Annual Report on the Japanese

Economy and Public Finance

2002-2003

- No Gains Without Reforms III -

October 2003

Cabinet Office

Government of Japan


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Section 3 Building Public Sector that Match Aging and Declining Population

    As we have examined in Section 2, the aging and declining population influences economic growth through a decrease in the labour force and a decline in the savings rate and, at the same time, the aging and declining population also has a major impact on the public sector consisting of national and local governments and the social security system, etc., as it increases the percentage of elderly people compared to the working generations, the main supporters of tax and social security system. If we try to maintain the current level of administrative services and social security benefits, national burdens consisting of taxes and social insurance premiums will have to be increased drastically and the gap in benefits and burdens between generations will widen. Moreover, there is a fear that an excessive rise in the national burden rate may stymie the vitality of the Japanese economy and society, affecting the economic growth of the country.
    Due to the progress in the aging and declining population, a rise in national burdens will become inevitable. However, in order to establish a sustainable public sector and to maintain the vitality of the economy and the society, any rise in national burdens must be curtailed as much as possible. To this end, it is essential to carry out drastic reform of the public sector.
    In this section, we will first identify the problems common to all parts of the public sector under the aging and declining population by setting out the relations between national burdens and economic vitality and then study concrete problems involved in the administrative and fiscal management of the national and local governments and social security system, centering on pension and medical services.

1. Growing National Burdens and Challenges Facing Public Sector
Rising national burden ratio
    The direct impact of the aging and declining population on the public sector is that it increases tax and social security contributions to finance increased social security benefit expenditures, such as pension and medical benefits, due to an increase in the percentage of the older generation, or the recipients of social security benefits. Japan's social security benefit expenditures have swollen year by year, rising to 78.1 trillion yen in fiscal 2000 (See Figure 3-3-1 (1)). Pension and medical benefits account for 52.7% and 33.3% of total expenditures, respectively, and their average annual growth rates in and after fiscal 1990 stand at the high levels of 5.5% and 3.5%. The percentage of social security benefits in the total expenditures of the general government (central and local governments and social security funds) in the national accounts has also been rising year after year, standing at 44.1% in fiscal 2001 (See Figure 3-3-1 (2)).
Figure 3-3-1 (1) Changes in Social Security Benefit Expenditures
Figure 3-3-1 (2) Changes in the Share of Social Security Benefit Expenditures to General Government
    Reflecting the growing outlays for social security benefit expenditure, the national burden ratio, or the ratio of national tax and social security contribution to national income, has been on a rising trend. The national burden ratio, which stood at 24.3% in fiscal 1970, is expected to rise to 36.1% in fiscal 2003. The potential national burden ratio, or the ratio of national burden plus fiscal deficits to national income, which stood at 24.9% in fiscal 1970, is also expected to rise to 47.1% in fiscal 2003(45) (See Figure 3-3-2), (See Column 3-4). The tax burden to the national burden ratio has been on a downward trend since the 1990s, reflecting a slowdown in tax revenues caused by the sluggish economy and reduction of tax, while the pension and health insurance to the social security contribution rate has been on an increasing trend, reflecting the aging of the population. In addition, fiscal deficits have been on an increasing trend since the 1990s, which has served to boost the potential national burden ratio.
    A comparison of the national burden ratios of major advanced countries shows that Japan's national burden ratio is not high by international standards, with the national burden ratios of other countries, except the United States, standing above Japan's ratio. However, in terms of the potential national burden ratio, the gap between Japan and other advanced countries is narrowing, reflecting Japan's huge fiscal deficits. Moreover, since the speed of the birthrate decline and aging of the population in Japan is much faster than in other countries, Japan's potential national burden ratio is expected to rise further, if the current public finance and social security systems are maintained as they are. According to an estimate(46) by expert members of the council on Economic and Fiscal Policy submitted to the Council on Economic and Fiscal Policy, if the current system is left as it is, Japan's potential national burden ratio is expected to rise above 60% in fiscal 2025. The expected increase in potential national burdens caused by the declining birthrate and aging population has raised fears about the sustainability of the public sector.
Figure 3-3-2 Ratio of National Burden to National Income

Column 3-4
Concept of National Burden Ratio

    There have been frequent discussions with regard to national burden ratio in the course of administrative reform and fiscal restructuring reform in Japan. There are several views regarding its definition and economic implications.
    The "national burden ratio" is defined as "(tax burden + social security contribution) / national income (or gross domestic product)." Generally speaking, "the ratio of tax/social security contribution to national income" is used in Japan, while OECD, when compiling statistics, commonly uses "the ratio of tax/social security contribution to gross domestic product".(47)(48)
    The potential national burden ratio which consists of usual national burden and fiscal deficit (= (tax burden + social security contrition + fiscal deficits of the general government) / national income or gross domestic product) is also frequently used, since, in the case where the proportion of fund raising through public bonds is large, the national burden ratio does not appropriately reflect the size of the government and since fiscal deficits have to be financed by tax burden in the end.
    Though it is not generally used, there are also people who use "national net burden ratio".(49) The national net burden ratio is defined as "the national burden ratio after deducting income transfer from the numerator of the national burden ration (tax burden + social security benefit) through the social security system," based on the belief that transfer accounts such as social security benefits are income reallocation from the people who contribute to the people who receive benefits and that they are different from, for instance, government's final expenditures, such as public investment and personnel expenses for public servants. According to an estimate made by Cabinet Office, the national net burden ratio has been declining moderately since the 1990s. This is due to the fact that, compared with the increase in social security benefits stemming from the aging of the population, the growth of other expenditures has been relatively curbed. Though social security contributions are returned to the people through social security benefits, if it becomes excessive amid the declining birthrate and aging population, it would impose excessive burdens on the working and future generations, causing an imbalance between generations. Therefore, when building a vibrant aging society, it is important to restrain any rise in the national burden ratio as much as possible and to curb the growth of social security benefits while ensuring people's security.
Figure Changes in National Burden Ratio Based on Different Definition


Expansion of public sector's income redistribution function and gap between generations
    The main economic functions of the public sector are as follows: (1) resource allocation function; (2) economic stabilization function; and (3) income redistribution function. Of these three, the income redistribution function has been strengthened in response to an increase in social security benefits stemming from the aging of the population.
    We will now take a look at the movement of the Gini coefficient(50) before and after income redistribution in Japan by using the Income Redistribution Survey by the Ministry of Health, Labour and Welfare. It shows that although the degree of inequality before income redistribution has been expanding year by year due to the aging of the population, the degree of inequality has been improved by income redistribution through taxes and social security and the degree of improvement has been expanding year by year (See Figure 3-3-3).
Figure 3-3-3 Effects of Income Redistribution through Tax/Social Security
    A study of the contribution of taxes and social security to the improvement of income inequality shows that although the degrees of improvement by taxes and social security were at the same level in 1981, the degree of improvement by taxes has been declining since then, while the degree of improvement by social security has been rising. This corresponds to the Japanese situation in recent years, where, as we outlined earlier, the ratio of tax burdens to national income has been on a decreasing trend, while social security benefits and contributions have been increasing due to the aging of the population.
    The relations between benefits and burdens through the public sector at each stage of people's lifecycle show that, in terms of burden, tax and social security contributions increase with age as people's income increases while in active service, but that, in terms of benefit, elderly people are the main beneficiaries as they are eligible for a pension and as medical benefits increase with age. The public sector thus works to redistribute income mainly between generations.
    Relations between benefits and burdens per household by age group of householders in 2001 show that those aged in their 50s or below are all net contributors and that their net contributions increase with age, while only those aged 60 or above have net benefits of 3.38 million yen due to an increase in social security-related benefits (See Figure 3-3-4).
Figure 3-3-4 Benefits and Burdens by Age Group (2001)
    Since income-earning capacity declines and risks of falling sick increase as one gets older, it is only natural that elderly people have net benefits through the public sector. However, it has become difficult to maintain the current benefit-burden structure amid rapid progress in the declining birthrate and aging of the population and the rising percentage of elderly people compared to the working generations who are the main contributors.
    We will now take a look at relations between lifetime benefits and burdens by using a generational accounting method. Benefits and burdens in the past and in the future are present values of the real figures in 2001 sweetened or discounted by a constant interest rate. It shows that those aged 60 or above have net benefits of about 65 million yen but that the younger the generation, the greater the net contributions, with the net contributions of the future generation (those below 20 and those to be born) standing at about 52 million yen(51) (See Figure 3-3-5). When interpreting these results, it is necessary to keep in mind that social security benefits include not only the benefits one receives but also the indirect benefits of replacing the costs for supporting one's old parents privately and that private burdens will increase adversely, without social security benefits. However, if the current system is maintained amid the progress in aging and declining population, it would compound the problem of the gap in benefits and burdens between generations, raising problems about the sustainability the public sector, centering on the social security system.
Figure 3-3-5 Lifetime benefits and burdens

