“Japan committed many serious errors in the 1990s. Many financial institutions collapsed and the government hesitated to respond. Lesson one therefore is that governments should intervene in events quickly,” says CHARLES HORIOKA, Professor of Economics at Osaka University.
The Japanese are, it seems to me, relatively slim; at least I have not seen very many fat people here in Osaka. Why are there many more obese people in Europe and in the US? Does it have some sort of an economic implication?
I think you are right. There are fewer fat people in Japan. But their number is growing; we might even be nearing the US and the West European countries. For economists, this is not a typical topic, but the institute for which I work (the Institute of Social and Economic Research at Osaka University, note by L.K.) is one of the centres of behavioural economics in Japan. We therefore apply economics to various aspects of human behaviour. My colleague, Professor Shinsuke Ikeda, in his study analysed the relationship between obesity and the level of indebtedness. He discovered that obese people also have a tendency to pile up greater debt. He explains it by saying that people who are not too disciplined and lack patience often overeat and also overspend, and therefore get into debt. Ikeda thinks that there is a causal connection between the two phenomena. His conclusions are statistically very convincing.
And we can perhaps see that even now, in this crisis period. It is referred to as a debt crisis and it struck the hardest in the US, which also has the greatest number of obese people.
Yes, this confirms the conclusions of the study. And another indicator is the level of savings. In the USA, the level of indebtedness is very high and the level of savings miniscule; in a number of Asian economies, the ratio is precisely the opposite.
How do you view the crisis?
I agree with the usual interpretation that it was triggered by risky mortgages and new financial derivatives in the States. It is very difficult to put the blame on someone specific, but it is probably also the government that is at fault, because it neglected the regulation of these new financial products and did not pay too much attention to unethical and irresponsible conduct in the private sphere.
So you see it as half and half – errors both on the part of the government and on the part of the market, market entities?
Yes, people, market entities, always try greedily to take as much as possible. The government therefore must regulate to a certain extent.
Is space therefore opening up for behavioural economics? Can it take deeper root in mainstream economics? Many people think that the models on which mainstream economics have built have failed, or that they are insufficient and that much more attention must be paid to people’s behaviour, which is often far from rational.
I think that an increasing number of phenomena cannot be explained by traditional and, after all, simple economic models. Increasingly greater space is opening up for behavioural economics.
Behavioural economists work with terms such as herd behaviour, and so on. Do you, too, view that as the trigger of the crisis?
Yes. And asymmetrical information as well: the buyers of those derivates were simply not told the full truth.
Nearly everyone – the media, economists, and politicians – today compare the crisis to the situation in Japan in the 1990s. Are there, in your view, any analogies? Can we learn from Japan’s experience?
I think that there definitely are analogies and I also think that Japan committed very serious errors. Many financial institutions were collapsing or going outright bankrupt and the government hesitated to respond. Lesson number one therefore is that governments should intervene in the situation as rapidly as possible and try to address the problems. In this regard, I think that the US intervened in the situation relatively quickly. Their measures are far from perfect, and they are schizophrenic in places…
Saving Bear Sterns, but not Lehman Brothers?
Yes, and also using government money for rescuing non-financial companies such as General Motors is as highly problematic.
But in spite of that, you think that the US government’s measures were faster, more forceful, and therefore also better than the (non-)interventions of the Japanese government in the 90s?
Yes. As for the timing of the intervention, the US government acted far faster than Japan did. Japan went through fifteen years of recession. There is simply no excuse for that in the case of such a developed economy.
Charles Yuji Horioka (52)
An American economist born in Boston, who has worked in Japan for many years, where he is a Professor at Osaka University. In his youth, he became famous with a study that he wrote together with the US economist Martin Feldstein (later the Chief Economic Advisor to President Ronald Reagan) which first mentioned the so-called Feldstein-Horioka Puzzle. He says about himself that he is eclectic – he combines various ideological streams in economics. He is also involved in the economics of happiness: “Young people in Japan, in particular, are literally obsessed with brand-name items, various accessories, like Louis Vuitton or Chanel purses. They just buy and buy. Not because of the purse, but because of the prestige of the brand name on the bag. People are not too religious; very few of them regularly go to church or a temple. Spirituality should be developed more, and they should be less focused on the material – then they would probably be happier,” he says. Horioka collects stamps and coins, he used to be a Marathon runner, and he swims and bikes. He drives a fifteen-year-old Nissan Match, which he says still serves him well.
What then specifically was the greatest error of the Japanese government? That hesitation?
I think that there were mistakes both in the sphere of fiscal policy, as well as monetary. At the end of the Eighties, monetary policy was too expansive. That led to a bubble. Its popping was inevitable. But then, monetary policy got too strict in turn. Then the government came out with a certain form of expansive fiscal policy. But that was insufficient, incorrect, and it came too late – the mixture of a restrictive monetary policy and an inefficient fiscal expansion only prolonged the recession, and especially the inability to cope with the problems in the financial sector only worsened the entire matter. The Japanese crisis was largely influenced by poor government policy.
Behavioural economics operates with the term moral hazard. This expression has become almost popular during this present crisis. Do you fear the effects of moral hazard in the future, that is, a situation when an excessive taking of risk is not punished by bankruptcy, but “rewarded” with a government bail out?
Yes, if people know that the government will bail them out again next time, they will carry on in their risky behaviour. Governments should, in my opinion, show much more clearly that the present rescues were exceptional and will not be repeated. Of course, a precondition for the crisis not being repeated is that regulation increases, such as would make it impossible for companies dealing in securities and other financial institutions to mislead clients.
Do you think that after the crisis more regulation will be required, or more market, in order for the system to function without similar shake-ups?
