Japan faces a pressing dilemma: how to manage its public finances while its population ages rapidly. Beyond the immediate concerns of debt and spending projections, the longer-term challenge is ensuring that future generations can thrive without being burdened by today’s fiscal policy decisions.
Growing debt burden
Japan already holds the highest public debt among advanced countries. After peaking at 261 percent of GDP in 2020 due to pandemic-related spending, public debt declined to 242 percent in 2023. However, this decline was not the result of fiscal consolidation but rather driven by positive economic growth and negative real interest rate. Despite the reduction, Japan’s public debt level remains very high.
A key driver of the high public debt is the rapid rise of social security expenditures, particularly those linked to an aging population, such as pensions, medical care, and long-term care. These costs now account for one-third of public expenditure, up from 17.5 percent in 1990, and will continue to rise as Japan ages.
The pressure from a fast-aging population on the budget will escalate. Births hit a record low in 2023, with a total fertility rate of just 1.20. At the same time, life expectancy is increasing, projected to reach 85.9 years for men and 91.9 years for women by 2070. By then, nearly 40 percent of Japan’s population will be aged 65 or older, compared to around 30 percent today.
Currently, social insurance contributions are greater than pension benefits. But medical and long-term care costs continue to soar, forcing Japan to increasingly rely on public debt to fill the funding gaps. By 2040, social security spending is projected to hit JPY 190 trillion, a 41.5 percent increase from 2023; long-term care costs are expected to nearly double to JPY 25.8 trillion, while medical spending could climb 65 percent to JPY 68.5 trillion.
How long can Japan sustain high public debt?
For now, Japan’s public debt is mostly funded by domestic savings. About 87 percent of Japanese government bonds are held by local investors, keeping borrowing costs low and stable. But a looming challenge threatens this stability.
As Japan’s population ages, household savings are gradually depleting. AMRO’s estimates, based on the government’s Family Income and Expenditure Survey, indicate that after a temporary pandemic-driven spike, the household savings rate is now declining and is expected to turn negative by 2030. This means more people will be drawing down their savings rather than adding to them.
When government debt outpaces household savings, Japan might have to turn to foreign investors for funding. Once this debt threshold is breached, this could bring higher borrowing costs, more market volatility, and greater financial risks.
AMRO’s recent analysis models two potential economic scenarios to help predict when Japan might breach this debt threshold. In the low growth scenario which assumes Japan’s GDP growth slows to 0.5 percent in the medium term and 0.2 percent in the long term, the debt threshold could be breached by 2033, with debt reaching 233.2 percent of GDP. In the high growth scenario where productivity gains push long-term GDP growth to 0.9 percent, the debt threshold would be reached by 2034, with debt estimated at 211.2 percent of GDP.
In both cases, Japan is likely to hit its debt threshold within the next decade.
Avoiding a fiscal strain
To improve the public debt dynamics and avoid reaching the debt threshold, Japan should adopt a comprehensive fiscal strategy—realigning policy needs with a consolidation plan of achieving a primary surplus. Key priorities include tax policy reform, expenditure rationalization, and social security reform.
Strengthening public spending efficiency is critical, as is a renewed commitment to limiting supplementary budgets to genuine emergencies or unforeseen shocks. A shift toward long-term fiscal prudence rather than short-term support measures will also enable Japan to allocate resources to structural reforms that can boost its economic growth potential.
Reforming the social security system is another critical step. With costs for pensions, medical care, and long-term care rising sharply, Japan must find ways to manage these costs while controlling debt and making the social security system more efficient and financially sustainable.
As Japan’s population ages, it must act now to avoid a financial crunch. While the path forward will not be easy, thoughtful policies and decisive actions can ensure Japan’s fiscal sustainability for generations to come.