Impact of rise in national burden ratio on economic vitality
    The excessive rise in the national burden ratio has raised fears that it may depress the sustainability of the public sector and at the same time have adverse effects on economic growth through a decline in economic vitality.(52)
    There are multiple channels through which the rise in the national burden ratio affects economic vitality.(53) One of its direct impacts is that a rise in national burdens lowers the disposable income of households, mainly of the working generation, and firms, restraining private sector savings and capital accumulation. It may also depress economic vitality through a decline in the working generation's willingness to work, a decline in the competitiveness of corporations and firm's relocation to foreign countries. The potential national burden ratio, which takes fiscal deficits into account, is an indicator of the size of public sector seen from the aspect of burden. If the size of the public sector, which is generally inefficient as compared with the private sector, expands excessively, it may lower the productivity of the economy as a whole.(54)
    In order to see what impact the above factors have on economic vitality from the macroeconomic viewpoint, we will take a look at the relation between potential national burden ratio(55) and economic growth in OECD countries. It indicates a loose negative correlation between the two. Economic growth tends to be lower for countries with higher potential national burden ratios (See Figure 3-3-6).
    However, we must be careful in our interpretation of this. This is because the relation between the two does not simply show that a rise in national burden ratio lowers economic growth. But there is also a reverse cause-and-effect relationship, such as between the declining birthrate, aging population and slow economic growth raising the national burden ratio. Therefore, it is necessary to conduct micro-economic analyses of household and corporate behavior. Still, since the loose correlation that exists between the two suggests that a rise in the national burden ratio may become a factor impeding economic growth, we must strive to prevent the ratio from rising excessively, while ensuring the security of the people.
Figure 3-3-6 Relation between Ratio of Potential National Burden to nominal GDP and Economic Growth in OECD Countries

Challenges facing the public sector to maintain its sustainability and economic vitality
    The pubic sector needs to be drastically reexamined in order to curb any rise in the national burden ratio as much as possible amid the progress in aging and declining population. The Japanese administrative and public finance systems and its social security system were established when the economy was posting a high rate of growth and its population was young. Therefore, it is now extremely vulnerable to low economic growth and changes in the movement of population. If we try to keep the current systems as they are, it would impose excessive burdens on the future generations and could depress economic vitality, and when the fiscal burdens of maintaining the systems become unbearable, it would become necessary to drastically cut benefits, leaving huge amounts of costs to the future.
    Japan needs to transform the public sector into a new system that is sustainable even under the slow economic growth and aging and declining population and allows stable economic activities without hampering economic vitality. In other words, it is to establish an "efficient small government." When doing so, Japan should introduce the ideas of new public management (NPM) in order to utilize private enterprise management know-how to increase the efficiency of administrative and public finance organizations, and strive to review the separation of roles of "the public and private sectors" improve budget quality and enhance its transparency by reforming budget formation processes. In addition, it is indispensable to establish an efficient social security system that will guarantee against real risks and not postpone burdens until the future generations, by reviewing the inter-generational and intra-generational balance of benefits and burdens.
    Now, we will examine measures to make administrative and public finance organizations efficient and vibrant by using the ideas of NPM and explore ways to reform the social security system, centering on pension and health insurance.

2. New Public Management (NPM)(56) and Administrative and Public Finance Organization Reform in Japan
Necessity to make administrative and public finance organizations efficient
    Due to such factors as declining tax revenues stemming from economic slowdown, economy-boosting measures, and increasing social security benefits, the fiscal deficits and outstanding obligations of the general government have reached an unprecedentedly high level, with the ratio of outstanding obligations to nominal GDP standing at over 140%, the highest level among major advanced countries in the end of 2002 (See Figure 3-3-7).
Figure 3-3-7 Fiscal Deficits and Government Debts of Developed Countries
    In order to cope with the situation, the government, under the "Structural Reform and Medium-Term Economic and Fiscal Perspectives" (decided by the Cabinet on Jan. 25, 2002) and the "Reform and Perspectives FY2002 Revision" (decided by the Cabinet on Jan.24, 2003), has been promoting fiscal restructuring aimed at (1) improving the quality of budget expenditure and curbing its size, (2) keeping the size of the government (the ratio of general government expenditure to GDP at or below its present (FY2002) level over the four years to FY2006, (3) achieving a surplus in the primary balance in the early 2010s (a fiscal structure that does not depend on new borrowings except for expenditures to repay past borrowings) (See Figure 3-3-8).
Figure 3-3-8 Primary balance of Central and Local Governments
    In order to rebuild public finance while minimizing the national contribution ratio, Japan must use private enterprise management know-how and the market mechanism to increase the efficiency of administrative and public finance organizations.

Change in the role the government is expected to play
    Reform of administrative and public finance organization is being called for not only for fiscal reasons but also for the reason that the role people expect the government to play has changed.
    The government provides public goods and services to the people by using taxes, etc. collected from the people. The relation between the government and the people corresponds to the relation between private corporations and "customers." Therefore, the government must be sensitive to the needs of the people and always review its roles.
    Seen from this viewpoint, it can be said that the role that the people expect the government to play has drastically changed in the last decade or so after the collapse of the bubble economy.
    First, the government is called to pick up on people's needs promptly and adequately. Japan is now pushing for structural form. In order to help the people overcome the pains accompanying the reform, the government must establish risk management systems and safety nets in various areas, such as financial system and employment. In order to take timely and appropriate measures to protect national life, it is necessary to establish administrative channels at national, local and other levels to get a sense of people's needs.
    Second, the government needs improving transparency and accountability. People have become increasingly concerned about whether the government's regulations and supervision are persuasive (accountability) and if its procedures are transparent (transparency) in various aspects of national life, such as medical services, food sanitation, environment, and privacy. As a result of the spread of the Internet, etc. the information gap between the government and the people has narrowed and the conventional administrative management that has been called "bureaucratic sectionalism" has come to be subject to severe criticism.

Reform of administrative and public finance organizations by using NPM ideas
    In response to needs for reforms, the government has been tackling reform of administrative and public finance organizations, while studying the new public management style that was utilized in administrative reforms in other advanced countries. The government intends to study measures to promote privatization, outsourcing, utilization of PFI, and independent administrative agencies, implement ex-ante assessment of the cost effectiveness of operations, set goals and carry out ex-post assessment in order to enhance its public management capability. The government also intends to study ideal public accounting systems in order to enhance its accountability to the public ("Basic Policies for Macroeconomic Management and Structural Reform of the Japanese Economy 2001"("Basic Policy 2001")). As for budget formation processes, the "Basic Policy 2003" says, "On promoting fiscal structural reform, the government improves the quality of the budget and strives toward transparency. Therefore, the budget process will be developed featuring prior goal-setting and rigorous ex-post assessment to fulfill accountability about how taxes have affected the lives of Japanese citizens."

History of NPM
    NPM is an approach to administrative and fiscal reform that originally emerged in advanced Anglo-Saxon countries, the United Kingdom and New Zealand.(57)
    Around the 1970s, the western advanced countries were plagued with multiple problems, such as economic slumps, high unemployment rates, expanding fiscal deficits, and inflation. Under such circumstances, there was a growing recognition that the Keynesian policy management that focused on government's economic stabilization function and income redistribution function has depressed economic vitality through bloated bureaucracy, distortion of the market mechanism and impediment of private sector vitality (or so-called "government failure").
    In the 1980s, a movement to review policy management methods gained momentum in the U.K. and New Zealand. In the 1990s, the movement spread to Sweden and other Scandinavian countries and then to Japan and France.
    NPM is an approach to improve the quality of goods and services that the public sector provides to the people and to reduce fiscal burdens as much as possible by putting the economic behavior (economic efficiency, customer satisfaction, accountability, etc.) of the private sector to work in the public sector. To this end, each process of policy formation, implementation, completion, and review must be organically coordinated. A government can provide satisfying goods and services to the public only when these series of process makes progress by feeding back information to each other. In the organic feed-back process, absorbing the public's needs and promoting decentralization through delegation of power would become important points (See Figure 3-3-9).
Figure 3-3-9 Administrative System Concept under New Public Management (NPM)

NPM's goals and concrete measures
    A case study of NPM implemented in the western advanced countries shows that the goals that should be achieved and concrete measures to achieve the goals in NPM are as follows (See Table 3-3-10).
Table 3-3-10 NPM Implemented in Various Countries
    The first goal is to pursue economic efficiency by incorporating the economic behavior of private corporations into government activities. From the standpoint of leaving to the private sector what can be done by the private sector, the government should review the scope of its activity and the methods to provide services. Among the concrete measures that should be considered are privatization, promotion of independent administrative agencies, utilization of the PFI,(58) and introduction of a voucher system.(59)
    The second goal is to enhance customer satisfaction. Seeing the people as "clients," the government must efficiently provide goods and services meeting their needs in order to enhance customer satisfaction. Among the concrete measures that should be considered are development and introduction of a "customer-oriented management model" and an "achievement-oriented management cycle." The "achievement-oriented management cycle" is a style of management designed to utilize policy evaluation results in next plans by adopting a cycle of planning (plan), implementation (do) and ex-post assessment (see) in administrative operations.(60) Its evaluation criteria are "output" (public goods and services provided by the government) and "outcome" (advantages of such goods and services rebounded to society). They are evaluated on a regular basis and evaluation results are fed back to the next plans. If such a management cycle is used in budget compilation and the results of policy performance evaluation are fed back, it would ensure an efficient use of budget.
    The third goal is to enhance accountability. Among the concrete measures that should be considered is introducing an accounting method similar to those generally adopted by private corporations, linking it with "achievement-oriented management cycle," and evaluating if results commensurate with the budget spent have been achieved or not. NPM also encourages preparing a balance sheet and other financial statements(61) with the aim of enhancing budget accountability.

