In all the gloom about the Japanese economy, our current account surplus is usually cited as one of our strong points. But is that true?
Japan’s current account surplus reflects an excess of national savings over national investment. It is made up of three elements: low and declining savings by households; high savings by the corporate sector; and substantial negative government savings, that is, deficits. Let’s have a look at the questions of household and corporate savings which are driving the current account surplus.
Charles Horioka argues that the “life cycle hypothesis” (LCH) provides the best theoretical framework for understanding household saving behavior in Japan, and probably in other countries.
The LCH suggests that our savings and consumption do not depend on our current income. On the contrary, our consumption and savings are constant percentages of the present value of our lifetime income. That is, people try to stabilize their consumption over their entire lifetime.
This means that when we are very young we borrow (or dissave) to maintain our lifestyle. In practical terms, our parents subsidize our youthful expenditures, although later on we might also take out a student loan. Then when we start working, we also start saving. Part of that saving might be invested in real estate. And when it comes to retirement, we spend our savings, in part because our pensions are usually much lower than our final salary. Also, there is little point in leaving our savings to our spendthrift children
This life cycle hypothesis can apply to an individual. It can also apply to nations. Virtually all countries now see their demographic structures ageing. This means that while a few decades ago, Western countries should have been saving in aggregate, now we should see countries having lower savings or even running down their savings as large segments of their populations reach retirement age.
According to Horioka’s empirical analysis, in Japan's case retired older people actually do dissave, as do even older workers, at least at advanced ages. In fact, there has been a sharp increase in the dissaving of the retired older people since the year 2000, being due mainly to reductions in social security benefits, increases in consumption expenditures, and increases in taxes and social insurance premiums. Horioka is convinced that we would also find the same evidence of dissaving in other countries with ageing populations.
His finding that older people dissave in Japan and that their dissaving rate has been increasing over time implies that the rapid population ageing will cause a sharp decline in Japan’s overall household saving rate. Since Japan’s household saving rate had already fallen to about 3 per cent in 2007, Japan’s household saving rate, which was formerly one of the highest in the world, will soon become zero or negative.
In short, Japan’s high household savings has just been money put away for the future. It is not a great sign of economic strength. Now that future has arrived, and we are saving less and less. Pretty soon, our savings will become negative which means that we will be depleting our assets. Not only is Japan's population disappearing, but its stock of household savings will also gradually disappear. By 2024, more than a third of Japan’s population will be over the age of 65, and retired households will outnumber households in their prime saving years.
Second, let’s move on to corporate savings. As we have previously discussed, when Japanese corporations eventually got through the lost decade, they still played tight even though they had worked off excessive debt. At the same time, the Japanese corporate sector has been reluctant to expand its investment. They are not very active in acquiring new productivity-enhancing technologies, expanding into new markets, developing new products or growing through mergers and acquisitions.
In short, they are unwilling to take on new risks to develop their businesses or lack the creativity to do that. If they are not willing to invest their savings in productive activities, this savings should be returned to shareholders who could either spend it or invest it elsewhere. But Japanese business elites are a law unto themselves, and shareholder activism barely exists. So high corporate savings is really a sign of weakness more than strength.
Which way is Japan’s current account surplus heading? First, hopefully the government will do something, like increasing the consumption tax, to reduce the budget deficit – but we will likely have a budget deficit for some time to come. Second, household savings are heading toward negative territory very soon.
So the only thing that can keep our current account in surplus is high corporate savings, that is, businessmen are sitting on pots of money, and not investing in the country.
In short, our current account surplus is not really a sign of strength.
Horioka, Charles Y. The (Dis)saving Behavior of the Aged in Japan
NBER Working Paper No. 15601. Issued in December 2009
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