Discussion Paper No. 599

THE STAGNATION OF
HOUSEHOLD CONSUMPTION IN JAPANCharles Yuji Horioka

January 2004
Revised June 2004

The Institute of Social and Economic Research
Osaka University
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, Japan

THE STAGNATION OF HOUSEHOLD CONSUMPTION IN JAPANCharles Yuji Horioka
Institute of Social and Economic Research, Osaka University, Osaka, Japan, andNational Bureau of Economic Research, Inc., Cambridge, Massachusetts, U.S.A.
December 31, 2003
Revised May 25, 2004, and June 8, 2004
Institute of Social and Economic Research, Osaka University
6-1, Mihogaoka, Ibaraki, Osaka 567-0047, JAPAN
Telephone: 81-(0)6-6879-8586, 8574, Facsimile: 81-(0)6-6878-2766
Email: horioka@iser.osaka-u.ac.jp

Prepared for the Venice Summer Institute (VSI) Workshop on “Economic Stagnation in Japan,”which was held July 25-26, 2003, in Venice, Italy, under the sponsorship of the CESifo, a joint
initiative of the University of Munich's Center for Economic Studies and the Ifo Institute for
Economic Research, Munich, Germany.

The conference volume is being edited by Michael

Hutchison and Frank Westermann and is forthcoming from MIT Press.
Abstract
In this paper, I consider the extent to which the stagnation of household consumption is
responsible for the decade-long recession in Japan during the 1990s and early 2000s and thereasons for the stagnation of household consumption during this period and find that thestagnation of private investment (and inventory investment) rather than that of household
consumption was the major cause of the decade-long recession, that household consumption
was nonetheless relatively stagnant during this decade, and that the stagnation of household
consumption was due primarily to the stagnation of household disposable income, the decline inhousehold wealth (which in turn was due primarily to the collapse of land and equity prices),and to a lesser extent, increased uncertainty about the future (especially about old age in generaland public old-age pensions in particular), the deterioration of future prospects, and deflationary
expectations concerning consumer prices.

1. Introduction
Japan’s economy has been in recession more or less continuously for more than adecade (Japan’s so-called “Lost Decade”), and Japan’s growth rate during this period has been
the lowest among the major industrialized countries of the world.

During the 1995-2002

period, for example, the annual growth rate of Japan’s real GDP averaged only 1.2%, which islower than all of the other G7 countries—Canada (3.4%), the United States (3.2%), the United
Kingdom (2.7%), France (2.3%), Italy (1.8%), and Germany (1.4%)--as well as the Euro area
average (2.2%) and less than half of all of the other larger OECD countries—Korea (5.3%),
Australia (3.8%), Spain (3.3%), the Netherlands (2.9%), and Mexico (2.6%)--as well as theOECD-wide average (2.7%).
In this paper, I consider the extent to which the stagnation of household consumption
is responsible for the decade-long recession in Japan during the 1990s and early 2000s and thereasons for the stagnation of household consumption during this period.

The paper isorganized as follows: section 2 considers the first issue, section 3 considers the second issue,
and section 4 is a brief concluding section.
To preview the main findings of this paper, I find that the stagnation of private
investment (and inventory investment) rather than that of household consumption was the major
cause of the decade-long recession in Japan during the 1990s and early 2000s, that household
consumption was nonetheless relatively stagnant during this decade, and that the stagnation ofhousehold consumption was due primarily to the stagnation of household disposable income,the decline in household wealth (which in turn was due primarily to the collapse of land andequity prices), and to a lesser extent, increased uncertainty about the future (especially about
old age in general and public old-age pensions in particular), the deterioration of future
prospects, and deflationary expectations concerning consumer prices.
My findings suggest that the best way to bring the Japanese economy out of recession
would be to stimulate private investment in housing and plant and equipment as well ashousehold consumption, and in my opinion, the best way of doing so would be to introduce
temporary and targeted tax breaks for housing and plant and equipment investment, household

1consumption, etc., and to reduce uncertainty about the future, especially about old age in generaland public old-age pensions in particular.

2. The Contribution of the Stagnation of Household Consumption to the Decade-Long
Recession
In this section, I consider the extent to which the stagnation of household consumption
is responsible for the decade-long recession of the 1990s and early 2000s.