New Japanese approaches
    Now, we will take a look at the progress in the Japanese approach to administrative and fiscal reform in line with the three NPM goals outlined above (See Table 3-3-11). As for the first goal (pursuit of economic efficiency through the use of the economic behavior of the private sector), the number of PFI projects has already exceeded 100,(62) and the number of incorporated administrative agencies established by April 2003 stands at 62. Another 45 incorporated administrative agencies are scheduled to be established by July 2004.
Table 3-3-11 Japanese Approaches to Reforms by Utilizing NPM Ideas
    As for the second goal (enhancement of customer satisfaction), nearly 11,000 projects were subjects of evaluation in fiscal 2002, the first year of the Government Policy Evaluation Act, and evaluation results were submitted to the Diet.(63) As for public work-related plans, efforts are being made to construct an achievement-oriented management cycle, with some ministries and agencies changing the focus of their planning to "outcome." Meanwhile, the "Basic Policy 2003" calls for implementation of "model projects." Implementing a "model project" means introducing budget compilation processes to declare a policy goal in a form understandable to the public (declaration), to efficiently use budgets in order to achieve the policy goal by flexibly executing them according to the nature of the projects (execution), and to evaluate the final results strictly (evaluation). As of August 2003, a total of nine ministries and agencies submitted "model project" proposals(64) and have made budget request for 10 items after exchanging opinions with the Cabinet Office. Efforts on "policy groups,"(65) which is also positioned as an innovation of budget compilation processes along with "model projects," are aimed at activating the private sector as much as possible by combining regulatory reform/institutional reform with budgets in order to achieve cross-organizational policy goals. It is important to make strict ex-post examinations of their results in order to reflect them in the next policies.
    As for the third goal (enhancement of accountability), steady progress has been made, including trial preparation of the "state's balance sheet (draft),"(66) publication of new special account financial documents, and preparation of "administrative cost statements" of special government corporations.(67) In addition, "model projects" will help enhance the government's accountability to the public, as their budget formation processes are easily-understandable for the public.
    Japan lagged behind the western advanced countries in initiating these reforms, but, it has made steady progress in various government fields. Given the facts that the need to make administrative and public finance organizations efficient for fiscal reasons and that the role the public expects the government to play changed, Japan must make ceaseless efforts to further promote these reforms.

Column 3-5
NPM Efforts in the western advanced countries

(1) Reforms in Anglo-Saxon countries
    Among the Anglo-Saxon countries, the U.K. was the first to initiate administrative and fiscal reforms. During the 1970s, the U.K. was plagued with what was called the "British disease" of fiscal deficits, inflation, and high unemployment rate. In the 1980s, however, the country began to scale down the government sector, introduced the principle of competition, and instituted regulatory reform and deregulation policies.
    The features of the British reform efforts were privatization of governmental corporations and introduction of agencies, and public finance- and budget-related reforms. In particular, the introduction of agencies in 1988 separated the division that provides goods and services from the division that makes policies and gave wide discretionary powers to the goods and services providing division.
    As for public finance and budget reforms, the country established "The code for fiscal stability" in 1998, giving the highest priority to sustainable public finance management, and laid down rules to achieve the goal.(68) In addition, the government decided to review its expenditures every three years in order to deal with medium- and long-term problems flexibly and efficiently. As for financial management, the government introduced accrual accounting and decided to make performance reports concerning output and outcome in order to enhance transparency by linking administrative evaluation and budget compilation.

    In New Zealand, in addition to the introduction of independent administrative agencies, organizational reforms were also implemented under "the State Sector Act" (1988) and "the Public Finance Act" (1989) that separated the roles played by ministers and by chief executive officers. Ministers are required to achieve "outcome." The role of chief executive officers and their subordinates is to provide the goods and services (= output) necessary to achieve the "outcome." Chief executives are given discretionary powers concerning the input (budget allocation, staff assignment) necessary to provide the output.

    Australia introduced "the Accrual-based Output Outcome Framework" for budget formulation in 1997. The system was designed to make budgetary performance evaluation by linking the goals that should be achieved by each administrative unit with budget and thus to make budget allocation efficient.

(2) Swedish approaches
    Sweden initiated reform by adopting NPM in the early 1990s, as it suffered a financial/currency crisis and as its fiscal deficits expanded. The country conducted a drastic review of its budget compilation process to parliamentary deliberation processes, including constitutional amendment, in a short period of time. In 1995, the country formulated the "Convergence Program." The program called for dissolving fiscal deficits by 1998. It also called for discontinuing bottom-up type budget compilation, and instead, called for determining total expenditures beforehand based on macro-economic outlook. When allocating expenditures, the emphasis was placed on maximizing output and outcome rather than minimizing input. Meanwhile, all agencies were required to publish performance reports and financial analysis reports in order to ensure thorough accountability.

    However, it is important to note that the implementation of NPM was a continuing process of trial and error even in these countries and that reviews and modifications were repeatedly made. Several problems have been identified in the process. For example, if the economic behavior of private corporations (liberalization of market entry, etc.) is adopted excessively, it temporarily overheats competition and the providers of goods and services who are unable to endure heated competition will withdraw from the market in succession, resulting in an oligopoly market situation, which is disadvantageous to the public. It has also become known that separation or delegation of power, like in the case of separation of the policy planning division from the operation division in agencies, requires new management know-how. Another problem is that although it is relatively easy to pursue accountability for output, it is not easy to make a policy evaluation with regard to outcome.
    It is not easy to evaluate the result of NPM in these countries. However, NPM has come to be adopted by many countries and implemented at various levels of public institutions on a trial-and-error basis.

Column 3-6
NPM in Local Governments -Mie Prefecture-

    In Japan, administrative reform utilizing NPM ideas was implemented earlier in the local governments (around 1995) than in the central government.
    According to a survey conducted by the Ministry of Public Management, Home Affairs, Posts and Telecommunications, 79% of prefectures and 58% of designated cities adopted a policy evaluation system as of 2001. On the other hand, the percentage of municipalities that have already adopted a policy evaluation system stood at 5%. However, at the community level, 65% of local governments (670 cities and 23 Tokyo ward offices covered by the survey) have already adopted or plan to adopt such a system. As for introduction of an accounting method (accrual accounting) similar to those adopted by private corporations, 71% of city and ward offices have already adopted or plan to adopt one.
    Mie Prefecture, which has been carrying on administrative reform of its own since 1995, has been drawing attention, as many of its reform efforts, including introduction of a policy evaluation system, correspond to NPM ideas.

Establishment of management cycle, organizational reform
    The prefecture has been promoting reform projects centering on the "Manifesto of Mie Prefecture Building," an overall program, setting the 14 years from 1995 to 2010 as its target period. The prefecture is pushing ahead with the second implementation program, positioning its "policy promotion system" as a system to carry out reform more efficiently.
    The "policy promotion system" is Mie Prefecture's original reform package, centering on the "Mie policy evaluation system." Under the policy promotion system, evaluation subjects and standards, ideas on evaluation criteria, evaluators, etc. are specified by type of operations, including measures, basic projects, and clerical work. The system also specifies such things as integration with management of the overall program, coordination with allocation of administrative management resources, such as budget (for example, conducting not only ex-ante policy evaluation but also mid-point and ex-post policy evaluation during the period of budget formation), and citizen participation. The prefecture also carried out a drastic reform of its personnel system and established a flattened organization with clear authority and responsibility, by abolishing the section-by-section system and instead adopting a team system. It hopes the new organizational setup will achieve the objectives of operations and enhance incentives.

Citizen participation
    Even if a policy promotion system is constructed, it can hardly be said that the residents of the prefecture are taking part in administrative management, if the actual management is completed within the organization. Therefore, the prefecture has published all evaluation documents in order to reflect the opinions of prefecture residents on administrative management. In 2002, the prefectural government submitted the "White Paper on Mie Prefecture Building" to the prefectural assembly in order to further promote resident participation. It is also actively utilizing public comments by holding direct dialogues with prefecture residents.


