Understanding Japanese Savings

Robert Dekle

• Publisher: Routledge
• Year: 2004
• ISBN:
  9781134793136
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Japan's savings are among the highest in the world, and these high rates have played a valuable role throughout the post-war period. However, over the next several decades, Japan's population will be ageing rapidly. Will this lower Japanese savings rates?
Using up-to-date financial and demographical data, author Robert Dekle finds that the answer to this question is an emphatic 'yes'. Understanding Japanese Saving holds key lessons for Western nations undergoing similar demographic transformations as well as developing countries looking to establish public savings institutions.

1 Introduction

Japanese saving and investment and aging

Japan’s saving and investment rates are among the highest in the world, and these high rates have played a valuable role throughout the post-war period. The high saving has provided the funds needed to finance corporate investment in plant and equipment during the high-growth era of the 1950s, 1960s, and early 1970s, and helped meet capital shortages abroad during the post-1973 era of stable growth. The high investment has allowed Japan to incorporate the latest technologies into its production process, and has raised living standards through better public infrastructure, both in cities and in rural areas. However, there are some who blame Japan’s high saving rate for her massive net export surpluses, leading to trade friction with her neighbors. Some also claim that Japanese firms are “overinvesting,” that the returns to capital are abysmally low, and that government infrastructure investment is determined mostly by political considerations and is inefficiently allocated.

Over the next several decades, Japan’s population will be aging rapidly. In 1955, only 5.5 percent of the population were 65 years or older; by 1998, 16.2 percent were elderly. Projections imply large increases in the elderly in the coming decades; by 2015, 25 percent of the population will be 65 or above. The main reason for this aging is the fall in the total fertility rate (births per family). The total fertility rate was more than 4 children per household before 1949, declining sharply to 2.1 in 1957. It has begun to fall again since 1974 and the current level of 1.4 was reached in 1997. There is still little sign that this has stabilized or returned to a higher level.

The main purpose of this book is to revisit the issue of the impact of demographic change on the Japanese saving–investment balance. There is widespread public belief that rapid aging–Japan’s demographic destiny–will lead to major shifts in the Japanese saving–investment balance. I show that this belief is largely true. Using updated government demographic projections, I show that the aging of the population currently under way will steadily lower Japan’s saving rate from 30 percent of the Gross Domestic Product (GDP) today to 19 percent of GDP in 2040. Japan’s total investment rate will decline from 28 percent of GDP today to about 22 percent of GDP in 2040. Given the more rapid decline in total saving, Japan’s current account will steadily narrow from its current level, and turn to deficit around 2015.

Overview of post-war Japanese saving and investment

It is well-known that the post-war Japanese economy is characterized by very high saving and investment rates. In fact, Japan’s saving rates are among the highest in the world–only Italy, Singapore, and Taiwan have higher saving rates. However, these high Japanese saving and investment rates are primarily a post-war phenomenon–in fact, a post-1955 phenomenon. If the period of the Korean War is excluded, Japan’s saving rate did not make it into the double digits until 1955, a full ten years into the post-war period. Thus, we can immediately reject the view that Japan’s high saving rate is the result of cultural factors such as national character or Confucian and Buddhist teachings, because although cultural factors were stronger in the pre-war period, the saving rate was lower.

The trends and fluctuation in Japanese saving and investment closely mirror the trends and fluctuations in Japanese GDP. The broad trends in post-war Japanese private and government saving rates, investment rates, and the net export surplus–GDP ratios, are depicted in Table 1.1.^1,2

The private saving rate rose steadily between 1955 and the mid 1970s, peaking (first) in 1978. Subsequently, the rate fell until the early 1990s, when it rose (again) to reach its post-war peak in 1998. There is a voluminous literature that seeks to explain the pattern and level of Japanese post-war private saving.³ The literature suggests that the most important reason for Japan’s high private saving rate is rapid economic growth. The permanent income/life-cycle hypothesis can explain the positive impact of income growth on the private saving rate if income growth is faster than expected. This hypothesis may have been valid until the early 1970s. The surge in private saving from the mid 1970s to the early 1980s is related to the two oil crises in the 1970s. The explanation given is that these crises added further fuel to the already rampant inflation and precipitated a recession, which in turn raised uncertainty about the future and increased the need to save for precautionary purposes. The fall in private saving from the mid 1980s to the early 1990s is because of robust consumption, stimulated by rising stock and land prices. In contrast, the mid to late 1990s rise in private saving is related to the recessionary economy, increased unemployment, uncertainty, and pessimism, all raising precautionary savings. Horioka (1991, 1992) finds that the level and growth of Japanese GDP explains about 65 percent of the variation in the private saving rate.

