Analyzing Japan’s economy 
Dr. Robert Madsen, Senior Fellow, Center for International Studies, MIT

If you’ve ever read a recent edition of the Economist Intelligence Unit’s quarterly report on Japan, then you’ve probably done so to take advantage of the deep economic insight of the report’s author, Dr. Robert Madsen. Dr. Madsen is a Senior Fellow at MIT’s Center for International Studies and a former Fellow at Stanford University’s Asia-Pacific Research Center. In addition to working with the Economist, Dr. Madsen is an economic consultant to both private organizations and government agencies in Asia and the US. Dr. Madsen holds a bachelor’s degree from Harvard University, a Ph.D from Oxford University, and a J.D. from Stanford Law School. Dr. Madsen recently gave a presentation, courtesy of the Japan Society, entitled “Japan’s New Economy” which focused on Dr. Madsen’s analysis of Japan’s current and future economy. This month’s Bridge Builder features key highlights from Dr. Madsen’s presentation.

The main focus of Dr. Madsen’s discussion was his theory that the high rate of savings in Japan has been at the core of the decade long recession. He called this “the fundamental problem” explaining that a high savings rate results in a low cost of capital which allows companies to easily borrow and invest in producing additional supply. This is normally fine if there is enough demand to meet that supply. But in Japan’s case, insufficient demand, because people save so much, leads to excess supply. The typical economic reaction to excess supply is Export- which Japan has done quite a bit of, but not enough. Remaining excess supply which stays inside the country leads to deflation and slow or negative growth. This fundamental problem, the high rate of savings, Dr. Madsen explained, is a direct result of Japan’s population demographics which features a large Baby Boomer group that reached late middle age in the 80’s and 90’s. Late middle age groups, in general, have a high propensity to save because by the time someone has reached his 50’s he is relatively debt free (mortgage all paid off) and can simply save more.

Dr. Madsen contends that the recent structural changes in Japan are not all that likely to help the economy with its fundamental problem because they don’t affect the savings rate or the supply/demand gap. Corporate Restructuring for example, has been great for making individual companies more profitable. But these reorganizations have been bad for the economy because layoffs mean less money in the economy to spend. Likewise, Government fiscal reforms have taken a lot of the “pork” out of government spending, particularly in the construction and national infrastructure area. However, this has also resulted in decreased demand in the economy which stifles growth. Dr. Madsen pointed out that government spending in the last few decades was one of the key drivers of the demand that fueled economic growth.

Japan’s business culture has undergone many changes in recent years but this too, says Dr. Madsen, has not really affected savings. Corporate reform has meant a great weakening in the Keiretsu system of vertical integration. Nissan, for example, severed ties with many suppliers during its corporate reform efforts causing many of them to go out of business. A downward trend in the pattern of cross-shareholdings among Japanese companies in a keiretsu formation has also become more obvious. M&A’s, hostile takeovers, and private equity group formation- have all increased in recent years- indicating a clear trend towards change in Japanese corporate practices. What does all this do to affect the savings rate? Not much and therefore are not likely to help Japan’s economy recovery.

So what is the outlook for Japan’s economy given the above fundamental problem and the analysis that the recent restructuring won’t really have an affect? Dr. Madsen says it might be good if we look at the current economic recovery as something that will last. The current growth is a result of increased demand mainly from China. As long as China continues to grow and demand the excess supply from the Japanese economy, supply will not be in excess of demand. However, Dr. Madsen points to the current slowdown as reason to speculate that a China driven recovery is not really cause for optimism. The truly bright outlook, according to Dr. Madsen, comes from recent changes in the household sector in Japan. Over the last 5-7 years, the Baby Boomer group has been retiring yet spending like they were still working. This has created a sharp drop-off in the household savings rate. And this is just the beginning of the Baby Boomer retirement process which will continue into the next decade. Dr. Madsen sees the drop in savings as a self-correction of the fundamental problem: decreased savings leads to a higher cost of capital, less investment, and less supply. Demand, meanwhile, will actually go up as these Baby Boomers spend their money on healthcare, tourism, and financial services. The Baby Boomers also transfer wealth to their children who spend the money on housing, for example. This all leaves Dr. Madsen feeling positive that the Japanese economy has a good chance at a recovery fueled by the same demographics that put a damper on the economy in the first place.

For more information on the Japan Society, please visit them on the web at www.usajapan.org  .

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