3. Reform of the Public Pension System
Current condition of the public pension system
    The Japanese public pension system is designed to reduce the risk of a decline in income-earning capacity caused by aging, disability, or death of the main wage-earner of a household by the society as a whole (risk pooling). The old-age pension, which presents problems in connection with aging and declining population, is an insurance against "the risk of losing income due to aging" and against "the risk of longevity," or uncertainty about when people die (See Column 3-7).
    The sustainability of the Japanese public pension system has declined considerably, as all pension schemes are in severe financial conditions due to a rapidly progressing declining birthrate and aging population and a prolonged economic recession. Take the employees' pension plan for example. Its premium income has been decreasing since fiscal 1998, as the number of insured people has been decreasing due to a decrease of the production age population and a decline in employment caused by corporate restructuring, and as per-worker compensation has been decreasing in nominal terms. On the other hand, expenditures for pension benefits have been increasing steadily, reflecting an increase in the number of beneficiaries caused by the aging population. As a result, and also due partly to the deterioration of the environment for reserve investment, the system suffered a budget deficit in actual cash value in fiscal 2001 (See Figure 3-3-12 (1)).
    The public pension system has reserves to prepare for future payments of benefits and to lower insurance premiums by investment returns.(69) However, the environment for reserve investment has become severe. Investment returns have been decreasing since fiscal 1997 due to the deterioration of the investment environment caused by lower interest rates and depressed stock prices, and the reserves posted a decrease in current value in fiscal 2001 due to smaller investment income and a decrease in appraisal value of invested assets caused by a sharp decline in stock prices (See Figure 3-3-12 (2)).
Figure 3-3-12 (1) Real Financial Balance for Employees' Pension System
Figure 3-3-12 (2) Changes in the Reserves of Employees' Pension Insurance and Reserve
    Since the pension system reform of 1999, the insurance premium (rate) of public pensions has been kept unchanged in consideration of severe economic conditions, and this has contributed to a decline in premium income. Therefore, lifting the freeze on premium hikes will become an important issue in the pension system reform slated for 2004. With the insurance premium burden for public pensions already being the heaviest among tax and other social insurance burdens, the question of at what level the public pension contributions and benefits should be set will remain the central issue in discussion on the ratio of national burden.

Column 3-7
Outline of Japanese Public Pension System

    As a result of the pension system reform in 1986, all Japanese aged 20 and above and below 60 become insured persons of the national pension plan (basic pension). They become category 1, category 2, or category 3 insured persons of the national pension plan depending on their occupation, etc., and the type of benefits they receive in the future differs depending on what category they belong to.
    The Japanese public pension system has a two-tier structure. There are employees' pension plans covering workers of private companies and mutual aid pension plans covering public workers in the second tier above the national pension plan. People joining either employees' pension or mutual aid pension plan have to join the national pension as well. As pension plans to supplement the public pension, there are corporate pensions (employees' pension fund, defined benefit corporate pension plan, defined-contribution pension plan, qualified retirement pension plan) for employees of private companies, and national pension fund and defined-contribution pension plan (individual) for self-employed workers. In addition, there are personal pension plans (See Figure 1).
    With regard to pension premiums, the national pension premium is fixed at 13,300 yen a month, while employees' pension and mutual aid pension premiums are set in proportion to total annual compensation (monthly pensionable remuneration plus bonus) (in the case of employees' pension, the employee and company split the premium (13.58% of total annual compensation) 50-50 (See Table 2)).
    With regard to pension payments, the national pension benefit is fixed at 66,417 yen (fiscal 2003) a month for those who contributed to the scheme for 40 years. On the other hand, in the employees' pension and the mutual aid pension, the annual benefit of the fixed portion and the portion proportional to compensation combined is set at 59% of the after-tax income of the working generation. These pension benefits are adjusted every year in accordance with consumer price inflation and after-tax income of the working generation ("index-linked" and "net income-indexed," respectively).
    The age of pension payment eligibility is to be raised gradually from the current 60 to 65 years old under the pension system revision of 1994 (for the fixed portion) and under the pension system revision of 1999 (for the portion proportional to income).(70)
Figure 1 Outline of Japanese Pension System
Table 2 Category of Insured Persons and Premiums


Problems involved in Japan's public pension system under the aging/declining population
    The Japanese public pension system has reserves, but it is generally called a "stepwise raising contribution method" in that premium contribution and pension benefits can be changed by step by step under the decreasing birthrate and aging population, unlike private insurance plans under which premium contributions and annual benefits are fixed at the time of buying insurance. In reality, however, the Japanese public pension system has been close to a "pay-as-you-go" system under which the pension benefits necessary to support the livelihood of elderly people are financed by premiums contributed by the working generation.(71)
    Pension plans based on a "pay-as-you-go" system are vulnerable to demographic changes in the case where the percentage of the premium-paying working generation (insured persons) to benefit-receiving elderly people (beneficiaries) rises due to declining birthrate and aging population. For example, if the current level of benefits is to be maintained under such a situation, the premium per insured person has to be increased. A "pay-as-you-go" system achieves a strong performance when, like during the high economic growth, population increases steadily and when the ratio of the working generation to elderly people is high. However, when the number of the supporters of the pension plans is decreasing and when economic growth, which determines wage levels, is slowing down, like the current situations in Japan, the sustainability of the pension plans based on a "pay-as-you-go" system inevitably declines.
    The fact that the declining birthrate and the aging in population in Japan has progressed faster than initially projected, in addition to the fact that the financing method is vulnerable to demographic changes, has made the management of the public pension system all the more difficult. In Japan, a fiscal recalculation of public pensions is made based on the "future estimated population," which is announced every five years, and pension system reform, including revision of insurance premium (rate) and benefit amount (rate), is carried out two years after the announcement of population estimate. However, the actual decline of birthrate and the extension of the average lifespan have been consistently faster than forecast by the population estimates. As a result, the revision of the level of contributions and benefits necessary to maintain the pension system has been inadequate.

Gap in public pension benefits and premium contributions between generations
    As described above, under the Japanese public pension system managed based on a financing method close to a "pay-as-you-go" system, a progress in declining birthrate and aging population will inevitably result in increasing premium contributions, unless the current benefit level is drastically reduced. This brings about a gap between generations in the ratio of pension benefits divided by premium contributions, with the ratio becoming higher for older generations and lower for younger generations.
    In order to see to what extent the gap between generations exists in the public pension system, let's examine, by using a generational accounting method,(72) the ratios of pension premiums and benefits to lifetime pay for each generation of households joining the employees' pension plan (See Figure 3-3-13 (1)).(73) First, let's take a look at households with full-time homemakers. People born in fiscal 1950 will receive more in benefits than they contributed as pension insurance premiums, while people born in fiscal 1970 will contribute more in pension premiums than they will receive in benefits. Benefit ratios (pension benefits divided by premium contributions) are higher (lower) for older (younger) generations.(74)(75)
    With regard to single-member households, people born in fiscal 1950 will make more premium contributions than they will receive in pension benefits, and the benefit ratios for younger generations are much lower than those for households with full-time homemaker (See Figure 3-3-13 (2)). This is because full-time homemakers receive basic pension benefits without paying insurance premiums, making the benefit ratio for households with a full-time homemaker relatively higher, while single-member households are not eligible for such benefits.(76)
Figure 3-3-13 Ratios of Pension Premiums and Benefits to Lifetime Wages for Each Generation
    The large gap in public pension benefits and contributions between generations stems partly from the facts that benefit levels were drastically raised, while contribution rates had to be kept at low levels in the past,(77) and that a hike in insurance premiums is expected in the future, while measures to curb benefits were taken recently, such as raising the age of pension payment eligibility and lowering benefit levels.
    The public pension system in some respects had to be based on inter-generational support.(78) Therefore, it is not advisable to make play with the problem of gap in contribution and benefit between generations (See Column 3-8). However, if the working and future generations alone are asked to shoulder the increasing burdens caused by the rapidly declining birthrate and aging population, they, especially young people, would lose confidence in the pension system, resulting in lowering the sustainability of the public pension system. An inter-generational gap may be inevitable to a certain extent, but it is important to strive to make the relations between contributions and benefits fairer for each generation by lowering elderly people's benefit levels and raising their contributions and by curbing a rise in premium contributions within a permissible range. Furthermore, it is necessary to construct a permanent, stable system that can flexibly cope with social and economic changes, such as rapidly progressing aging and declining population and slow economic growth (See Column 3-9).(79)

Column 3-8
Funding Method as a Financing Method for Public Pension System

    It is often pointed out that the financing method for the public pension system should be changed to a funding method in order to correct the benefit ratio gap between generations caused by the progressing declining birthrate and aging population.(80)(81) Under a funding method, each working generation sets aside funds necessary for retirement life and uses the accumulated funds and management gains on the funds as pension benefits after reaching the age of pension payment eligibility.
    The biggest characteristic of the funding method is that since income redistribution takes place only within the same generation, unlike the pay-as-you-go method based on income redistribution between generations, it is robust against demographic changes and does not cause a gap in contributions and benefits between generations even under the aging and declining population. Another characteristic of the funding method is that since premiums are accumulated to prepare for future pension benefits, instead of being used immediately for payment of benefits to retired generations, it raises the savings level of a country as a whole, leading to expectations of a rise in the level of gross domestic product in the long run.(82)
    However, since the current system is in effect operated in a manner close to a pay-as-you-go method, the benefit obligations of the employees' pension plan alone stood at 720 trillion yen as of the end of fiscal 1999. Of this amount, 450 trillion yen (including 330 trillion yen for compensation-proportional benefits), or the amount after deducting 170 trillion yen in accumulated funds and 100 trillion yen in state contribution, must be financed by future insurance premium income.(83) If the pension system is to be shifted from the pay-as-you-go method to a funding method under such circumstances, the working generations in the transition period would have to make contributions to support already retired elderly people in addition to contributions to prepare for their own retirement years (the so-called "double burden" problem).(84)
    In order to avoid the burden of paying off pension obligations from concentrating on specific generations, various methods have been proposed, including a method of gradually shifting the burden by raising pension premiums and lowering the level of benefits, and a method of securing necessary funds at once by issuing government bonds and raising the funds to redeem the government bonds widely and shallowly through tax hikes. In any case, measures to shift to a funding method must be studied in tandem with realistically permissible measures to pay off pension obligations.

