What Lessons Can Be Drawn from Japan’s High Debt-to-GDP Ratio?

The U.S. national debt reached $32 trillion in the second quarter of 2023, which is approximately 120% of U.S. gross domestic product (GDP). On its own, $32 trillion is a large number, but is a debt-to-GDP ratio of 120% also considered high? According to historical data, the answer is yes. Twenty years ago, the U.S. debt ratio was only 56% of GDP. Looking further back in time, the previous high was 118% in 1946,We calculated this ratio using historical debt data from the Treasury Department and GDP data from the Bureau of Economic Analysis. following the heavy expenses associated with World War II.

Additionally, the Congressional Budget Office has projected that if current laws remain unchanged, the U.S. will continue to run a large primary deficit, at over 3% of GDP annually until 2053. Under this scenario, the U.S. will need to steadily increase its debt level to finance its deficit. Given that the CBO is currently forecasting the economy to grow less than 2% annually through 2053, this means that the debt-to-GDP ratio will keep growing as well. Under this forecast, it seems unlikely that the U.S. will begin running a fiscal surplus anytime soon. Given this high level of national debt, paired with the uncertainty of a future government surplus, there is concern regarding the United States’ ability to sustain its public debt.

Looking at Japan’s Debt Burden

Some economists have turned to Japan as an example to address this concern. Why? For more than two decades, Japan’s national debt has floated above 100% of its GDP. In fact, as of the second quarter of 2022, Japan’s debt-to-GDP ratio was 226%. In other words, Japan has been able to maintain a very high level of debt for decades.

Researchers have also pointed out similarities in the fiscal problems faced by the U.S. today and Japan 20 years ago. Due to Japan’s rapidly aging population, economists predicted that the heavy burden of social security expenses would result in a large fiscal deficit, which could then lead to a public debt crisis. However, a crisis has yet to occur.

When examining Japan’s debt-to-GDP, it may therefore seem fair to assume that concerns regarding the U.S.’s high level of debt are overstated. In this blog post, we show that, while simple, a comparison based solely on the debt-to-GDP ratio overlooks several other key factors. A more comprehensive view of the debt issue necessitates an examination of the public sector’s balance sheet as a whole, the level of net liability and the revenue from its asset returns.

Consolidated Balance Sheets Explained

We must look outside the federal government’s level of national debt for a few reasons. First, the government’s liability position may be more than its level of public debt. For example, the government may also have other types of borrowing from the private sector or hold unfunded pension obligations to government retirees.

Secondly, any operating surpluses or deficits sustained by independent government agencies such as the Social Security Administration will eventually be felt by the general public. So arguably, there is no reason to focus solely on the liabilities and assets of the executive departments of the federal government, ignoring all other public institutions. In some countries, these public institutions likely hold a sizeable asset position in the form of social security funds or sovereign wealth funds. As we will discuss, Japan’s social security fund is quite large—around 55% of GDP in the second quarter of 2022. In short, it is important to look at the public sector as a whole, given that its overall level of assets indicates the country’s ability to offset any outstanding liabilities, including debts.

Looking at the Numbers for Japan and the U.S.

The tables below report the consolidated balance sheets of Japan’s and the United States’ public sectors for the third quarter of 2022.

Notice that for Japan, the net debt-to-GDP ratio (government bonds-to-GDP ratio) found in the consolidated balance sheet is only 114%, which is much smaller than the debt-to-GDP ratio reported earlier (226% in the second quarter of 2022). This is a direct result of intragovernmental holdings, which refers to public debts that are owned by its own agencies, such as the social security fund and the central bank. For example, the Bank of Japan’s holdings of Japanese government debt is equivalent to around 100% of GDP.

For the same reason, the United States’ net debt-to-GDP ratio is also lower (only 78%) in the consolidated balance sheet. On a consolidated balance sheet, intragovernmental holdings will appear on both the asset and liability sides, and hence they cancel each other out. For example, in the U.S., the Social Security trust fundsCurrent U.S. law mandates that the Social Security trust funds may hold only Treasury bonds. and the Federal Reserve System both hold a significant amount of assets in the form of U.S. Treasuries. These holdings contribute to the reduction of the debt-to-GDP ratio shown in the consolidated balance sheet.

Additionally, the first table illustrates the Japanese government’s large asset position. Again, this is in large part a result of that country’s sizable social security fund, which is equal to 55% of GDP.

A lower level of net liabilities, defined as liabilities minus assets, is indicative of a strong fiscal situation. The Japanese public sector’s liabilities—currency, bank reserves, and government bonds—are 252% of GDP, which is quite high.

However, the consolidated balance sheet shows a large number of assets, which represent 134% of GDP. Thus, Japan’s resulting net liability position is only 119%. As for the U.S., with a liability position totaling 142% and a much smaller asset position (23% of GDP), the country’s net liability position is similar to that of Japan’s.

Considering the Debt Servicing Burden

The final key aspect is the revenue from returns on the assets and liabilities held by each country’s public sector. There is a large return gap between assets and liabilities on Japan’s consolidated balance sheet. Due to Japan’s low interest rate policies, the returns on bank reserves and government bonds are essentially zero, which suggests that the interest burden on the country’s debt is not heavy. Meanwhile, Japan maintains a risky asset position with many domestic equities (30% of GDP) and foreign bonds and equities (55% of GDP), and therefore, the returns are quite high.

Essentially, the Japanese government’s strategy is to borrow at an extremely cheap rate and invest in risky, high-return assets—a factor that partially explains why Japan can sustain a high level of debt despite running a consistent deficit.For more on how the Japanese government is using this strategy to fund its social security commitments, see my recent working paper with Harold L. Cole and Hanno Lustig, “What about Japan?”

Why the U.S. Situation Is Different

However, this is not the story for the United States. In fact, the return difference on the U.S. public sector balance sheet is small, meaning the U.S. government borrows at a rate that is close to its average asset return.

In short, as a way of supporting the large deficit caused by the aging population, Japan’s strategy involves a concept called financial repression, meaning the government uses regulatory methods to borrow cheaply and widen the returns gap on their balance sheet.

For this to hold, some economic agent must be willing or forced to lend to the government cheaply. In this case, the economic agent is Japanese households. When Japanese households—who hold a large amount of low-return demand deposits—deposit their savings into banks, the banks can then lend cheaply to other domestic borrowers such as the government. However, this is not the case in the U.S., where households’ largest portfolio share is equity. Therefore, opportunities for a cheap funding source are much more limited for the U.S.

Given differences in the level of net liability and in the revenue from returns between the U.S. and Japan, the aggressive fiscal and monetary policies adopted by Japan may not be appropriate or even feasible for the United States. Thus, we should not rely on the Japanese experience to predict the U.S. fiscal situation.

1. We calculated this ratio using historical debt data from the Treasury Department and GDP data from the Bureau of Economic Analysis.
2. Current U.S. law mandates that the Social Security trust funds may hold only Treasury bonds.
3. For more on how the Japanese government is using this strategy to fund its social security commitments, see my recent working paper with Harold L. Cole and Hanno Lustig, “What about Japan?”