Nordic solutions for Japanese trilemma

Country will have to abandon small government

Inequality in Japan is widening, although it is still limited when compared with the US and major European economies. The share of income earned by the top 1% of households is growing, but at a slow pace, and inequality among the working-age population has not increased.

Globally, governments face a trilemma between a more egalitarian society, growth (achieved through globalisation and technological innovation), and the size of government. A country can achieve two of these options, but not all three at the same time.

Japan has managed to cap the widening of inequality by sacrificing the growth opportunities created by technological changes and globalisation. To achieve growth, despite an aging and shrinking population, Japan has to accelerate innovation and globalisation, even though this raises the concern that inequality may widen.

So far, Japan has been pursuing an egalitarian society and small government, thereby sacrificing globalisation and innovation. In contrast, the US has chosen globalisation and innovation and small government, leaving inequality to widen. The Nordic countries have chosen an egalitarian society and globalisation and innovation, resulting in a large welfare state.

Nordic countries deepened globalisation through their relationship with the European Union. Denmark, Finland and Sweden are members of the EU, and Finland is a member of the euro area as well. While Iceland and Norway are not members of the EU, they participate in the European Economic Area, as well as the Schengen agreement, whereby border controls have been abolished between 26 European countries.

Nordic countries have some of the lowest Gini coefficients, a measure of economic inequality, among Organisation for Economic Co-operation and Development members. Relative poverty rates in other OECD countries are also much higher.

The size of the government has expanded in return. Tax and social security contributions relative to GDP in the Nordic counties are among the highest in the OECD.

The situation in the Nordic countries provides Japan with important policy suggestions. If Japan chooses to pursue globalisation and innovation while trying to achieve an egalitarian society, it needs to shift towards a larger government. More specifically, it means that, in addition to improving education and training systems, Japan must reform its redistribution policy. It needs to strengthen redistribution among the working-age population and among the aged to prevent widening inequality, rather than promoting redistribution from workers to the aged.

Accelerating globalisation also means that, in addition to lowering barriers to agricultural imports and inward foreign direct investment, Japan will have to accept more immigrants.

That is what the Nordic countries – which  face the same risk of an aging and shrinking population as Japan – have done. The share of foreign-born citizens as a proportion of the total population is high in Sweden and Norway. The share in Denmark and Finland is smaller, but still much larger than in Japan.

Accelerating globalisation and innovation is essential if Japan is to maintain its standard of living and the sustainability of its fiscal and social security systems, but this policy choice raises the risk of widening inequality. To prevent this, Japan needs to engage in a wide range of reforms, particularly regarding the size of the government.

Japan is at a critical crossroad.

Jun Saito is Senior Research Fellow at the Japan Centre for Economic Research.

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