Annual Report on Japan' s

Economy and Public Finance


- No Gains Without Reforms -

December 2001

Cabinet Office

Government of Japan

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Chapter 3

   Overall Assessment of Japan' s Public Finance

Section 2 Public Finance as Seen from Stock Data of Assets and Liabilities

   The structural public finance reform has become an urgent policy challenge in Japan as central and local government finance has been growing tighter. In order to grasp the real picture of public finance in such conditions, recommendations say, we should look not only at budget deficits and other flow indicators but also at assets, liabilities and other stock data.
   Central and local governments have already trying to develop their respective balance sheets and other financial statements on an accrual basis. On an accrual basis, profits or losses are booked irrespective of real cash spending when economic deals are done to cause changes to credits or liabilities. Financial statements that cover the whole of the public sector (general government and public corporations) are useful for considering stock financial conditions of the whole public sector. Since massive work is required to make such statements, none has so far developed them.
   Nevertheless, the present data of the System of National Accounts, as released by the Cabinet Office, specify financial and non-financial assets and liabilities of the public sector for each year on the basis of the 1993 United Nations System of National Accounts, or 93SNA, which Japan adopted on revising data in October 2000. In this section, we make the addition of pension liabilities and other modifications to the data to develop the asset and liability stock data for FY 1999 that are used for outlining Japan' s fiscal conditions. We also develop the stock data for FY 1990 to allow a comparison between FY 1990 and 1999. Furthermore, we estimate the market value of assets for road and airport construction projects according to the income capitalization method.

1 Balance Sheet for Public Sector

 Background for development of balance sheet for public sector
   Some local governments had tried to develop balance sheets earlier. Over the recent years, however, local governments have been more serious in doing so, attracting public attention. The background for such moves include some points:
   First, central and local government finance has deteriorated since the collapse of the so-called 'bubble' economy in the early 1990s as tax revenues have declined on an economic slump and tax cuts and as public bond issues have increased to raise funds for frequent economic stimulus packages. Earlier, discussions on budget deficits had been based on flow (government spending, tax revenues, etc.) balances, primary budget balances, indicators of revenues' dependence on public bond issues and other flow indicators, and some stock indicators including outstanding public bonds (as a absolute value and a percentage of GDP). Recently, however, we have realized that not only these data but also outstanding assets and liabilities on a stock basis are important.
   Second, some local governments have launched new administrative reforms including the introduction of business management for the administrative area, in response to such reforms in foreign industrial countries. They are now testing administrative assessment based on the new public management theory(11). The NPM theory has been developed in Britain and some other countries since the latter half of the 1980s. It is designed to introduce business management ideas, methods and success stories into administrative management to increase the efficiency and reinvigorate the administrative sector(12).
   Based on such idea, the Outline of Basic Policies for Macroeconomic Management and Structural Reform of the Japanese Economy (Basic Policies), as adopted by the Cabinet in June 2001, discussed how the public accounting system should be as a new administrative method for reforming the policy-making process. It said, "We will continue trying to specify administrative costs and financial conditions of the public sector by considering the scope for the utilization of accrual and other business accounting ideas and for balance sheets."
   Third, these developments and moves to disclose administrative information have growingly required the financial authorities to be accountable for fiscal conditions. In response, the administrative reform outline, as adopted at a cabinet meeting in December 2000, calls for reviewing the public sector accounting system in order to give easy-to-understand explanations about fiscal conditions and improve the transparency and sight of public finance(13).
 Problems with developing stock data of assets and liabilities
   Among public finance data, state finance settlement reports give revenue and spending flow data and state property reports provide stock data of assets. But these data alone may not be sufficient to outline stock for the whole of the public sector.
   First, the current state accounting system fails to book public pension and other future liabilities that the public sector may have to shoulder. It also falls short of providing the whole picture of stock data of assets and liabilities for the whole public sector. Since the public sector has to shoulder public pension, retirement allowance and other future liabilities, we must grasp these liabilities on an accrual basis in order to understand real fiscal conditions.
   Second, some components have failed to provide the whole picture of stock data linked to revenue, spending and other flow data. Central and local governments provide flow data in the form of budget and settlement reports, while failing to give systematic stock data. The central government provides stock data for each category of assets(14).
 Characteristics and limitations of current SNA-based national balance sheet
   In contrast, SNA-based data adopt the accrual basis and mark-to-market valuation.
   As for the national balance sheet among 93SNA-based data, the Annual Report on National Accounts, as released by the Cabinet Office, specifies balances of financial and non-financial assets and liabilities to indicate a general government balance sheet. In addition, it specifies balances of assets and liabilities for the whole public sector and the general government components (the central government, local governments and the social security fund)(15).
   The SNA is based on accrual accounting and final payment principles. Upon the introduction of the 93SNA, improvements included the introduction of fixed asset depreciation in social infrastructure. (Final payment principle: When a local government implements a public works project with state subsidies, attention is given to who would be responsible for the implementation and the management after the completion of the project, and the total project value is considered to be payments by the local government that would be finally responsible for the project). The SNA, in principle, adopts the mark-to-market rule for valuation of assets and liabilities. (In actual estimation, however, replacement costs and others are substituted for market prices).
   However, there are limitations on using existing SNA-based balance sheets to outline financial conditions of stock for the whole of the public sector(16). First, such balance sheets fail to specify future liabilities as to retirement allowances and public pensions on an accrual basis. Therefore, they are not suitable for grasping the public sector' s financial conditions including future liabilities. Second, the existing balance sheets have only a rough classification of asset categories and there is no complete balance sheet for each of central and local governments. Specifically, the existing balance sheets refrain from specifying details of tangible fixed assets. Therefore, we cannot find what tangible fixed assets the government has. Such assets may include roads, harbors, etc. Another problem is that only general government figures are available for tangible fixed assets in value. There is no specific figure for the central government or each local government. This means that any balance sheet for each government is incomplete.
   There are some more problems. First, the existing SNA-based balance sheets indicate gross outstanding assets and liabilities and fail to offset assets and liabilities within each category and between categories. Second, all assets and liabilities are marked to market. For example, market values of outstanding public bonds, as specified among liabilities, are different from real redemption costs.
   Considering the characteristics and limitations of SNA-based balance sheets, we refrain from depending directly on budget and settlement statistics for making the estimates here. We start from SNA statistics and make modifications to SNA-based balance sheets if necessary in order to develop stock data of assets and liabilities for the public sector.
 Precedents of public sector balance sheet development
   Efforts have so far been made to develop public accounting balance sheets at the central government, prefectural governments and national special accounts. At the central government, the Ministry of Finance has published a draft balance sheet consolidating general and special accounts(17). Local governments have long tried to develop their balance sheets and have stepped up such efforts over the recent years(18). In March 2000, the Ministry of Public Management, Home Affairs, Posts and Telecommunications published guidelines for development of balance sheets at local governments in order to allow comparison between local government balance sheets(19).
   Among others, the Liberal Democratic Party has worked out guidelines for balance sheets of special accounts at the central government and has been prompting the government to develop a balance sheet for each special account(20). Furthermore, public corporations have published their balance sheets based on business accounting principles.
   Based on these precedents, we develop stock data to indicate the whole picture of assets and liabilities for the public sector on an SNA basis.

