Section 3 Building Public Sector that Match Aging and Declining Population

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.

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.

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)

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.

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).

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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