Column 3-9
Public Pension System Reform in Sweden

    Other major countries are also carrying out reforms to raise the sustainability of their public pension system amid rising pension benefits caused by the progress in declining birthrate and aging population. The reforms can be classified into (1) "adjustment reform" to adjust benefits by such measures as raising premiums and lowering benefit levels, while maintaining the basic framework of the system, such as defined-benefit pay-as-you-go methods (Japan, Germany, etc.) and (2) "sweeping system reform" to change the current system designs by, for example, introducing a defined-contribution plan (See Appended Table 3-5). As an example of the sweeping system reform, let's take a brief look at the contents and significance of the public pension system reform in Sweden.(85)
    In its pension system reform implemented in 1999, Sweden introduced a defined-contribution system in place of the conventional defined-benefit system, while maintaining the pay-as-you-go financing method. Defined-contribution is normally used in pension plans employing a funding method. In the case of Sweden, contributions made by individuals are recorded in each individual's account, the contributions are assumed to be managed at the interest rate corresponding to wage growth rate, and pension benefits are calculated based on the aggregate sum of total contributions and "deemed investment profits in order to balance premium contributions with benefits. Since it computes defined-contribution pensions without actually accumulating the contributions for the future,(86) it is called a "notional defined-contribution" system.
    The new system has abolished the conventional basic pension, limited the role of state subsidy to the maintenance of the guaranteed pension system to secure minimum pension benefits, and is of a two-tier structure with the portion of notional defined contributions forming the first tier and the portion managed in a funding method forming the second tier. In addition, the new system has fixed the contribution rate at 18.5% (16% for the pay-as-you-go portion and 2.5% for the funding portion) to keep the burden on working generations at a certain level, and has introduced a mechanism to automatically lower benefit levels (automatic balance mechanism) in order to restore balance when the contribution-benefit balance is disrupted (See Figure).
    As a result of the reform, the public pension system is expected to improve its credibility, as it has made the relation between contributions and benefits transparent, and is also expected to remove the unfairness between generations concerning contributions and benefits. The introduction of the automatic balance mechanism is expected to stabilize the public pension system for a long time, as it automatically reduces benefits by taking future pension assets and obligations into account.
    However, since the new system was introduced only recently and is designed to replace the old system in 20 years, its effects have to be examined closely in the future. Moreover, since the financing method of the new system is basically a pay-as-you-go method, it may become difficult to maintain the system, as in the case of the old system, when economic growth drops faster than assumed or when the declining birthrate and aging population progress faster than anticipated. In particular, we have to keep a careful watch on how lowering of benefits through the automatic balance mechanism will be implemented without causing friction.
Figure Public Pension System in Sweden


Problems of intra-generational gap
    In order to enhance the credibility and sustainability of the public pension system, it is important to make the relations between contributions and benefits fairer for each generation as well as between generations. The current system brings about disparities depending on people's employment style and lifestyle. The existence of such disparities not only has a considerable impact of people's lifestyle choice but also contributes to lowering the sustainability of the public pension system, as it narrows the scope of people to support the system. Keeping the above problems, we will examine the following three points; (1) difference in contribution methods for basic pensions between pension plans, (2) gap stemming from women's different lifestyles, and (3) gap within older generations.

Problems of intra-generational gap: (1) Difference in contribution methods for basic pensions between pension plans
    The fixed-amount basic pension benefits, which constitute the first tier of Japan's public pension system, are paid from contributions to the national pension plan (category 1 insured persons) and employees' pension plans, such as the Employees' Pension Insurance, except for a certain percentage of the portion covered by state subsidy. When calculating contributions, in the case of employees' pension plans, a fixed-rate premium is applied and the contributors (National pension category 2 insured persons) pay a fixed amount of basic pension premiums in proportion to the number of persons, including contributors' spouses, covered by the basic pensions belonging to the employee's pension plans. As a result, in employees' pension plans, income redistribution is made through basic pension contributions from upper-income groups to lower-income groups and from employees to full-time homemakers within the same generations. On the other hand, National pension category 1 insured persons pay only a fixed amount of premiums and there is no income redistribution involved (See Table 3-3-14).
Table 3-3-14 Basic Concept of Basic Pension Contribution System
    As just described, the national and employee pension plans differ in terms of contribution methods with regard to the portion of fixed-amount basic pension benefits. Moreover, the relationship between premium contributions and benefits in the employee pension plan is vague, as basic pension contributions and compensation proportional contributions are collected together.
    The above difference in the contribution to basic pension benefits has further widened due to a large number of national pension category 1 insured persons not contributing premiums and those who do not join the national pension plan. Participation in the plan is basically mandatory, but there are many people who do not join the plan and those who do not pay premiums. This has lowered the collection rate of national pension premiums. Specifically, as of the end of fiscal 2001, the number of people who do not pay premiums stood at 3.27 million and those who had not joined the plan stood at at 630,000 for a total of 3.9 million (See Figure 3-3-15 (1)), accounting for 5.5% (about one for every 18.2 persons) of the people covered by the national pension plan, which stood at 70.8 million. Since the contribution methods are different between national pension category 1 insured persons and those joining employees' pension plans, let's examine the ratio of those not paying premiums to the total number of national pension category 1 insured persons, which stands at 22.7 million. The ratio comes to 17.2% (about one in every 5.8 persons). Moreover, of the people paying premiums, the percentage of those who paid in full stood at 81% as of the end of fiscal 2001, with the remaining 19% paying only partially.
    The payment ratio (number of months premiums were paid / number of months premiums had to be paid x 100) has been on a downward trend, standing at 62.8% in fiscal 2002 (See Figure 3-3-15 (2)).
Figure 3-3-15 (1) National Pension Category 1 Insured Persons
Figure 3-3-15 (2) Trend of National Pension Premium Payment Ratio
    Behind these situations lie the facts that people's premium paying capacity has declined due to prolonged severe economic conditions and that there are lack of understanding and anxiety about the future of the public pension system on the part of the people, mainly young people.
    In addition to the increase in the number of people not contributing premiums or not joining the national pension plan, an increase in the number of people who are exempted from paying premiums has made the financial condition of the national pension plan even more severe. Under the public pension system, people who are unable to contribute premiums for economic or other reasons are exempted from paying premiums. In recent years, the number of such people has increased, reflecting severe economic and employment situations, standing at 5.24 million as of the end of fiscal 2001 (See Figure 3-3-15 (1)).
    Under the national pension system, since the people not contributing premiums and those not joining the pension plan are excluded from the number of people on whom the calculation of contributions is based, an increase in the number of such people will result in raising the per-capita unit price of contributions made by premium contributors to employees' pension plans, such as the Employees' Pension Insurance, and the national pension category 1, and this in turn will result in increasing the cost burden for basic pension benefits.(87)
    As a matter of course, those exempted from premium payment are not required to make premium contributions in consideration of their inability to bear the burden of premium payment and therefore it is not advisable to treat them in the same way as those not paying premiums or those not joining the national pension plan. Still a rise in the number of people not paying premiums or not joining the pension plan even though they are capable of doing so is a big problem. In order to correct the intra-generational gap and not to produce non-pensioners in the future, thorough measures must be taken to collect premiums from delinquents.

Problems of intra-generational gap: (2) Gap stemming from women's different lifestyles
    The Japanese public pension system gives preferential treatment to households with full-time homemakers in premium contributions and benefits, and this has given rise to an intra-generational gap stemming from women's different lifestyles.
   Under the national pension system, category 1 insured persons, consisting of self-employed people, workers in agriculture, forestry and marine industries, and students, etc., contribute premiums on an individual basis, while category 3 insured persons (11.33 million as of the end of March 2002), consisting of spouses of salaried workers and public servants, do not pay premiums even though they have the right to benefits. Insurance premiums for basic pension benefits of category 3 insured persons are paid by the insurance system to which the spouses belong.(88) As a result, households with full-time homemakers are given preferential treatment for premium contributions and benefits (See Figure 3-3-13). It has been pointed out that the category 3 insured person system that requires no premium payment, coupled with other systems, such as allowance for dependents, are discouraging women from working.(89)
    The category 3 insured person system was effective in preventing women from becoming non-pensioners.(90) However, with women's lifestyles becoming increasingly diversified, it is now pointed out that the system that guarantees pension benefits for full-time homemakers not paying premiums is unfair. Amid the decreasing size of the working age population, the fact that women are discouraged from working due to the existence of the pension system that gives preferential treatment to full-time homemakers is problematic also from the standpoint of securing work force and increasing the supporters of social security systems.(91)(92) The "Direction and Points of Contention concerning Pension Revision," which the Ministry of Health, Labour and Welfare published as a basis for pension reform in 2004, makes four reform proposals to remedy the problem of the category 3 insured person system; (1) division of pension rights between husband and wife, (2) adjustment of contributions, (3) adjustment of benefits, and (4) cutback in category 3 insured persons. A study is also being made so that employees' pension plans cover part-time workers. Through these measures, efforts should be made to correct the gap stemming from different lifestyles of women.(93)