Breakdown of Public Sector and Assets for Estimation
   In this estimation, the public sector and assets are broken down as follows in line with a breakdown in the 93SNA:
(1) Breakdown of Public Sector
   The public sector is divided into the general government (central and local governments and the social security fund) and public corporations (public financial corporations and public non-financial corporations).
(2) Breakdown of Assets and Liabilities
   Assets and liabilities are broken down into financial assets and liabilities and non-financial assets.

2 Developing Stock Data of Assets and Liabilities

 Purposes of stock data development
   Stock data of assets and liabilities for the public sector are here developed for the following purposes:
(a) Disclosure of financial conditions and details of assets and liabilities for the public sector
(b) Specification of component-by-component financial conditions (central government, local governments, public financial corporations, etc.)
(c) Specification of social infrastructure development conditions (stock levels)(21)
(d) Grasping financial conditions from a long-term viewpoint
   Since the accumulation of public debts and public finance structure reform are controversial, we through the estimate here grasp financial conditions of the public sector and provide materials for future discussions (a, b and d). Considering that substantial public works spending was implemented under frequent economic stimulus packages in the 1990s, we also outline the social infrastructural stock formation for the public sector and each of public sector components (c).
 Developing SNA-based stock data of assets and liabilities for the public sector
   In this estimation, we use the 93SNA data as released by the Cabinet Office and refrain from calculating settlement statistics or from valuating assets and liabilities on our own. We thus base our estimation on the principles and estimation methodology adopted for the 93SNA and take care to have estimated component-by-component figures match published macroeconomic data (however, some figures may be changed on the introduction of accrual basis).
   First, we develop stock data for the end of FY 1990 and 1999 to allow comparison between outstanding assets and liabilities at the end of FY 1990 and those at the end of FY 1999.
   Second, we break down the public sector and its assets and liabilities by component. The public sector is broken down institutionally into five components-the central government, local governments, the social security fund, public financial corporations and public non-financial corporations. This allows us to grasp SNA-based financial conditions for the whole and each component of the public sector(22). We also classify assets and liabilities for each component and add up them again in order to specify details of assets and liabilities.
   Third, we introduce the accrual accounting principle more strictly for developing stock data of assets and liabilities in order to book pension, retirement allowance and other future liabilities(23).