I first consider theperiod of analysis as a whole (1991-2002) and then divide this period into two subperiods(1991-1997 and 1997-2002) because GDP growth was considerably higher during the first
subperiod than it was during the second subperiod (1.58% vs. 0.36%).
Table 1 shows the average annual real growth rate of gross domestic product (GDP)and the various components thereof during the 1991-2002 period as a whole, the 1991-1997
subperiod, and the 1997-2002 subperiod, and as can be seen from this table, the average growthrate of GDP during these three periods was a mere 1.03%, 1.58%, and 0.36%, respectively,
whereas the average growth rate of household consumption during the same three periods was
1.35%, 1.94%, and 0.65%, respectively.

Thus, the average growth rate of household

consumption was considerably higher than that of GDP in all three periods albeit not high inabsolute terms and not nearly as high as the average growth rate of some other components of
GDP: the growth rate of the consumption of private non-profit institutions serving households
was 4.55%, 4.64%, and 4.44%, respectively; that of the net exports of goods and services was
4.55%, 3.09%, and 6.32%, respectively; that of government consumption was 3.07%, 2.82%,
and 3.38%, respectively, during the three periods considered; and those of public fixed
investment and inventory investment were 4.00% and 2.18%, respectively, during the 1991-97
period).

Preliminary figures show that the growth rate of household consumption fell short ofthat of GDP during all four quarters of 2003 and in the first quarter of 2004, but if this mostrecent period is ignored, the average growth rate of household consumption exceeded that ofGDP, which implies that household consumption did not act as a drag on the economy and infact raised rather than lowering the growth rate of GDP.1

2

What did act as a drag on the economy were private fixed investment and inventory
investment (changes in inventories), both of which showed slower growth than GDP and in fact
showed negative growth throughout the 1991-2002 period (with one exception): -1.19%,-0.96%, and –1.47%, respectively, in the case of private fixed investment, and –193.06%, 2.18%,
and –183.19%, respectively, in the case of inventory investment during the three periods
considered.

A breakdown of private fixed investment shows that private housing (dwelling)

investment declined especially sharply (-2.58%, -0.72%, and –4.76%, respectively, during thethree periods considered), which suggests that it might have been the primary culprit of thedecade-long recession.

Preliminary figures indicate that private housing investment continued

to decline in the first, second, and fourth quarters of 2003 but showed positive growth in thethird quarter of 2003 and the first quarter of 2004, indicating that it continued to act as a drag on
the Japanese economy until very recently.
Table 2 shows the contribution to real GDP growth of each component thereof during
the 1991-2002, 1991-1997, and 1997-2002 periods, and as can be seen from this table,household consumption made by far the largest contribution to real GDP growth during the
1991-2002 and 1991-1997 periods (70.30% and 64.95%, respectively) and the second largest
contribution (96.70%) during the 1997-2002 period.

If the components of GDP are ranked bytheir contribution to real GDP during the 1991-2002 period as a whole, government
consumption was in second place with a contribution of 44.60%, 24.65%, and 143.02%,
respectively, net exports of goods and services was in third place with a contribution of 9.20%,
3.51%, and 37.24%, respectively, government fixed investment was in fourth place with acontribution of 4.40%, 17.26%, and –59.00%, respectively, and the consumption of private
non-profit institutions serving households was in fifth place with a contribution of 4.34%,
2.58%, and 13.00%, respectively, during the three time periods considered.

Some haveclaimed that strong export growth prevented the decade-long recession from becoming evenworse, but the contribution of net exports to real GDP growth was relatively modest and it
ranked only third or fourth.

The contributions of private fixed investment (-25.30%, -13.82%,

and –81.94%, respectively) and inventory investment (-7.54%, 0.86%, and –49.01%,3

respectively) to real GDP growth were negative in all but one case during the three time periods
considered, with the contribution of private fixed investment being especially large in absolutemagnitude.

A breakdown of private fixed investment shows that private housing investment

was responsible for 43.28%, 16.28%, and 65.72%, respectively, of the negative contribution ofprivate fixed investment during the three time periods considered, meaning that its impact does
not clearly dominate that of private plant and equipment investment, contrary to what I surmised
earlier (more on this later).
Some of the foregoing results concerning the average growth rates of each componentof GDP and its contribution to real GDP growth are seemingly at odds with one other, but thedifferences can be explained by the shares of each component in total GDP.

