Fiscal policy and an ageing population in Japan A sales tax was introduced in Japan in 1989, initially at a rate of 3%, and this was later increased to 5% in 1997. The intention is to increase the rate to 8% in 2014 and to 10% in 2015. This will still leave the tax rate below other countries. The tax increase in 1997 was not opposed by many of the Japanese people, but since then Japan's Gross Domestic Product (GDP) has fallen by 10%. It was US$5069 billion in 2011. There has been deflation and this has badly affected tax revenue, which has fallen 22% since 1997, leading to a doubling of the Japanese Government's debt. The Japanese Government was required to spend a great deal of money in March 2011 when a devastating earthquake and tsunami (coastal flooding) struck the country's north-eastern coast, leaving 20000 people dead or missing; it has been estimated that the rebuilding work will cost US$260 billion. The Japanese Government's debt is now at a very high level, as can be seen in Table 1. Table 1: Government debt as a percentage of GDP in 2011 Country | Government debt as a % of GDP --- | --- Japan | 200 Greece | 147 Italy | 127 Iceland | 120 Portugal | 103 The Japanese Government has decided to increase sales tax to help pay for the pensions and health care of the ageing population. The problem is that the higher tax rate might lead to a fall in consumption, leading to an increase in unemployment. It may not help the country to get out of recession. The average annual growth in Gross Domestic Product over the last five years has been -0.3%. Many Japanese people are anxious and worried about the future, especially fearing that the government might try to reduce its public sector debt, leading to further increases in unemployment. The rate of unemployment in Japan is currently above its average rate over the last ten years. Economists in Japan are thinking of ways to promote economic growth to get the country out of recession, such as through encouraging increased productivity and greater entrepreneurship. It is certainly the case that there is a high savings ratio in Japan. This is despite the fact that interest rates are at their lowest ever level. There is a strong tradition of saving in Japanese culture and the level of interest rates is clearly only one influence on the decision of how much people save. The ageing population is a particular problem in Japan. The percentage of the Japanese population that is over the age of 60 is 30.5%. The life expectancy of Japanese men is now 80.1 years and Japanese women 87.2 years, giving an average of 83.7 years. Table 2 shows how this compares with a number of other countries. Table 2: Average life expectancy in selected countries in 2011 Country | Average life expectancy --- | --- Japan | 83.7 Singapore | 81.0 United Arab Emirates | 78.1 Kenya | 56.9 Afghanistan | 45.5

Mark scheme

Marking points from the official mark scheme (Oct/Nov 2014). The mark or mark type is shown in brackets.

1. [2] Deflation refers to a fall (1) in the (general) price level (1). Rise in the value (1) of money (1). Rise in the purchasing power (1) of money (1). N.B.: Do not reward a fall in the rate of inflation which simply means that prices are rising more slowly than before.
2. [1] 200% of (U.S.)5069bn = U.S. 10 138 bn
3. [4] Expenditure: Up to 2 marks: damage caused by earthquake and tsunami/natural calamity (1) cost of rebuilding and reconstruction (1). Up to 2 marks: ageing population (1) large expense of paying for pensions and health care (1). Up to 2 marks: unemployment (1) expenditure by the government on unemployment benefits/expenditure on measures to reduce unemployment/lower tax revenue (1). Up to 2 marks: fall in GDP (1) so any given debt figure will become a greater % of GDP/lower tax revenue (1). Revenue: Up to 2 marks: fall in prices/deflation (1) has led to a fall in tax revenues (1). Up to 2 marks: sales tax is low (1) compared with many other countries; e.g. EU average is about 20% (1).
4. [6] Up to 4 marks for why it might: It will increase costs of production (1), increase the price of products (1), this may reduce spending/demand (1), lower spending may reduce output/revenue (1), lower output may reduce demand for workers (1) to maintain profits, firms may seek to lower costs (1), may achieve this by dismissing workers (1). Up to 4 marks for why it might not: Up to 3 marks: it will depend on what the government does with the tax revenue (1), if it spends all of it, the level of demand would be unchanged (may even be higher) (1), spending on education and health care could make people more employable (1). Up to 2 marks: other costs of production may fall (1) leaving the price of products unchanged (1). Up to 3 marks: firms may absorb the higher rate (1) leaving the price of products unchanged (1), firms are more likely to leave the price the same if demand is elastic (1). If demand is inelastic, a rise in price will have less impact on demand and so on output and employment (1).
5. [6] Up to 4 marks on increased productivity: Up to 3 marks: an increase in productivity (defined as output per factor per period of time) (1) means that more could be produced from a given set of factors (1) and this could contribute to an increase in output and economic growth (1). Up to 3 marks: could lower costs of production (1), reduce prices (1), increase demand (1), this may encourage firms to produce more due to higher profits (1). Up to 4 marks on greater entrepreneurship: Up to 4 marks: greater entrepreneurship (defined as the ability to take crucial decisions/to take risks/organise the other factors) (1) could lead to development and innovation (1) and this could lead to new/better products (1), could increase demand (1) and this could contribute to an increase in output and economic growth (1). Maximum of three marks for a list or list-like response.
6. [4] Up to 2 marks: knowledge that there is going to be an increase in the rate of sales tax (1), making products more expensive in the future (of course, this could be an argument for spending now) (1). Up to 2 marks: Japanese people anxious and worried about the future (1), especially fearful of further increase in unemployment (1). Up to 2 marks: the unemployment rate in Japan is already very high (1) and is above its ten-year average (1). Up to 2 marks: a strong tradition of saving in Japan (1); a key element of Japanese culture (1). Up to 2 marks: save in case of emergencies (1) e.g. an earthquake (1). Up to 2 marks: for ageing population (1) explained in a relevant manner (1). Up to 2 marks: for deflation (1), increase saving because products will be cheaper in the future (1).
7. [1] Answer: 83.7 – 56.9 = 26.8 (1)
8. [6] Up to 4 marks for stating that it is always a problem: Up to 2 marks: an increase in the dependency ratio (1) with fewer people working to support more older people (1). Up to 3 marks: increased government spending on health care (1) and pensions (1) involves an opportunity cost (1), example (1). Up to 2 marks: there may need to be higher taxes for those in work (1) which could cause a disincentive to effort effect (1). Up to 3 marks: it could lead to a shortage of workers (1) which could push up wages (1) leading to inflation (1). Up to 4 marks for stating that it is not always a problem: Up to 2 marks: older people can be an economic asset (1), such as through their knowledge and experience (1). Up to 2 marks: firms could be encouraged to give jobs to older people (1) through various government schemes (1). Up to 2 marks: the government could increase the retirement age (1), and so control the extent of any problem (1). Up to 2 marks: indicates a good health care system (1), increased life expectancy/improved living standards (1). Up to 2 marks: dependency ratio may be falling (1) if the increase in average age is increasing the size of the labour force (1). Up to 2 marks: may be importing labour (1) to overcome the potential fall in the supply of labour (1). Maximum of 3 marks for a list or list-like answer.