3 Japan' s Public Finance as Seen from Stock Data

   The stock data of assets and liabilities as estimated here are specified on Table 3-2-1(24). We here used the estimated data to outline the public sector' s financial conditions in terms of stock. Specifically, we use the stock data at the end of FY 1999 to outline the present financial conditions of the public sector and compare outstanding assets and liabilities at the end of FY 1990 with those at the end of FY 1999.
 Valuation of net assets for public sector
   We must first discuss the interpretation of net assets as the gap between gross assets and liabilities. The net assets amount to a private company' s capital to indicate the soundness of the financial position. If a company' s capital is negative, the firm is in insolvency where it cannot cover liabilities with proceeds from sales of all assets. The insolvency means a financial crisis.
   It is inappropriate to adopt the same idea for valuating the public sector' s net assets as that for valuating a private firm' s capital. There are three reasons for this. First, the public sector, especially the general government (the central and local governments and the social security fund) is destined to survive. It is unreasonable to discuss whether the public sector can be liquidated to pay liabilities. Second, the central and local governments' tax collection and other rights secure their credibility. Third, the public sector must provide public goods and services that the private sector cannot provide easily. This means that the public sector assets are mostly difficult to sell or cannot be sold. It is unreasonable to valuate public sector assets as salable in the manner of private companies' assets(25).
   The valuation of unsalable public sector assets at market prices (replacement costs) can meaningfully indicate the value of assets that have been formed as against outstanding liabilities as a result of public sector activity. Therefore, we must note that negative net assets do not necessarily indicate a financial collapse of the public sector.
   We should not misinterpret stock data of the public sector. It is wrong to use numerical net asset data alone to assess public finance policy. If the size of net assets alone is used to assess public finance policy of the public sector, the government may concentrate spending in large-scale public works projects booked as outstanding assets and may reduce public services contributing to forming education, welfare and other human capital components that are not booked as assets. We must also note that government activity' s external effects (e.g. reinvigoration of a regional economy through road development) are not booked in stock data. Therefore, it is problematic to use the size of net assets alone for assessing the government' s public finance policy(26).
 Outstanding assets and liabilities at end of FY 1999
   Table 3-2-1 indicates stock data at the end of FY 1999 as developed with the methodology as described above. Assets for the whole of the public sector total ¥2,274 trillion (4.4 times as large as nominal GDP) including ¥1,647 trillion in financial assets and ¥627 trillion in non-financial assets. Among financial assets are ¥649 trillion in loans (39% of financial assets) including ¥553 trillion in loans provided by public financial corporations (33%). Cash and deposits account for ¥502 trillion (30%) including ¥437 trillion in deposits at the Ministry of Finance Trust Fund Bureau. Of non-financial assets, tangible fixed assets account for ¥426 trillion (68%), mostly in social infrastructure such as roads, water and sewage facilities, waste disposal facilities and others owned by local governments.
   The public sector' s liabilities aggregate ¥2,422 trillion. Their major components are public financial corporations' cash and deposit liabilities worth ¥791 trillion, outstanding government bonds worth ¥369 trillion and public financial corporations' borrowings worth ¥343 trillion. As a result, net assets as the gap between assets and liabilities come to a negative ¥148 trillion (amounting to 29% of nominal GDP).
   Let' s outline component-by-component stock data(27). The central government' s outstanding assets at the end of FY 1999 total ¥221 trillion, of which financial assets account for 51%. The central government' s tangible fixed assets aggregate ¥82 trillion including roads, flood prevention facilities and air traffic facilities (airports). Due to the final payment principle as adopted for the SNA as discussed earlier, the sum is much smaller than tangible fixed assets of local governments. It is only one-third of the tangible fixed asset value for local governments. The central government' s liabilities total ¥651 trillion, of which public pension liabilities account for ¥156 trillion (24%) and outstanding government bonds for ¥369 trillion (57%). As a result, the central government' s net assets turn out to be a negative ¥431 trillion. Excluding public pension liabilities, net assets are still a negative ¥275 trillion(28). The central government' s negative net assets as estimated here are larger than earlier estimates. This may be because the adoption of the mark-to-market principle for the estimation has led asset price declines in the 1990s to reduce market prices of outstanding assets. However, the estimates change depending on the estimation method and should be flexibly interpreted.
   Local governments own massive tangible fixed assets and land accounts for a major part of their assets. Therefore, their outstanding assets total ¥435 trillion, two times more than the central government' s. Local governments hold massive social infrastructure including roads, flood prevention facilities, school and social education facilities, water and sewage facilities and waste disposal facilities. On the other hand, local governments' liabilities aggregate ¥196 trillion, amounting to only 30% of the central government' s. They include borrowings (¥73 trillion), local government bonds (¥51 trillion), pension liabilities (¥37 trillion) and retirement allowance liabilities (¥34 trillion). Local governments' net assets come to a positive ¥239 trillion.
