This Selected Issues paper for Japan illustrates the impact of fiscal and structural reforms on the Japanese and world economies. Japan faces a sizable fiscal deficit, against a backdrop of weak trend growth and growing imbalances in the world economy. Moreover, upward pressure on health care and social security spending owing to an aging population will add significantly to strains on public resources in the near future. The Japanese government is taking a range of measures aimed at raising productivity growth and stabilizing the public debt in relation to GDP over the medium term.

Abstract

This Selected Issues paper for Japan illustrates the impact of fiscal and structural reforms on the Japanese and world economies. Japan faces a sizable fiscal deficit, against a backdrop of weak trend growth and growing imbalances in the world economy. Moreover, upward pressure on health care and social security spending owing to an aging population will add significantly to strains on public resources in the near future. The Japanese government is taking a range of measures aimed at raising productivity growth and stabilizing the public debt in relation to GDP over the medium term.

II. Household Savings in Japan1

A. Introduction

1. Japan’s household saving rate has fallen dramatically since the early 1980s. The saving rate, based on national income accounts data, declined from 18 percent in 1981 to 6 percent in 2002 with a brief pause during the bubble years. This drop in savings has prompted discussion about Japanese savings in the future and long-term growth prospects. The interest in this issue has been growing as demographic projections indicate that Japan will experience a rapidly aging population, which could lead to a further reduction in household savings.2

uA02fig01

Japan: Household Savings Rate

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: Cabinet Office.

2. This chapter focuses on the implications of demographic change for household saving, presenting illustrative saving projections. Section B reviews household savings behavior in Japan, comparing it with other OECD countries, and section C examines models of saving and demographics, and the official demographic projections. Section D considers evidence on aggregate saving behavior, using macro data; section E investigates household savings exploiting additional information on cohort behavior to provide a different perspective on savings trends. Finally, section F concludes.

B. Japanese Savings in an International Context

3. In a cross-country context, the decline in Japan’s household savings rate stands out. There are wide disparities in saving behavior across OECD member countries. The saving rate in the United States has also fallen, but from a low level, while saving rates in some continental European countries, such as Germany, have been reasonably stable. Japan, once considered a big saver relative to other OECD countries, has seen its saving rate fall below that of many other OECD members, converging toward the OECD average.

uA02fig02

Saving Rates: Selected OECD Countries

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: OECD.

4. In spite of the secular decline in their savings, Japanese households’ net wealth remains high relative to other industrialized countries. Japan’s large stock of wealth is a result of high saving rates during much of the postwar period and the associated rapid increase in land prices in the 1980s that pushed nonfinancial wealth to very high levels. Since the collapse in asset prices, the stock of wealth has remained flat in relation to income. By comparison, net wealth in the other G-7 countries has increased since the late 1980s, although some countries have experienced some unwinding of that increase, notably the United States after the tech bubble burst in 2000.

uA02fig03

Net Wealth in Selected OECD Countries

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: OECD.

C. Savings and Demographics

5. Modern theories of consumption behavior find a strong link between demographics and savings. The life-cycle model of household behavior regards saving as motivated by the desire of households to smooth lifetime consumption in the face of uneven income flows. It postulates that households save a portion of their income during their working years in order to finance their retirement. Thus, the higher the ratio of the retired population to the working-age population, the lower aggregate savings will be.

6. Accordingly, population aging has important implications for the future savings behavior. Official projections indicate that Japan’s population is expected to stop growing before the end of the current decade and then is projected to decline by 27 million over the next 50 years.3 Two main factors contribute to this demographic trend: the Japanese population has the lowest birth rate and the highest life expectancy among industrial countries, while inward immigration flows—typically involving young workers—are very low by international standards.4 Clearly, caution must be exercised when using long-term projections of this kind, as such projections become more uncertain the further into the future.

uA02fig04

Japanese Population Projection

(Medium Variant)

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: National Institute of Population and Social Security Research.

7. Another important demographic factor is the development of the old-age dependency ratio. This is a broad indicator measuring the burden an aging society places on its working-age population and is defined as the ratio of the population aged 65 and over to the population aged 20 to 64. In 2000, this ratio was 28 percent. With the projected aging population, this old-age dependency ratio is expected to rise to 70 percent by 2050. Overall, these demographic trends may have a significant effect on the aggregate saving rate.

uA02fig05

Old-Age Dependency Ratio

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: National Institute of Population and Social Security Research.

8. There have been numerous studies of Japanese savings behavior.5 Most of the earlier studies focused on explaining Japan’s high saving rate before its rapid decline in the 1990s. Recently there has been renewed interest in explaining the downward trend in savings, linking it to the rapidly aging population. These studies have used aggregate household savings data from the national income accounts as well as data from household surveys. The next part of this chapter reviews the macro evidence on saving and demographics, while the following section examines household survey data, looking at saving behavior across different age cohorts. Combined with projected demographic trends, the analysis provides illustrative scenarios for household savings for the medium and longer term.