Problems of intra-generational gap: (3) Gap within older generations
    The average income and assets of elderly people are at the same level or higher than those of the working generations. However, there is a wide gap in income and assets within the same older generations. Since people's income-earning capacity varies, it is only natural that long years of work result in producing such a gap. However, the gap also stems from the fact that the size of compensation one received when he was in active service is maintained even after retirement, as the portion of compensation-proportional benefits in the employees' pension plan is paid in accordance with the total compensation he received while in active service (See Figure 3-3-16).
Figure 3-3-16 Number of People Eligible for Old-Age Welfare Annuity (excluding Transferred Old-Age Pension) by Amount of Benefits
    Since the amount of pension benefits under a social insurance system is determined by the amount of contributions one made while he was in active service, a person whose income was high while in active service and who contributed more to the pension fund receives benefits after retirement. However, in a country like Japan, where the public pension system is managed in a pay-as-you-go method amid declining birthrate and aging population, it means the higher a person's income level was while he was in active service, the more he receives income transfers from the working generations after retirement.
    In view of such a situation, it would be better to review the preferential treatment in pension benefits accorded the elderly people whose total income, including pension benefits, is high, and to ask elderly people with high tax-paying capacity to contribute to the pension fund in accordance with their ability. Under the current tax system, many of the elderly people do not pay income and residential taxes because the minimum guaranteed amount of deduction for public pensions, etc. in the case of elderly people aged 65 years old or higher is set at 1.4 million yen, while the minimum guaranteed amount of deduction for employment income is set at 650,000 yen, and because the minimum taxable income for aged households is extremely high compared with that for working households due to the availability of deductions for the elderly. Moreover, since the deduction for public pensions, etc. is applied uniformly to retirement income despite various economic conditions of elderly people, even high-income earners are often omitted from the taxation base, causing an imbalance in tax burden with other income. This has caused unfair burdens of taxes not only between generations but also within the same older generations (See Table 3-3-17 (1), Figure 3-3-17 (2)).
Table 3-3-17 (1) Comparison of Minimum Taxable Income (Income Tax)
Figure 3-3-17 (2) Comparison of income tax between aged people and working people
    In order to make tax burden equitable between generations and within older generations by asking elderly people to bear the fair share of taxes commensurate with their economic power, it is necessary to examine pubic pension deduction and other systems, while giving due consideration to low income earners living only on a pension income.
    When addressing the modality of elderly people and the public pension system, how to treat elderly people's employment income is an important point of discussion. Since the public pension system is a system to pool risks of a decline in elderly people's income earning capacity, it is not necessarily appropriate to provide pensions uniformly to elderly people having wage income, especially from the standpoint of balancing tax burden with younger generations who are required to make more premium contributions from their wage income in the future. Therefore, under the system of old-age pension for active employees, pension payment to people 60-69 years old(94) having wage income is suspended partially or in its entirety in accordance with their wage income. This, however, works as a penalty against employment, impeding elderly people's willingness to work.
    The 1994 system reform has made the system for old-aged pension for active employees more neutral on elderly people's decision-making concerning employment and retirement, as it now allows the total income of wage and pension to increase in accordance with an increase in wage income. The system should be further improved, while balancing the two objectives of correcting the gap within older generations and not impeding elderly people's willingness to work.

Toward construction of a sustainable public pension system
    Amid the aging and declining population, the sustainability of the Japanese public pension system has declined considerably and we can no longer expect "generous benefits with small contributions." It is necessary to correct the gap between generations to a permissible level by reforming the modalities of contributions and benefits, and to establish a system robust against the risks of demographic changes and economic fluctuations. In addition, it is necessary to revamp the system to make it neutral in its effect on people's choice of employment and lifestyle in order to ensure fairness within the same generations. It is also necessary to take strong measures against people not paying premiums and those not joining the national pension plan. Through these efforts, the public pension system should be made more credible and more sustainable even at a time when the nation's aging population hits a peak in the future. A public pension system that will serve as fundamental to the people's "security" and "vitality" must be established.

4. Reform of the Health Care System
Increase in national medical care expenditure
    According to the "National Medical Care Expenditure," which estimates the costs required for treatment of diseases at Japanese medical institutions, etc., medical bills have swollen year by year in Japan. Though the costs decreased in fiscal 2000, when the nursing-care insurance system was introduced, they rose to 31,323.4 billion yen in fiscal 2001, or 246,000 yen per person (See Figure 3-3-18) (See Column 3-10).
Figure 3-3-18 Changes in National Medical Care Expenditure
    A comparison of the growth rates of national medical care expenditure and national income shows that national medical care expenditures have been increasing faster than national income and that the ratio of national medical care expenditure to national income has been rising since fiscal 1992.(95) Reflecting the sharp growth of national medical care expenditure and slow growth of insurance premiums caused by severe economic conditions, the financial conditions of various medical insurance systems have deteriorated, causing a sharp decline in the sustainability of the systems. For instance, the government-managed health insurance system's income consisting of premiums, etc. has been on the decrease since fiscal 1999 due also to a decrease in average index monthly earnings caused by the decreasing number of insured persons. On the other hand, its spending has been increasing due mainly to contributions to medical care expenditures for elderly people. As a result, the government-managed health insurance system posted the largest deficit on record in fiscal 2002 and exhausted its reserves(96) accumulated since fiscal 1984 (See Figure 3-3-19).
Figure 3-3-19 Financial Balance for Government Health Insurance System
    If the growth of spending for medical bills is proportionate to the growth of wage income, which constitutes the base for the system's income, then, a premium rate, once set at a certain level, would not need to be revised to balance the system's financial account, with other things being equal. However, if the aging of the population progresses further and if national medical bills keep increasing faster than national income, it would become inevitable to revise the premium rate and insurance benefits.

Column 3-10
About Gross National Medical Expenditure

   "National Medical Care Expenditure" is an estimate of the costs required for treatment of diseases at medical institutions, etc. in a given year.(97) The estimate includes medical care bills and dispensing fees, but since it limits the scope of medical expenditure to treatment of diseases, it does not include such expenses as normal pregnancy and childbirth expenses, disease-prevention and health-management expenses, and over-the-counter drug purchases. As an indicator covering not only medical expenditure for treatment of diseases but also costs for health promotion, disease prevention, health management and expenses for health insurance management and equipment purchases, the Institute for Health Economics and Policy estimates "gross national medical expenditure.(98) According to this estimate, the gross national medical expenditure in fiscal 1999 came to 38,011.4 billion yen, about 1.2 times as much as the National Medical Care Expenditure in the same year, which stood at 30,933.7 billion yen.
Figure Changes in Gross National Medical Expenditure and National Care Medical Expenditure


Background of the rising national medical care expenditure
    In order to identify factors behind the rising national medical care expenditure, let's analyze the contribution of "impacts of the revision of medical treatment fees and revision of drug price standards," "population increase," "aging of population" and "others (advancement, etc. of medical technology) to a rise in national medical care expenditure.
    The analysis shows that "aging of population" pushes up the growth rate of national medical care expenditure by about 2 percentage points every year (See Figure 3-3-20). It also shows that the percentage of medical care expenditures for elderly people(99) in the national medical care expenditure has been increasing year by year, indicating that the rising national medical care expenditure is largely attributable to the increasing medical care expenditure for elderly people (See Figure 3-3-18). As to per-capita national medical care expenditure by age group, though the annual medical care expenditure for people aged below 50 is less than 200,000 yen, it is higher for older age groups, with the annual medical care expenditure for people aged 70 or older topping 600,000 yen. Therefore, amid aging of the population, the medical care expenditure for elderly people has been increasing faster than the national medical care expenditure at an annual rate of 6-9%. In fiscal 2001, it amounted to 11,656 billion yen, accounting for 37.2% of the national medical care expenditure.(100)
Figure 3-3-20 Breakdown of National Medical Care Expenditure Growth Rate by Factor
    The national medical care expenditure is expected to increase further, given that the number of elderly people, whose per-capital medical expense is high, will increase due to the aging of population. The question of how to curb the growth of national medical care expenditure, mainly expenditure for elderly people, at a reasonable level has increased its importance.(101)
    Besides the aging of the population, there are other factors behind the rising national medical care expenditure, such as advancement of medical services. The average points (one point = 10 yen) per inpatient or outpatient receipt(102) have been on a rising trend, though the average point per outpatient receipt has been declining recently following the downward revision of medical treatment fees. Changes in the component ratios of inpatient receipts by point group show that the ratios of groups with 100,000 points or more have increased, indicating that medical costs have been spiraling due to the advancement of medical services (See Figure 3-3-21).(103)
Figure 3-3-21 Component Ratio of Points Per Inpatient Receipt

