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Vol. 62, No. 1, pp. 44-56 (2011)

“Will a Growth Miracle Reduce Debt in Japan?”
Selahattin Imrohoroglu (Department of Finance and Business Economics, Marshall School of Business, University of Southern California), Nao Sudo (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan)

Japan has the highest debt to GDP ratio among the developed nations. In addition, the population is projected to age rapidly over the next few decades, which will significantly increase the ratio of government expenditures to GDP. In this paper, we explore the effect of economic growth driven by total factor productivity on Japanese debt in the face of higher future social security expenditures. Our main finding is that a decade of fast growth of total factor productivity, at an average of 6% per year, may help Japan eliminate its debt. This result suggests that the policy makers may well focus on growth-inducing policies such as lower distorting taxation and structural reforms that incentivize the entrepreneurial activity and innovation to drive growth.