   Let' s discuss public corporations. Public financial corporations (e.g. Development Bank of Japan and Government Housing Loan Corporation) own outstanding assets worth ¥1,215 trillion that naturally concentrate on financial assets. They have employed cash and deposits, and borrowings to raise funds for most of the assets. Their net assets are a positive ¥30 trillion. Even though their net assets are positive, we must check their performing and non-performing loans to decide whether these institutions are financially sound or not.
   Public non-financial corporations (e.g. Japan Highway Public Corporation and local public housing corporations) hold outstanding assets worth ¥168 trillion, including ¥27 trillion in financial assets like local government bonds, loans, equity shares and investments, as well as tangible fixed assets like sewage and waste disposal facilities, roads, and municipal and natural parks. Their liabilities aggregate ¥136 trillion including ¥52 trillion in non-equity securities, ¥37 trillion in borrowings and ¥35 trillion in equities and investment. Their net assets come to a positive ¥32 trillion.
 Changes in public finance policy and conditions in the 1990s
   Next, let' s compare the public sector asset and liability stock at the end of FY 1999 with that at the end of FY 1990.
   The public sector as a whole increased assets by ¥847 trillion (59%) from ¥1,427 trillion to ¥2,274 trillion in the nine years and liabilities by ¥1,128 trillion (87%) from 1,294 trillion to ¥2,422 trillion. As a result, the public sector' s net assets declined by ¥280 trillion from a positive ¥132 trillion at the end of FY 1990 to a negative ¥148 trillion at the end of FY 1999.
   Among components, financial assets and liabilities scored respective sharp increases of ¥747 trillion (88% of the total asset increase) and ¥1,128 trillion. Among non-financial assets, tangible fixed assets increased by ¥132 trillion from ¥294 trillion to ¥426 trillion, while land assets declined by ¥36 trillion due to asset deflation in the 1990s. Contributing to boosting liabilities were a rise in public financial corporations' cash and deposits (¥369 trillion) and an increase in central and local government bonds (¥246 trillion).
   Let' s look at changes in component-by-component assets and liabilities in the 1990s. The central government' s assets increased by ¥64 trillion (41%) in the nine years to ¥221 trillion and its liabilities by ¥310 trillion (91%) to ¥651 trillion. Its negative net assets expanded by ¥246 trillion from ¥185 trillion to ¥431 trillion. The asset increase included ¥38 trillion in financial assets and ¥28 trillion in tangible fixed assets, with land assets' fall limited to ¥800 billion. The liability rise included ¥208 trillion in outstanding government bonds.
   Local governments boosted assets by ¥45 trillion (11%) to ¥435 trillion and liabilities by ¥87 trillion to ¥196 trillion between FY 1990 and 1999. As a result, their net assets decreased by ¥42 trillion to ¥239 trillion. Among assets, tangible fixed assets increased by ¥79 trillion, while the adoption of the mark-to-market principle lowered land assets by ¥43 trillion. As for liabilities, outstanding local government bonds increased by ¥34 trillion and public financial corporations' borrowings expanded by ¥29 trillion. These changes contributed to the net asset decline. The net asset drop for local governments was smaller than for the central government. This is because local governments boosted tangible fixed assets 2.8 times faster than the central government, with a rise in outstanding local government bonds limited to only 16% of the increase in outstanding central government bonds. The final payment principle as adopted for the SNA has thus had a great impact on the far smaller net asset decline for local governments.
   The social security fund saw its net assets declining by ¥26 trillion from a positive ¥8 trillion to a negative ¥18 trillion as pension liabilities increased from ¥121 trillion to ¥232 trillion on a rise in the number of pensioners.
   As indicated above, each component of the general government reduced net assets, while public corporations increased net assets. Public financial corporations boosted assets from ¥620 trillion to ¥1,215 trillion and liabilities from ¥608 trillion to ¥1,185 trillion. Their net assets thus increased by ¥18 trillion to ¥30 trillion at the end of FY 1999. Public non-financial corporations expanded net assets by ¥16 trillion from ¥17 trillion to ¥32 trillion.
 Asset formation
   How much was asset formation in the 1990s? According to the SNA-adopted final payment principle, the public sector as a whole increased tangible fixed assets by ¥132 trillion form ¥294 trillion in FY 1990 to ¥426 trillion in FY 1999.
 Social infrastructural stock formation
   What tangible fixed assets did the public sector develop in the 1990s? Contributing to a 44.9% increase in tangible fixed assets between FY 1990 and 1990 were roads (18.5%), flood prevention facilities (6.0%), sewage and waste disposal facilities (6.0%), airports (3.3%), school and social education facilities (3.1%), and municipal and natural parks (2.4%) in the contribution percentage order (see Figure 3-2-2)
   Shares of the increase (flow) in tangible fixed assets between FY 1990 and 1999 were 41.1% for roads, 7.4% for airports, 13.3% for sewage and waste disposal facilities, 13.3% for flood prevention facilities, and 6.9% for school and social education facilities (see Figure 3-2-3). In contrast, shares of tangible fixed asset stock in FY 1990 were 29.8% for roads, 12.1% for flood prevention facilities, 10.3% sewage and waste disposal facilities, and 4.1% for airports. These asset categories' flow-base shares thus exceeded their respective stock-base shares. But school and social education facilities' share of total tangible fixed assets was 9.3%, larger than their flow-base share.
   In tangible fixed asset development in the 1990s, roads, airports, sewage and waste disposal facilities, and flood prevention facilities scored relatively larger growth from their respective shares of total stock in FY 1990, while a rise in school and social education facilities was moderate.