For example,

household consumption made by far the largest contribution to real GDP growth during the
1991-2002 period as a whole as well as during the 1991-1997 subperiod and the second highest
contribution to real GDP growth during the 1997-2002 subperiod even though, as noted earlier,the average growth rate of household consumption was much lower than that of some othercomponents of GDP during all three periods considered simply because it is by far the largest
component of GDP with a share of 52.6 to 54.5% (see Table 3).

Conversely, the consumptionof private non-profit institutions serving households contributed relatively little to real GDP
growth during all three periods considered even though it showed the first or second highest
growth rate simply because its share of GDP is so small (0.8 to 1.2% or sixth among the sevencomponents of GDP).

Similarly, the contribution of the net exports of goods and services toreal GDP was only third or fourth highest even though its growth rate was the first or third
highest simply because its share of GDP is so small (1.7 to 2.5% or fifth among the sevencomponents of GDP).

As another example, inventory investment contributed much lesstoward holding down real GDP growth during the 1991-2002 period as a whole as well as
during the 1997-2002 subperiod even though it declined much more sharply than private fixed
investment during these periods simply because its share of GDP is so much smaller (-0.3 to
0.6% or smallest among the seven components of GDP in the case of inventory investment vs.
19.1 to 24.4% or second largest among the seven components of GDP in the case of private

4fixed investment).

As a final example, private housing investment did not contribute more to

holding down real GDP growth than did private plant and equipment investment (except during
the 1997-2002 subperiod) even though its growth rate was much higher (except during the
1991-1997 subperiod) simply because its share of GDP is so much smaller (3.5 to 5.2% in thecase of private housing investment vs. 15.6 to 19.2% in the case of private plant and equipment
investment).
We turn finally to the composition of household consumption.

Data for the

1991-2001 period are shown in Table 4 (data for 2002 are not yet available as of this writing),
and as can be seen from this table, “communication” (13.95%) showed by far the most rapid
growth during the 1991-2001 period (presumably because of the rapid diffusion of cell phones),
followed by “health” (2.87%), “restaurants and hotels” (2.42%), ”housing, electricity, gas andwater supply” (2.34%), and “recreation and culture” (2.25%), while “clothing and footwear”(-2.35%) and “education” (-1.32%) declined (see column (1) of Table 4).
In terms of the contribution of each component to real household consumption growth,“housing, electricity, gas and water supply” made by far the largest contribution during the
1991-2001 period (37.57%) because its growth rate was relatively high (2.34%) and because its
share of total household consumption was by far the highest (24.10% in 2001) (see columns (2)and (3) of Table 4).

The overwhelming contribution of housing-related expenditures was due

primarily to the increase in the imputed rent on owner-occupied housing (imputed services ofowner-occupied dwellings), whose average growth rate was 2.48%, whose share of total
household consumption was 17.07% in 2001, and whose contribution to real household
consumption growth was 28.03%.

Imputed rent on owner-occupied housing is likely to be

mismeasured because it is not a market transaction but rather is imputed using various
assumptions, and I doubt that it grew as rapidly as the official figures suggest during a period
when land prices were declining steadily.

Thus, the fact that imputed rent on owner-occupied

housing was the single largest source of growth of household consumption during the
1991-2001 period, according to the official figures, suggests that there is considerable
uncertainty about exactly how much consumption grew during this period.

5

“Communication” made the second largest contribution during the 1991-2001 period(21.29%) even though its share of total household consumption was only 3.85% in 2001
because its growth rate was by far the highest during this period (13.95%).

“Recreation andculture” and “restaurants and hotels” made the third and fourth largest contributions during the
1991-2001 period (18.14% and 11.34%, respectively) because both their growth rates as well as
their shares of total household consumption were relatively high (2.25% and 12.05%,
respectively, in the case of “recreation and culture” and 2.42% and 7.06%, respectively, in thecase of “restaurants and hotels”).

By contrast, the contribution of “clothing and footwear” wassizably negative during the 1991-2001 period (-10.49%) because its growth rate was sizably
negative (-2.35%) and because its share of total household consumption was moderately high
(5.18% in 2001), and the contribution of “education” was also negative but negligible (-2.08%).
With the exception of housing-related expenditures, necessities such as “food andnon-alcoholic beverages,” “alcoholic beverages and tobacco,” and “clothing and footwear” werethe most stagnant and contributed the most to the stagnation of household consumption during
the 1991-2001 period, whereas luxuries such as “communication,” “recreation and culture,” and“restaurants and hotels” showed the strongest growth and contributed the most to holding up
household consumption during this period.

