighting on banks’ balance sheets, plus allow absorption of a greater amount of debt. This is why the G-20 exempted Japan from the necessity to reduce its fiscal deficits.

I disagree that selling assets makes no difference to deficits.In the late 1980s when the government privatised NTT (Nippon Telegraph and Telephone), there was not only the $70-80 billion gained via the series of offers from privatisation itself but there was also a rise in both corporate and income taxes – because you can tax a privatised company’s profits plus the dividends on mostly retail investors’ participations in the IPO (initial public offering). Longer-term, these flows will jump-start asset reflation, which will be extended by the greater productivity of assets under private-sector than public-sector management. Judging by the experimental reverse privatisation of Yu-pack, such an argument might be made for Japan Post. Apart from Post and JT, one potential target would be the highways (perhaps follow the JR (Japan Rail) model and privatise plus regulate, to minimise profiteering). Then you have several hundred trillion in financial assets, comprised of foreign reserves, stocks, Zaito debt and FILP deposits. Of course, it would not make sense to dump all of this at once, but selective thinning out of the portfolio as assets reflate would make sense. That was the idea when Fortress proposed setting up a fund that would buy non-performing assets from banks and governments projecting a 20 per cent return. While they might be wildly optimistic asset valuations are quite low in Japan and there is plenty of room to maximise the productivity of some of the currently government-owned or supported assets instead of using fiscal stimulus to keep zombie firms from going bankrupt.

Richard Katz –

The statutory tax rate on corporate earnings is 40 per cent. The actual average tax:profits ratio for the corporate sector as a whole is closer to 26 per cent. If the government owns NTT, it gets all of the profits. If it sells it and taxes the profits, over the long haul, it gets a fraction of the profits. Unless NTT more than doubles or triples its profitability simply by virtue of not being government-owned, there is net loss in the future revenue stream for the government. There is a big difference between government ownership and government management. Management is JR running too many mostly-empty trains due to government pressure. Government ownership of shares of a firm run like a private one is a very different kettle of fish.

The government should get totally out of certain businesses when it will raise efficiency and potential GDP growth. But the impact of that in Japan is rather marginal given the low share of government-run businesses. Without a genuine program to raise the efficiency of the private sector and deal with chronic shortfalls in domestic private demand, Japan will remain addicted to deficit. One-time only sales of assets won’t solve the problem anymore than the sale of a division by a private firm that still doesn’t know how to make money. It only postpones the inevitable.

Japan Postal Bank and Japan Post Insurance should be abolished, not privatized. Turning one of the world’s biggest governmental monopoly banks and insurers into private monopolies doesn’t promote efficiency.

As for the other financial assets (foreign reserves, stocks, Zaito debt and FILP deposits) how does transferring ownership of pure paper promote growth if the real assets behind this paper remains problematic? Debt is debt, whether owed by the government or the private sector. We’ve seen lots of private debt crises, such as the US subprime. The issue is whether the assets backing that debt create the financial wherewithal to finance the debt service. Transferring debt backed by bad assets from government hands to private hands does not create financial solvency.

Naomi Fink –

Increasing efficiency is central to the success of privatization. If its not possible to maximise profits and reduce costs by electing private-sector management, privatisation is a mere transfer of assets. More transparent and better-quality management of the assets does matter and one clear purpose of privatisation should be to raise the marginal revenue of the privatised entity.

Therefore, when discussing the merits of offloading the business from the government’s balance sheets as a going concern, one must consider both sides of the balance sheet – if the government achieves poor marginal utility from the assets with regard to their pareto efficiency, then the government’s costs are also likely to be larger than those which would be imposed upon a more efficient manager of those assets. But it is not a foregone conclusion that private-sector management, even if subject to government regulations, will necessarily achieve a negligible change in efficiency of asset allocation.

Certainly, corporate governance is a very valid concern, shared by many overseas investors in Japanese stock. But low levels of current productivity is precisely why many wish to get in here – to achieve the superior returns that accompany increases in marginal revenue. This is where widening the investor base – particularly opening the doors to a variety of foreign investors – might help. While the government is reluctant to ‘sell out’ to foreign investors, there is probably value in exploring a model wherein foreign investors provide valuable information on the efficiency – and thus pricing – of private sector assets, long skewed by indiscriminate government handouts to for-profit firms.

While the impact of government getting totally out of certain businesses in Japan is rather marginal given the low share of government-run businesses, public financial intermediaries do control 30 per cent of domestic lending, which has the same effect. If we are to believe Modigliani and Miller, firm valuation is not determined by whether the firm is capitalised by debt or equity. The high rate of government intervention in lending could explain the high level of tolerance for poor corporate governance as well as the low level of competition among private sector lenders.

Regarding the link between IPO’s and asset reflation to the example of NTT shows a large proportion of retail investor participation in the offer. Retail investors, large holders of cash, dissave (thus reversing one of the key drivers of asset deflation) and divest deposits into equity assets. Thus, bank deposits do not build and are not funneled by banks into JGB (Japan government bonds) holdings, a trend that continues until investors turn risk averse once again about the ability of their future income flows. The IPO is no universal salve to poor asset allocation and deflation but is one trigger which, if followed through by greater productivity in assets throughout Japan, could restore a ‘virtuous circle’.

Regarding the statutory tax rate, the tax base is too narrow in Japan. According to the OECD, only one-third of corporates pay taxes at all. Broadening the tax base might be done in tandem with a decrease to the headline corporate tax rate. If a greater number of firms pay taxes then presumably this should minimise the impact of cutting taxes on the handful of large corporates who actually pay.

Regarding Japan Postal Bank and Japan Post Insurance the question is whether the government will realistically abolish both – and they probably will not. Minimising these entities’ inefficiencies is a good compromise. There is an alternative to establishing private-sector monopolies and here ‘privatise and regulate’ can work both ways. Instead of ‘running half-empty trains,’ forcing JP Bank/JP Insurance to adhere to private-sector regulations on disclosure, record-keeping and capitalisation, plus pay private sector taxes could have a positive effect on private sector competitiveness. Exempting intra-Japan Post transactions from consumption tax, the universal guarantee on bank deposits, the exemption from Basel II capitalization, and the idea that know-your-counterparty rules should not apply uniformly to JP Bank as to private sector banking institutions all puts private sector institutions at a cost disadvantage. The argument that imposing these guidelines will merely add to JP Bank’s cost base makes the controversial assumption that the benefits of these private-sector guidelines are not valuable contributors to risk-weighted profitability – which if valid must be taken up with the BIS (Bank for International Settlements) and anti-money laundering task force immediately. Greater disclosure requirements to answer to private-sector shareholders is significant.Greater transparency is central to identifying a firm’s operating inefficiencies, such that if JP Bank/JP Insurance truly prove, under private sector standards unable to efficiently deploy their assets, the case for breaking up these large state-controlled ‘monopolies’ emerges much more clearly than it would under limited-disclosure government ownership.

The quality of asset allocation matters more than the transfer itself of assets from the public to private sector. The idea of privatising half of Japan Post under the Kamei plan most likely would have been little more than a transfer of assets veiling a privately-funded expansion of government-controlled monopoly, and it is probably quite helpful in this regard that the USTR and European Trade Commission decided to push for a ‘level playing field’ in postal privatisation.

This is an edited version of a conversation first published at Michael Cucek’s blog Shisaku.