D. Macro Evidence on the Impact of Demographics on Savings

9. To quantify the interrelation between population dynamics and household savings, a standard aggregate saving equation is estimated first. As discussed above, an important prediction of the life-cycle model is that an increase in the old-age dependency ratio toward more elderly households would reduce the aggregate saving rate. In addition, the model suggests that the larger the share of the young in the population, and the greater the stock of wealth, the lower the saving rate.6 In some equation specifications, separate fiscal variables have been added to determine if private savings is subject to Ricardian equivalence, but this is not investigated in the present study.7 To conduct the empirical analysis, annual national income data from 1980 to 2003 is used.

10. The estimated aggregate household saving equation for Japan is consistent with the predictions of the life-cycle model.8 In particular, the coefficients on the old-age dependency ratio, young-age dependency ratio (defined as ratio of minors to working-age population), and wealth as a share of disposable income are all negative, while the coefficient on inflation is positive, capturing precautionary motives.9 All of these estimates are statistically significant at the 10 percent level or above. As wealth increases, the saving rate declines as households tend to save less out of current income. As the number of retirees relative to the working-age population increases, the saving rate declines as retirees tend to spend out of their accumulated stock of wealth. Similarly, as the number of minors relative to the working-age population increases, the saving rate declines, as those who have not yet begun to work consume and do not save.

Long-Run Saving Rate Model

article image
Source: Fund staff estimates.

11. For illustrative purposes it is possible to highlight the effect demographic changes may have on aggregate savings. Based on the coefficient estimates and projections for the explanatory variables, household saving rates are projected to decline. For comparison, an initial or benchmark projection for saving for 2004–10 is generated that is based on setting the path of all the variables equal to their 2004 value. This yields a constant saving rate of 6.0 percent. An alternative path for the household saving rate, using estimates for the explanatory variables, projects savings to decline 2¼ percentage points by 2010.

uA02fig06

Saving Rate Projection

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: Fund staff estimates.

12. The demographic effects of aging are both statistically and economically significant. The aggregate saving rate projection can be decomposed to show the contribution of each explanatory variable to the decline in the saving ratio: the projected rise in the old-age dependency rate more than fully accounts for the projected decline in savings over the medium term (see the table). The simulation of the model further into the future indicates that the household saving rate is likely to decline steadily in the coming decades as a result of the shift toward a more elderly population.

Contribution to Change in Saving Rate, 2004-2010

article image
Source: Fund staff estimates.

E. Evidence Using Household Survey Data

13. Further insight on the likely evolution of saving behavior can be gained by looking at household survey data.10 In particular, the data from the Family Income and Expenditure Survey (FIES) are used to examine the major features of the household saving rate, including the saving propensities across different age groups.11 The general trend of the household saving rate based on the survey data is somewhat different from the trend revealed in the aggregate national accounts data. The discrepancy between these two data sources stems from differences in the way the two saving rates are defined, in particular the treatment of rents. Indeed, several authors have argued that it is quite difficult to reconcile the two series, owing to the number of transformations that are undertaken to derive the national accounts data.12 Nevertheless, using the two data sources is helpful because each provides a different snapshot of household saving.

14. Household saving behavior, as revealed by the survey data for the period 1995 to 2003, differs across age cohorts. The data display a humped-shape pattern consistent with the life-cycle model. The saving rates are positive and large for each age category, with the 30 to 39 age group reporting the highest savings rate. As expected in a life-cycle model, the saving rate of elderly households (households with a head who is 60 years old or older) is lower than that of the younger households.

Savings Rate of Households

article image
Sources: Family Income and Expenditure Survey; and Fund staff estimates.

15. In general, the saving rates for the different cohorts have been fairly stable over time. There is one exception to this observation. The saving rate of elderly households with salaried workers has declined rapidly since the late 1990s, dropping to 12.1 percent from 22.6 percent. This decline has been associated with a fall in disposable income for this cohort while consumption remained roughly constant. The survey data indicate that the decline in disposable income was due to a fall in both employment income and public pension income.

16. The micro data allows for a comparison of the saving behavior for different types of elderly households. The saving rate in the table above pertains to elderly households whose head of household is still working as a salaried worker and does not include information about the retired elderly. In 1995 the FIES started collecting data on a broader set of elderly households including retired elderly households. The saving rate of retired households (where the head of household is older than 65 and retired) is negative and large in absolute magnitude, ranging from -5.2 percent to -19.6 percent. The aggregate saving rate of both retired and working households is -2.3 percent, compared with 23 percent for the working-age households computed from the 2003 FIES.

uA02fig07

Saving Rate: Elderly (60 and Over)

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: Family Income and Expenditure Survey.