Table 1.1 Japanese private and government saving, investment, and net exports (in percent of GDP)

The literature suggests that the second most important reason for Japan’s high private saving rate is the favorable age structure of the population. Until the early 1970s, the proportion of the aged (over 65) to the working-age population (20–64) the so-called “dependency ratio”–was low in Japan. According to the life-cycle hypothesis, an increase in the dependency ratio has a significant negative effect on the private saving rate. Horioka (1991, 1992) finds that adding the dependency ratio to the equation already including the level and growth of GDP raises the proportion of private saving explained from 65 to 75 percent. Moreover, he estimates that a one percentage point increase in the dependency rate will cause the private saving rate to decline by one percentage point. These and similar estimates suggest that the 12 percentage point increase in the dependency rate between 1975 and 1998 has depressed private saving by about 12 percentage points annually.

The government saving rate rose until the mid 1960s, then gradually fell to its historical low in 1978. Subsequently, the rate rose (again) until the early 1990s, when it started to decline to (almost) its new low in 1998. The trend in Japanese government saving is also closely related to economic growth. Government saving surged until the mid 1960s, as growth rates were consistently above government projections, leading to rising tax revenues. From the mid 1960s, however, the demand for government services increased, dampening the budget surpluses. The recessionary 1970s led to counter-cyclical measures and a further drop in government saving. To halt the decline in government saving, the Japanese government in the early 1980s introduced budget freezes and reformed the tax system. These measures and strong economic growth in the mid to late 1980s led to rising budget surpluses. However, as the economy slumped in the early 1990s, falling tax revenues and the need for expansionary fiscal policy again depressed government saving rates.

The investment rate also rose steadily, peaking in 1973. Since then, it has fallen slightly. Compared to household and government saving rates, the investment rate has remained comparatively stable. The main determinant of Japanese investment has again been economic growth. As GDP growth surged in the 1950s and 1960s, investment was able to take advantage of newly available technologies. Since the early 1970s, the investment rate has dipped somewhat, but has remained at a high level. The surge in investment rates in the late 1980s is related to the cheap financing available to firms, owing to rising stock and land prices. Although private investment has dipped in the 1990s, rising government investment owing to expansionary public works projects in the mid to late 1990s has kept overall investment rates high.

Japanese net exports were in persistent deficit until the early 1970s, reflecting strong investment demand and inadequate saving. However, by the mid 1980s, the surge in saving and decline in investment pushed Japanese net export surpluses (as a percentage of GDP) into record territory. Subsequently, as a result of strong domestic consumption in the late 1980s and strong government investment in the 1990s, the net export surpluses (as a percentage of GDP) declined.

Plan of this book

So much for the overview and casual description of the determinants of Japanese saving and investment. The major objective of this book is to rigorously characterize the determinants of Japanese saving and investment. In Chapter 2, I assess the shape of the Japanese elderly’s age–wealth profile. If the Japanese elderly on average are reducing their wealth, then as the population ages, household saving should fall. However, if the Japanese elderly are on average holding their wealth constant, then the rapid aging should not by itself decrease the aggregate household saving rate by much. Moreover, I investigate the bequest motive of the Japanese elderly. Only when bequests are left for altruistic reasons is the dynastic household model applicable to Japan.

In Chapter 3, I examine whether private investment is determined by economic fundamentals, such as productivity growth and demographics. Only when private investment is largely determined by fundamentals would aging affect the level of investment. However, the determination of private investment is a highly controversial topic, and other factors besides fundamentals may influence private investment rates, such as stock market “bubbles.”

Chapter 4 is the crux of the book, in which I present the simulation model of Japanese saving, investment, and government budget balances, based partly on the empirical results of Chapters 2 and 3. Based on the results of Chapter 2, regarding the specification of household preferences in our simulation model, I have assumed that households are dynastic and Ricardian, and very altruistic. Based on the results of Chapter 3, regarding the specification of the investment function, I have assumed that investment is driven by fundamentals, such as profits, which are in turn determined by productivity growth and demographics. I have disregarded “bubbles” and other non-fundamental factors in influencing Japanese private investment. Using recent government demographic projections, I show that the aging of the population under way will lower Japan’s total saving rate from 30 percent of GDP today to 19 percent of GDP by 2040. Japan’s total investment rate will decline from 28 percent of GDP today to about 22 percent of GDP in 2040.