Necessity of reforming medical insurance system
    Japan achieved universal health insurance coverage in 1960. However, reflecting its historical background that individual insurance systems were established by occupation or by region, the current medical care insurance system in Japan consists of a number of systems, and premium contributions and state contributions differ from one system to another (See Attached Table 3-6).(104)
    Under the current system, employees and their dependents subscribe to employees' health insurance and those not subscribing to employees' health insurance subscribe to national health insurance in their domicile. In other words, a large majority of employees subscribe to employees' health insurance while in active service and subscribe to a local health insurance plan (national health insurance) after retirement. Consequently, there are many people of working generations in employees' health insurance and many people of older generations in national health insurance. Since medical care expenditure increases as one gets older, financial burdens build up on national health insurance, whose premium income is smaller and whose medical care expenditure is larger than those of employees' insurance (See Figure 3-3-22). Therefore, the "Retiree Health Care System" has been established for people eligible for old-age pension of an employees' pension plan and their family members who joined national health insurance after retirement but chose not to be covered by the Health and Medical Service Law for the Aged. Persons covered by the Retiree Health Care System receive benefits from national health insurance and the costs for the benefits are financed by retirees' premiums and contribution to retirement funds from each employees' insurance program (See Figure 3-3-23).
    In addition, the patient charge on older people aged 75 or above (those eligible for the medical care for the aged) is to be slashed to 10%, with the remainder to be contributed by municipalities. The funds for medical benefits are to be financed jointly by public funds contributed by state, prefecture, and municipal governments, and contributions to funds for senior medical care from each medical insurance assurer (See Figure 3-3-23).(105)
Figure 3-3-22 Participation Rate by Type of Insurance
Figure 3-3-23 System of Fiscal Coordination among Medical Insurance Plans
    As just described, under the Japanese medical care insurance system, the burden of premium payment, benefit level, and state subsidy differ from one system to another. And, medical expenses for the aged are covered by working generations and older generations through the Retiree Health Care System and the Elderly Health Care System.(106) In fact, a study of the relation between medical expenses and premium contributions by age group shows that premium contributions are larger than medical expenses for people aged 59 and below but that medical expenses are larger than premium contributions for people aged 60 and above, with medical expenses exceeding contributions by more than 400,000 yen a year for people aged 70 and above (See Figure 3-3-24).(107)
Figure 3-3-24 Age-by-Age Medical Expenses, Premiums and Over the counter payments
    Since working generations pay much of aged people's medical expenses under the Retiree Health Care System and the Elderly Health Care System, if medical expenses for elderly people continue to increase drastically due to the aging of the population, it would result in excessively increasing the burden on the young generations, raising concerns about the financial sustainability of the health insurance system. Japan should reform its health care system, medical insurance for the aged in particular, in order to prevent the aging and declining population from adversely affecting the financial sustainability of the insurance system (See Column 3-11).
   

Column 3-11
Reform plan for medical treatment for the aged

    A basic policy to reform the health insurance system was adopted by the cabinet on March 28, 2003.(108)
    Under the basic policy, the Elderly Health Care System covering people aged 65 and above is to be revised so that it will become more responsive to the characteristics of each age group-senior citizens 75 years old or over and senior citizen 65 years old or over but less than 75. The basic policy calls for asking elderly people to bear the fair share of premium contributions and ensuring the equity in premium contributions within older generations and between the aged and the young. Specifically, it calls for (1) establishing a system to finance medical expenses for senior citizens 75 years old or over by premiums contributed by the insured, support from national health insurance and employees' insurance, and public funds, and (2) enrolling the senior citizen 65 years old or over but less than 75 in national health insurance or employees' health insurance and securing the stability and fairness of the system by adjusting the imbalance between medical expenditure and contributions between systems stemming from the maldistribution of the senior citizen 65 years old or over but less than 75. In addition, it calls for promoting efforts by the state, prefectural governments, and local communities in order to balance medical expenses per elderly person with those of young people, and ensuring reasonable medical expenses by making various services more efficient through closer coordination of health care, medical treatment, and nursing.
Figure Basic Concept of Reform Plan for Medical Treatment for the Aged


Problems to be addressed for reasonable medical expenses
    Even if the fairness in premium contribution among older generations and between the aged and the young has been achieved through reform of the health insurance system, an increase in national medical care expenditure cannot be avoided due to the rapidly aging population. Therefore, it is vital to make overall medical expenditure correspond to economic and fiscal conditions by slashing costs while maintaining the quality of services through the promotion of efficiency and appropriateness on both demand and supply sides. In medical services, the demand side is tempted to call for more than an appropriate level of services and the supply side is also tempted to provide more than an appropriate level of services, resulting in increasing medical expenditure. Therefore, one of the important points in promoting reform is to design a medical system that would provide both the demand and supply sides with incentives to correct medical expenses to a reasonable level.

Problems to be addressed for reasonable medical expenses: (1) Appropriate medical behavior on the demand side
    First, let's take a look at problems that should be addressed by patients who receive medical services.
    Since costs for medical services are mostly covered by insurance, patients are often less conscious about medical costs than they are about costs of other ordinary goods and services and they are likely to try to have more than necessary check-ups. Therefore, it is necessary to raise their cost consciousness about medical services by requiring them to bear the fair share of medical costs.
    The system revision in fiscal 2002 has raised the self-pay ratio to 30% for young people and to 10% for elderly people(109) with the aim of putting the severe financial conditions of health insurance back on a sound footing and correcting such medical behavior on the part of patients. Since the system revision went into effect only in April 2003, there are not enough data available yet to estimate the impact of the revision on the medical behavior of patients. However, according to a study that analyzed the impact of the previous revision in September 1997(110) that also raised self-pay ratios, the number of hospital-visiting days for a chronic disease or flu and the number of receipts for such checkups have decreased in the case of members of corporate health insurance societies.(111) The study also shows that the increase in self-pay ratio for elderly people was effective in bringing medical bills down to a more appropriate level.(112)
    However, since bringing down medical bills to an appropriate level by raising self-pay ratios means an extra financial burden on low income earners and elderly people, it goes without saying that we must pay due consideration to them.(113)

Problems to be addressed for reasonable medical expenses: (2) Improvement of the efficiency of health care service provision
    In order to efficiently utilize scarce medical resources and financial resources, it is important to improve the efficiency of medical service provision as well as to correct medical behavior. Generally speaking, when providing medical services, unlike providing ordinal goods and services, there is wide "asymmetry of information" between consumers, or patients and suppliers, or medical institutions and therefore medical institutions are inclined to provide medical services more than necessary.
    In fact, a study of the relation between the number of beds per 100,000 people and medical bills for each person with regard to national health insurance insurers by prefecture shows that medical bills rise as the number of beds increases, suggesting the existence of a large number of medical institutions may produce more medical treatments (See Figure 3-3-25).
    Therefore, the point of reform is how to provide medical institutions with incentives to offer high-quality, efficient medical services, while accepting the existence of asymmetry of information. Measures to improve the efficiency of medical service provision are briefly examined below from the four aspects of (1) health care service fee system, (2) drug pricing system, (3) medical service provision system, and (4) medical institution management.
Figure 3-3-25 Hospital Expense Per National Health Insurance Insurer and Number of Beds Per 100,000 People

(1) Health care service fee system
    The current health care service fee system in Japan is basically a "fee-for-services system" in which medical institutions' income increases as the amount of medical practice, such as medical treatment and medication, increases. Therefore, it does not provide medical institutions incentives to slash costs. Rather, it often results in excessive medical treatment and medication. As a way to remove these disadvantages, some people propose that the fee-for-services system should be replaced with a "prospective payment system" in which the payment rate is established for each disease in advance of the provision of services. The system has already been introduced in some medical institutions. The system is more likely to provide medical institutions with incentives to keep medical costs within the predetermined payment rate and therefore provides incentives to improve efficiency.
    However, since doctors can expect a certain amount of income regardless of medical treatment actually provided under the prospective payment system, it should also be kept in mind that the system is likely to provide doctors with incentives to provide low-cost medical services and avoid patients whose treatment is deemed to require above-the-line costs.
    We believe that the scope for prospective payment system should be expanded in accordance with characteristics of each disease and based on a full analysis of the advantages and disadvantages of the fees-for-services and prospective payment system.
    It is pointed out that the current medical service provision is not standardized, with the content of medical treatment differing depending on medical institutions and doctors. This has caused a disparity between the actual costs(114) for medical services and medical service fee points even for the same kind or degree of injuries, a government report said. The Price Structure Policy Committee's workshop on medical prices, which prepared the final report,(115) also said that doctors, therefore, are tempted to provide medical services too much or too little (See Figure 3-3-26). In order to correct the distortion in medical care supply and to provide patient-oriented medical services, medical services should be standardized by bringing medical fee points closer to actual conditions and by promoting "Evidence Based Medicine (EBM)"(116) that actively uses information based on scientific evidence.
Figure 3-3-26 Disparity Between Cost and Medical Points (Number of Patients)

(2) Drug pricing system
    In the current drug pricing system, there are gaps (drug price gap) between drug prices set by the government (standard drug price) and medical institutions' actual purchase prices, providing medical institutions with incentives to prescribe more than the necessary amount of drugs.
    The percentage of drugs(117) as a portion of medical costs, which stood at above 30% until the mid-1980s, has declined recently, standing at 19.9% in 2001 (See Figure 3-3-27). The decline can be attributed to biannual revisions of the drug price standard, a narrower drug price gap, and an improvement in the use of drugs. The gap should be narrowed further.
    As one of the measures to further improve the use of drugs, the use of generic drugs that are cheaper than original drugs should be promoted.(118) The market size of generic drugs in Japan is smaller than in the U.S. and European countries. It is hoped that the market size will be expanded in the future.(119)
Figure 3-3-27 Changes in the Ratio of Drugs to Total Medical Points

(3) Reform of medical service provision
    It has been pointed out that the efficiency of medical service provision in Japan may decline as functions of various health care service providers are not fully specified. Therefore, the efficiency of the medical service provision system should be increased by taking such measures as the promotion of division of functions in hospitals and clinics (for instance, separation of functions in chronic and acute diseases, improvement of personal doctor's functions, promotion of home medical care, and establishment of a comprehensive regional medical system), the acceleration of efficient use of medical resources, such as advanced medical equipment, and the management of public medical institutions in accordance with their roles.
    With regard to medical care for the elderly, problems such as long hospitalization are still pointed out. Therefore, a system to efficiently provide medical benefits and care benefits to elderly people must be established by promoting smooth transfer from medical services for the aged to elderly care services.