4 Income capitalization method-based Estimation of Road and Airport Development Projects

   Japan and some foreign countries have positively introduced public sector cost calculation based on accrual accounting. Such cost calculation has been used as an important mans to assess administrative projects and as useful information for efficient distribution of resources in budget formation.
   In valuating individual projects of the public sector after social infrastructure and other assets are formed as stock through the projects, it is useful to look into how much service the assets can provide. Instead of how much the formation of public sector assets costs (replacement costs), we should consider how much benefit the assets can give to the people. It may frequently be difficult to assess the value of benefits from public sector assets, since the public sector provides public goods and services(29). However, fee income is used to cover project costs in some areas. In these areas, fee income is considered to be the price paid by beneficiaries and may be used for estimating the value of project assets(30).
   In valuating public sector assets as earlier discussed, we developed stock data of assets and liabilities for the whole of the public sector on a replacement cost basis that pays attention to the cost for forming assets. In contrast, the estimation here focuses on how much benefit assets formed through public sector projects can provide to the people. Typical projects for the estimation are financed with fee income. We also use the income capitalization method to assess the value of road and airport development projects that increased assets more than other projects in the 1990s, as discussed earlier(31).
 Assessed values of assets based on income capitalization method
   The estimation here covers four road-related corporations (Japan Highway Public Corporation, Metropolitan Expressway Public Corporation, Hanshin Expressway Public Corporation and Honshu-Shikoku Bridge Authority) for the road development area and New Tokyo International Airport Authority and Kansai International Airport Co. for the airport development area.
   We adopt the income capitalization method for estimating the value of each project asset. The income capitalization method does not measure the value of an asset with the cost for acquisition of the asset but considers the asset value as the present value of cash flow that the asset will generate in future. Cash flow is discounted to indicate the present value(32).
   Since the value of an asset depends on anticipated future income, it is important to correctly estimate future income. As such income, we in this estimation utilize cash flow from business activity as booked on administrative cost and other financial statements at each public corporation(33). Although income may change depending on economic growth, demographic and other projections, we here assume that annual income in future would remain unchanged from a base year. Future income is discounted by a certain percentage (some 3% in an average interest rate as paid actually by public corporations) to indicate the present value of such income as the value of the business assets in question.
   As future income cash flow, we calculated business cash flow booked in cash flow statements based on business accounting. We used FY 2000 administrative costs and other financial statements as data for working out future income cash flow.
   Using the values of business assets and liabilities (road construction bonds, borrowings and central government investments) based on the income capitalization method, we estimated an asset-liability gap.
   Table 3-2-4 shows valuation of business assets, liabilities on book and their gap, based on the income capitalization method.
   According to the table, the asset-liability gap comes to a negative ¥820 billion for the four road-related public corporations and a positive ¥140 billion for the two airport corporations(34). In this way, the asset-liability gap, as calculated in line with income capitalization-based business assessment, is negative for some road-related corporations.

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