17. Cohort saving data allow one to measure the likely impact of demographic changes on the saving rate. We assume that the saving rates across different age groups remain unchanged from their most recent (2003) levels. This is a reasonable assumption as the saving rates of each age category (except elderly households) has been relatively stable over time.13 Population trends can then be used to project the aggregate saving rate out to 2050. This projection shows that the age distribution of the population is shifting toward older age groups and away from the younger age categories.14 For example, in 2000, the population over 16 years of age was 108 million and is projected to drop to 88 million by the year 2050. The share of the population over the age of 60 is projected to increase from 27 percent to nearly 50 percent by 2050, with the most rapid increase in the share of the elderly occurring in the current decade.

uA02fig08

Projected Age Distribution of Population

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Source: National Institute of Population and Social Security Research.

18. The cohort saving behavior and the population projections illustrate once again that the saving rate is likely to fall. The extent of the decrease is likely to depend importantly on the saving behavior of the over-60 population, which in turn will depend in part on the elderly’s employment status. As a lower bound, it is assumed (although implausibly) that there is no retirement. This projection captures simply the effect aging has on savings. Given this assumption, the projected saving rate declines 3½ percentage points by 2050, with the largest ten-year decline (1 percentage point drop) occurring in the current decade. A more plausible projection, based on the assumption that anyone older than 70 is retired and the 60–69 population remains working, generates a saving rate that declines 9 percentage points by 2050.15 Once again, the largest fall (2½ percentage points) occurs in the current decade.

uA02fig09

Projected Saving Rate

Citation: IMF Staff Country Reports 2005, 272; 10.5089/9781451820645.002.A002

Sources: Family Income and Expenditure Survey; and Fund staff estimates.

F. Summary and Conclusion

19. This chapter has analyzed the likely impact on the household saving rate from a shift of Japan’s demographic structure toward a more elderly population. Projections using both the aggregate data and the cohort data illustrate that the household saving data is likely to decline steadily in the coming decade. The results using the macroeconomic data suggest the saving rate will fall 2¼ percentage points after six years, while the cohort data indicate a decline, ranging between 1 to 2½ percentage points, depending on the elderly’s employment status.

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1

Prepared by Hali Edison (ext. 36946).

2

The September 2004 World Economic Outlook investigates how demographic change affects regional and global economies.

3

This projection is from Japan’s National Institute of Population and Social Security Research, representing the medium variant. As there is a great deal of uncertainty with such projections the Institute also produces high and low variant projections.

4

The fertility rate in Japan is at present 1.2, compared with 2.1 in the United States. Life expectancy at birth is currently 81 years, the highest in the world and a full five years higher than in the United States. Since the 1950s, U.S. life expectancy has increased by 7 years, while Japanese life expectancy has risen by 17 years. Among OECD countries, Japan has one of the lowest shares of foreigners in the total population and labor force. In 1998, the population share of foreigners in Japan was 1.2 percent, while that of Switzerland was 19 percent.

5

Some of the more important earlier studies include: Hayashi (1989, 1997), Hayashi, Ando, and Ferris (1988), Horioka (1984, 1997), and Yashiro and Oishi (1993). More recent studies explore the sharp decline in savings and the role of the elderly, including Horioka (2004a, b, c) and Koga (2005).

6

The influence of wealth on savings may be ambiguous. During the late 1980s, the decline in savings rates coincided with sharp increases in household net wealth, indicating a strong negative correlation between the two series. At other times, the correlation between savings and wealth is positive, reflecting an increase in both income and wealth.

7

Fiscal variables have been used to explain private savings and test for the possible presence of Ricardian equivalence, whereby forward-looking agents offset bond-financed tax reductions by higher savings. We do not follow this approach because the focus is on household rather than private savings. See for example OECD (2004), De Mello and others (2004), and DeSerres and Pelgrin (2003). The OECD estimate the offset coefficient to be about 35 percent in the short run and 70 percent in the long run.

8

As pointed out by Meredith (1995), evidence based on aggregate data typically support the prediction of the life-cycle model regarding demographics and saving.

9

There are several ways in which inflation can affect saving independently from its influence via the real interest rate. The increase in inflation may capture the effect of uncertainty such that as inflation rises saving would increase for precautionary motives. Also, an unexpected rise in inflation may lead households to hike savings to compensate for capital losses.

10

This approach has been followed, for example, in Bosworth and others (1991), Kitamura and others (2001).

11

The survey reports saving rates by age group for head of household for salaried workers, with two or more members. This coverage was expanded to include data on retired households (head of household over 60) after 1995.

12

See, for example, Hayashi (1997), Kozo, Sato, and Inada (2003), and Koga (2005). In particular, according to Hayashi (1997) comparing the two saving rates is not straightforward because the SNA data involves many stages of imputations and transformations, while the survey data concern cash items. Specifically, he points to six major differences: i) imputed rents; ii) business income; iii) employment income; iv) medical expenditures; v) social security benefits; and vi) depreciation.

13

Pension benefits are expected to fall further, but a reasonable assumption may be that the elderly extend their working life enabling them to maintain their savings rate.

14

This scenario uses the medium variant population projection. The alternative high/low projections also yield similar results.

15

Applying the average saving rate of retired and working households yields a saving rate that declines 2¼ percentage points in the first decade and 6¼ percentage points by 2050.

Japan: Selected Issues
Author: International Monetary Fund