(4) Promotion of modernization and efficiency of hospital and clinic management
    It is pointed out that, in the field of medical services, moves to promote the computerization and standardization of terms and forms are slow, making it difficult to provide comparable objective information concerning medical services and thus preventing the modernization and efficiency of hospital and clinic management. Therefore, it is necessary to promote the computerization of medical records and receipts and the modernization and efficiency of the management of medical institutions through disclosure and external evaluation, etc. Incidentally, according a study on the productivity of medical institutions, private-run hospitals are more productive than public hospitals (See Attached Table3-7) and the efficiency varies widely from one hospital to another.(120) Therefore, in order to promote the efficiency of medical institutions, it is necessary to review the ways hospitals and clinics are managed, while giving incentives to make operations efficient.
    In Japan, establishment of profit-oriented medical institutions by incorporated companies, etc. is prohibited under the Medical Service Law.(121) The prohibition stems from various concerns about possible adverse effects of the management of medical institutions by incorporated companies. For instance, the operation of a hospital by an incorporated company may result in raising medical expenses. Another reason is that the incorporated company may withdraw when the operation does not justify the costs, causing some trouble for local communities to secure appropriate medical services. On the other hand, there are also opinions that the entry of various entities into the market would enhance productivity, improve quality of medical services in response to patients' needs, and strengthen the management base of medical institutions through diversification of fund raising, such as stock issue.
    In any case, the handling in the whole country should be considered in the light of the experience of the incorporated companies in managing medical institutions in the special zones for structural reform.(122)

Problems to be addressed for reasonable medical expenses: (3) Strengthening the function of the insurer
    In addition to the efforts on the part of consumers and suppliers described above, the function of the insurer should be strengthened in order to bring medical bills down to a more appropriate level through health care providers' collection and assessment of information, provision of information to the insured, the so-called direct contract of medical treatment fee between an insurer and a medical institution, primary check of receipts, direct payment of medical treatment fees to medical institutions, and other measures.
    Due to the existence of asymmetry of information between medical institutions and insured persons, provision of appropriate medical services is somehow left to the discretion of medical institutions. However, if insurers fulfill their original function as agent for insured persons, it is expected to lead to the improvement of the efficiency and quality of medical services.

Toward construction of a sustainable medical service system
    Amid the progress in the aging of the population, an increase in the national medical expense, mainly medical treatment for the aged, is inevitable. We have to address the task of establishing a medical system that is stable and sustainable even in the circumstances of declining premium income caused by a decrease in the number of supporters of the medical insurance system due to the declining birthrate and by slow economic growth. To this end, it is necessary to bring swelling medical expenses down to a more appropriate level and balance them with economic and fiscal conditions, while striving to secure necessary medical services through the measures discussed above, such as review of the medical-care system for elderly people, improvement of medical behavior on the part of patients, and provision of high-quality, efficient medical services.

5. Reforming the Social Security System Taking Into Consideration Its Integrated Nature and Mutual Relationship
Establishment of a social security system responding to uncertainties, such as demographic changes and economic growth
    The Japanese population is aging and declining at a speed unprecedented in the history of the world. We have discussed its large impact on the future growth of the Japanese economy in Section 2. But, economic growth depends on many factors. To begin with, demographic change itself bears uncertainties. And even if a demographic change is known, its impact on economic growth depends on such factors as the trend of the labour force participation rates of women and elderly people, domestic savings rate, availability of foreign savings, and the trend of total factor productivity. Moreover, future policy efforts have a major impact on each of the factors. Therefore, we can discuss anticipated economic growth only in general terms.
    On the other hand, as we discussed earlier in this section, the aging and declining population has raised questions about the sustainability of the public finance and social security systems, along with its impact on economic growth. The reform of the public finance and social security systems has been only half done partly because a collapse of the systems is not immediately visible. However, in order not to shift any more burdens to future generations, the drastic reform of the systems should be expedited.
    When carrying out the system reform, we must strive to establish a sustainable and stable social security system by taking into account the uncertainties about population estimates and economic growth. Only after doing so can we establish a reliable and credible system.

Necessity of comprehensive reform of the social security system
    System reform is apt to be carried out separately area-by-area and tends to lose a unified vision. However, since the purpose of the social security system is to provide the public with a safety net through pension, health insurance, nursing care, livelihood protection and other measures, it should not be carried out vertically along the lines of government's compartmentalized public administration. The social security system must be considered comprehensively to ensure consistency among the various systems.
    The problem we face when carrying out a comprehensive reform of the social security system is how we should make the system efficiently insure against risks under fiscal constraints. In the past, generous benefits and benefit overlaps and inconsistencies between systems did not pose a big problem, as supporters of systems kept increasing thanks to an increase in young population and as tax and premium income kept increasing on the strength of economic growth. However, now that those happy days are gone, it is vital to make benefits efficient from the viewpoint of comprehensive social security and strengthen the consistencies between systems. It is also vital to reconsider the principle of the social security system with regard to the role that the system should fulfill.

Strengthening of the linkage throughout the whole social security system
    In order to efficiently allocate the limited financial resources of the social security system, it is necessary to develop a system to provide necessary benefits efficiently, by adjusting benefit overlaps between different systems and those benefits that can be provided more efficiently by other systems. For instance, the pension system provides living expenses, including housing expense, while the housing expenses for those staying in nursing care facilities for a long time are provided by Long Term Care Insurance. Benefit overlaps between systems should be adjusted on the basis of the purpose of each system. Besides, it is hoped that the nursing care for elderly people provided by medical institutions contrary to their original purpose will be smoothly transferred to care services provided under the elderly care insurance system. It is also hoped that nursing care services will shift from facility nursing care to home nursing care.
    It goes without saying that the adjustment throughout the social security system is necessary not only for correcting benefit overlaps but also for maintaining the level of benefits that are really necessary. For instance, when the benefit level of public pension has to be lowered, its impact on aged households differ greatly depending on their premium contributions and self-pay ratio for medical service and other systems. Therefore, reviewing of the level of contribution and benefit should be made based not only on the financial balance of each system but also on the benefits and contributions in the social security system as a whole.(123)

Reconsideration of the roles the social security system should play
    In order for the social security system to function as a sustainable safety net under severe fiscal constraints, it is necessary to reconsider the roles that the social security system plays, make it more focused and efficient, and reduce benefits to an affordable level.
    Specifically, in addition to reviewing the contributions and benefits of the social security system as a whole, it is also necessary to review the system by separating areas for public security from those that should be handed to private sector services and self-help efforts. As for the areas for public security, a study should be made on an ideal combination of cash benefits and benefits in kind and an ideal combination of contributions by insurers, tax, and individuals in a cross-sectional manner to make the system most effective. When providing public social security services, the private sector should be further utilized in the areas that would lead to the expansion of choices for individuals and improvement of service quality, while giving full consideration to ensuring the quality and stable supply of services.
    Moreover, the review of the social security system should be made integrally with tax reforms. In order to cover social security benefits that are increasing along with the progress in the aging of the population, it is necessary to develop sustainable public finance and social security systems by appropriately combining social security contributions and tax burdens. If the system in which future increases in burden are put on the working generation is retained, it will become too heavy a burden for future generations. Therefore, it is important to develop a structure in which burdens are shared by as many people as possible. Elderly people capable of paying premiums should make contributions according to their capacity. The social security system should keep a balance between benefits and contributions, while maintaining its consistency with the tax system.

Enhancement of the sustainability of the social security system by increasing supporters
    The sustainability of the social security system can be enhanced even when the population is aging and declining, by implementing the comprehensive system reform we have discussed above.
    However, in order to make the sustainability stable in the medium and long terms, we have to come back to the basic problem of increasing the supporters of the system. As long as the social security system is in some respects based on inter-generational support, it is vital to foster future generations smoothly in order to maintain the system. As we discussed in Section 1, the basic cause of the current rapid decline in birthrate is that various systems and practices are unable to fully respond to the realities, such as women's increased participation in society and a change in people's sense of value. It is necessary for the society as a whole to complement the declining childbirth and child-raising functions of families in order to enhance the next generations' support capacity by strengthening policy measures. In addition to supporting the fostering of next generations, measures should be implemented to secure stable employment and enhance income levels by promoting employment of women and elderly people and sustainable economic growth. Implementing these measures is in itself an important policy objective, and it will eventually contribute to enhancing the sustainability of the social security system. Japan should take comprehensive measures to make the social security system, which is fundamental to people's "security" and "vitality," sustainable.


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