Having a free market is good in principle, but I do think that regulation is required to a certain extent. Financial institutions must be, as I have already said, prohibited from misleading investors. Regulation should cover all financial products.
Ok. So is more regulation required, or “merely” better regulation? Was not the level of regulation sufficient before the crisis?
No, it was not. Newer and newer financial products were being created, to which the current regulation did not apply. We need new regulation to cover new products. But regulation should not be excessive. The market should not be suppressed too much.
What does the average Japanese person think about the crisis?
Most people blame the US. They think that what is happening in the States is having a large impact on us, as on other countries. The US is also blamed because it is a key export market – it is very important for Japan. The public is pessimistic, companies are laying people off, and GDP is going down rapidly. The pessimism then spills over into demands that government representatives would be more forceful in dealing with the crisis and try to give the economy a boost.
What I meant was whether people in Japan blame the West in general, not merely the US. Japanese society is not as individualistic. Are they attacking the western way of life in this regard?
Yes, I think they do. The differences between the West and Japan are considerable. In principle, it is the same economic system; but if you look, for example, at the ratio of the salary of the manager of a large corporation and a rank-and-file worker, it is far lower in Japan than in the US. And that very thing can lead to self-centred conduct in the US, to the pursuit of one’s own interests at any cost – much more can be gained this way than if you behaved the same way in Japan.
How can the Japanese economy get out if its present problems as fast as possible? Do you have any recommendation?
Giving any advice is very difficult. Interest rates are already so low that they cannot really be reduced any further. The indebtedness of the Japanese government is the highest in the developed world; so, consequently, it is also difficult to offer any further financial stimuli. The government therefore does not have many options. Nevertheless, I think that, for example, the present programme of short-term tax refunds is a very expensive measure that will not have a great effect.
Is it something similar to what Bush’s administration put forward last year?
Yes, the principle is that the government will give each inhabitant the same amount of funds. But because most people are afraid of the future, they will probably save the money; consumption, and in turn the economy, will not be got going. Much more important would be measures that would decrease people’s uncertainty about the future, primarily their fear of losing their job. The government should therefore support the creation of jobs. That would be wise. Furthermore, people are anxious as concerns old age, because the ageing of the Japanese population is very significant and the present form of the pension system may not keep up with that pace. The pension system needs to be reformed as well as the health insurance systems. I think that this type of targeted government policy would be more efficient and furthermore not cost as much. Merely handing out extra money will not have any effect
You mentioned the ageing of the population. That has an impact on the overall level of savings in the Japanese economy, because old people usually save less than young people. Do you fear the future developments in this regard?
For a long time, I have been predicting that the rapid ageing of the population will lead to a significant reduction in the savings of Japanese households. That is precisely what is happening now. The level of household savings now amounts to about three percent, whereas during the peak it was 23 percent. That is a drop by twenty percentage points. Furthermore, the level of savings in Japan is today lower than in the developed world – that is, with the exception of the US, where it is even lower. I think that hand in hand with the continued ageing of the population, we will see a further drop in the level of savings. On the other hand, I do not know whether it is necessarily a problem. The population as a whole is dying off. With a lower population, there is no need to maintain such a high productive capacity in the economy. Demand for investments will be lower. Savings in the economy will therefore drop, but so too will investments. This may therefore not necessarily lead to any great imbalance. And furthermore, money can always be borrowed abroad – for example China and South-East Asian countries have a very high level of savings. And in addition, the ageing of their population is significantly delayed compared to Japan. Over the next few decades, these countries will be able to lend to other countries, including Japan. So perhaps it is not such a great problem after all.
What about Japan and its pension system?
That, on the other hand, is problematic. It is a pay-as-you-go system, which is therefore significantly dependent on the demographic trend. With the ageing of the population, the financing of such a system becomes a problem. It is possible to reduce pensions and increase pay-as-you-go contributions, or increase the retirement age – but I think the best solution is to switch to a system based on pension funds. But making that transition is very hard. In 2005, the Japanese government introduced relatively revolutionary legislation (up to that point, the retirement age had been increased or contributions had been raised), when it reduced pension payments. I think it was a step in the right direction. Of course, if payments are reduced too much, old people may have problems maintaining their standard of living.
Do you fear inflation in relation to the anti-crisis measures? Warren Buffet warns against significant inflation in the US.
I think that the threat of inflation may concern certain countries, but not Japan. We have had deflation for many years, and reversing that trend is very difficult. If we transformed deflation into some appropriate inflation, it would be positive for the Japanese economy.
Nearly thirty years ago, you and Martin Feldstein published a famous study in which the so-called Feldstein-Horioka Puzzle appeared for the first time, which made it into textbooks all over the world. But it has its critics, who question it to a large extent. Do you still stand behind it?
Many things have changed since then. Financial markets are much more globalised, as are capital flows. Economies are far more liberalised. Although capital flows much more freely, study after study shows that people tend to invest in their own country (“home bias”). I think that the basic points of the argumentation in our old article still apply.
The Feldstein-Horioka Puzzle
The puzzle arises from the fact that the level of savings in each country is highly correlated to the level of investments. This is shown by statistical figures. Economic theory – and here is the disagreement – however stipulates something else: capital – money – should always flow to the country in which investment promises a higher additional yield. For example, a Frenchman should therefore not tend to invest in France, if his investment will yield more abroad. The level of savings in a country should therefore not be related to the level of investments; those should always flow to the country in which they will appreciate the most. But as Martin Feldstein and Charles Horioka noted in 1980 in the Economic Journal, there is a greater correlation of the level of savings to the level of investments – investments do not just flow out easily (not even today, nearly thirty years after the study was published, when capital markets are looser and the world economy is far more globalised). And a puzzle is born.
The interview was obtained in Osaka in March 2009.