In Chapter 4, I also show that the aging of the population will worsen public finances. I forecast future government spending from projected demographics. Given the forecasted government spending, large tax increases will become necessary for the current government debt to be sustainable.

One way of mitigating the aging problem is to increase immigration into Japan. In Chapter 5, I compare the saving and investment balances that occur without immigration (Chapter 4), to the inflows that occur with immigration. Consistent with the United Nation’s recommendations, I assume that from 2005 to 2040, Japan will allow 400,000 immigrants annually. With the larger labor force from the immigration, output in 2020 will be 22 percent higher, and 50 percent higher by 2040. I show that the decline in private saving is much milder with immigration than without immigration. Private and public investment rates gradually fall over time, but the decline in these investment rates is much less rapid with immigration. Public finances drastically improve with immigration.

In Chapter 6, I examine how land and housing prices impact residential choice, and the saving behavior of the Japanese elderly. Total wealth is the sum of financial wealth and real-estate wealth. I show in Chapter 2 that the Japanese elderly desire not to bring down their total wealth. I attribute this to the desire of the elderly to leave bequests to the next generation. However, if there are constraints to bringing down their real estate wealth, then although the elderly may prefer to lower their total wealth, they may be prevented from doing so by the existence of these constraints. In Chapter 6, I examine whether the constraints on reducing real estate wealth are binding–that is, whether the elderly desire to reduce their real estate wealth, but are prevented from doing so. If constraints on reducing real estate wealth are binding, then the removal of these constraints may result in greater consumption and dissaving by the Japanese elderly.

In the concluding Chapter 7, I draw some lessons from the Japanese saving and investment experience for current-day developing countries. In this book, I show that Japanese saving and investment are determined by fundamentals. In particular, saving in Japan is determined by growth and demographics. Thus, developing countries cannot change their saving rates with public policy. However, I show that the Japanese government has influenced how saving is allocated, from investment in the traditional sector to investment in the modern, more productive sector.

2 The saving behavior of the Japanese elderly

Introduction

The main purpose of this chapter is to estimate the shape of the average Japanese elderly’s age–wealth profile, using previously unanalyzed Japanese household-level data. Specifically, the chapter examines whether the Japanese elderly are on average reducing their total wealth or keeping their total wealth intact, where total wealth is defined as the sum of financial wealth and wealth in real estate.

Why is it important to assess the shape of the Japanese elderly’s age–wealth profile? The Japanese population is aging very rapidly. If the elderly on average reduce their wealth, then as the population ages, aggregate household saving should fall. However, if the Japanese elderly are on average holding their wealth intact, then the rapid population aging should not by itself decrease the aggregate household saving rate by much. An increase in the aged will also mean that the elderly cohorts will carry more weight in the future in the determination of aggregate household saving. As the elderly gain in number and in relative wealth, their saving behavior will become more important in affecting the saving rate of the overall economy.

Moreover, I investigate the bequest motive of the Japanese elderly. Do the Japanese elderly leave sizable bequests, and if they do, what motivates them to leave the bequests? Generally, there are three reasons why the elderly leave bequests. First is altruism: the elderly simply care about the welfare of the young. Second is accidental: the elderly may not be willing to bring down their wealth in the event of exceptional longevity–most households leave some wealth at death. Third is the cost of child services to the elderly: the child may be a supplier to the parent of services such as incontinence care or phone calls and visits. The price of these services charged by the child is a transfer from the parent. Only when bequests are left for altruistic reasons is the dynastic household model developed in Chapter 4 applicable to Japan. When bequests are left for other reasons, the elderly are more selfish than altruistic, and the elderly’s saving behavior would adhere more closely to the life-cycle model, rather than the dynastic model.

The principal finding of this chapter is that the average Japanese elderly’s age–wealth profile is flat; the elderly are not dissaving. Part of the reason for the lack of dissaving appears to be bequests driven by altruism, if it can be assumed that the intensity of the bequest motive (altruism) is stronger if one has more surviving children. Thus, dynastic household models may apply well to Japanese households.

The shape of the Japanese elderly’s age–wealth profile and the strength of the elderly’s bequest motive have been examined by a large earlier literature. Two useful summaries of the earlier literature are Hayashi (1997; chapter 10) and Horioka (2002). In general, the earlier literature has found that the aged save until they get very old (about age 80–85), and then dissave very little. A substantial fraction of wealth held by the aged is eventually transferred to their children mainly through bequests. However, there is controversy in the earlier literature surrounding whether these bequests reflect altruism of the elderly towards their c...