[Viewpoint] Japan’s savings crisisJapan is heading toward a savings crisis. The potential future clash between larger fiscal deficits and a low household savings rate could have powerful negative effects on both Japan and the global economy.
First, some background. Japan was long famous for having the highest savings rate among industrial countries. In the early 1980s, Japanese households were saving about 15 percent of their after-tax incomes.
Those were the days of sharply rising incomes, when Japanese households could increase their consumption rapidly while adding significant amounts to their savings. Although the savings rate came down gradually in the 1980s, it was still 10 percent in 1990.
But the 1990s were years of slow growth, and households devoted a rising share of their incomes to maintaining their level of consumer spending. Although they had experienced large declines in share prices and housing values, they had such large amounts of liquid savings in banks that they did not feel the need to increase savings in order to rebuild assets.
A variety of forces have contributed to a continuing decline in Japan’s household savings rate. The country’s demographic structure is changing, with an increasing number of retirees relative to the workers who are in their prime saving years.
Surveys tell us that younger Japanese are more interested in current consumption and less concerned about the future than previous generations were.
The household savings rate, therefore, continued to fall until it was below 5 percent at the end of the 1990s and reached just above 2 percent in 2009. At the same time, the fiscal deficit is more than 7 percent of GDP.
The combination of low household savings and substantial government spending would normally force a country to borrow from the rest of the world. But Japan maintains a current-account surplus and continues to send more than 3 percent of its GDP abroad, providing more than $175 billion this year for other countries to borrow.
This apparent paradox is explained by a combination of high corporate savings and low levels of residential and nonresidential fixed investment. In short, Japan’s national savings still exceed its domestic investment, allowing Japan to be a net capital exporter.
The excess of national savings over investment not only permits Japan to be a capital exporter, but also contributes - along with the mild deflation that Japan continues to experience - to the low level of Japanese long-term interest rates. Indeed, despite the large government deficit and the enormous government debt - now close to 200 percent of GDP - the interest rate on 10-year Japanese government bonds is just 1 percent, the lowest such rate in the world.
But what of the future? While the current situation could continue for a number of years, there is a risk that rising interest rates and reductions in net business savings will bring Japan’s current-account surplus to an end. One reason for a rise in the interest rate would be a shift from low deflation to low inflation. Prices in Japan have been falling at a rate of about 1 percent a year. If that were to swing by 2 percentage points - as the government and the central bank want - to a positive 1 percent inflation rate, the interest rate would also increase by about 2 percentage points. With a debt-to-GDP ratio of 200 percent, the higher interest rate would eventually increase the government’s interest bill by about 4 percent of GDP. And that would push a 7 percent of GDP fiscal deficit to 11 percent.
Higher deficits, moreover, would cause the ratio of debt to GDP to rise from its already high level, which implies greater debt-service costs and, therefore, even larger deficits. This vicious spiral of rising deficits and debt would likely push interest rates even higher, causing the spiral to accelerate.
The larger deficits would also eliminate all of the excess savings that now underpins the current-account surplus. The same negative effect on the current-account could occur if the corporate sector increases its rate of investment in plants and equipment or reduces corporate savings by paying higher wages or dividends. The excess savings could also decline if housing construction picks up.
Japan’s ability to sustain high fiscal deficits, low interest rates and net capital exports has been possible because of its high private savings rate, which has kept national savings positive. But, with the current low rate of household saving, the cycle of rising deficits and debt will soon make national saving negative. A shift from deflation to low inflation would accelerate this process.
The result in Japan would be rising real interest rates as the low private savings rate runs head-on into large fiscal deficits. That would weaken the stock market, lower business investment and impede economic growth. Japan might itself become a net drain on global savings.
*The writer is Professor of Economics at Harvard and former Chairman of President Ronald Reagan’s Council of Economic Advisors. Copyright: Project Syndicate, 2010.
By Martin Feldstein