Thus, somewhat surprisingly, consumption

patterns became more affluent during the 1990s despite the stagnation of household incomes
and wealth, suggesting that the decade-long recession was not severe enough to impoverish
Japanese households.

However, it could be that the increasing affluence of consumption

patterns is attributable to an increase in income and wealth disparities among Japanesehouseholds, and if this explanation is the correct one, it implies that the poor became evenpoorer.
In any case, household consumption did not cause the decade-long recession in Japan
during the 1990s and early 2000s (assuming that the growth rate of imputed rent onowner-occupied housing was not upward biased during this period).

In fact, household

consumption prevented the recession from becoming even worse and was the main contributor
to economic growth during the 1990s and early 2000s, with housing-related expenditures,6

communication, and recreation and culture contributing the most.

The main causes of therecession were the sharp declines in private fixed investment and, to a lesser extent, inventory
investment.

Note, however, that this conclusion must be regarded as tentative until a more

rigorous analysis can be done.
Saito (2000) does a similar analysis for the earlier postwar period and finds thathousehold consumption made the largest contribution to real GDP growth during the earlier
postwar period as well but that its contribution (and also the contribution of government
consumption) were not as large as they were after 1991.

Thus, the role played by household(and government) consumption during the post-1991 period was large not only in absolute terms
but also relative to the earlier postwar period.

3. The Causes of the Stagnation of Household Consumption
In the previous section, we found that household consumption did not cause thedecade-long recession during the 1990s and early 2000s, but it is nonetheless true thathousehold consumption was relative stagnant during this period.

In this section, we analyze

the causes of the stagnation of household consumption during the 1990s and early 2000s.
Economic theory predicts that household consumption will be influenced by thefollowing factors, among others:(1) Household disposable income(2) Household wealth(3) Uncertainty about the future (for example, about income, employment, retirement, public
old-age pensions, etc.)(4) Future prospects (for example, about income, employment, etc.)

These factors may have contributed to the stagnation of household consumption
during the 1991-2002 period if:

7

(1) Household disposable income had declined or been stagnant(2) Household wealth had declined(3) Uncertainty about the future had increased(4) Future prospects had deteriorated

during this period.

We look at each of these factors in turn.

(1) The Stagnation of Household Disposable Income
The average annual real growth rate of household disposable income was only 0.50%
during the 1991-2002 period, which is far less than the average annual real growth rate ofhousehold consumption during the same period (1.35%).

This suggests that the stagnation ofhousehold disposable income was a major cause of the stagnation of household consumption
and that it would have caused household consumption to be even more stagnant had it not been
for other factors operating in the opposite direction.
Figure 1 shows the annual real growth rates of household consumption and household
disposable income during the 1991-2002 period, and as can be seen from this figure, the two are
relatively close in most years (with the exception of 1996 and 2001).

The growth rate ofhousehold consumption far exceeded the growth rate of household disposable income in both ofthese years.

It could be that the growth rate of household consumption was considerably

higher than the growth rate of household disposable income in 1996 because the consumption
tax was raised from 3% to 5% on April 1, 1996, and consumers accelerated purchases of goods
and services to take advantage of the lower consumption tax.2(2) The Decline in Household WealthHousehold wealth (net worth) declined during the 1991-2002 period as a whole, duelargely to the sharp decline in land and equity prices, and the average annual real rate of declineof household wealth during this period was 0.84%.

Thus, it is quite possible that thestagnation of household consumption during this period was due at least partly to the decline in8household wealth (a reverse wealth effect).
Figure 2 shows the annual real growth rates of household consumption and household
wealth during the 1991-2002 period, and as can be seen from this figure, the two are relatively
close in most years (with the exception of 1991-92 and 1999).

The growth rate of household

consumption exceeded that of household wealth in 1991-92 and conversely in 1999.
The relatively strong growth of household consumption in 1991 despite the relatively
sharp decline in household wealth in that year can be explained by the relatively strong growthof household disposable income in that year.

What cannot be explained is why household

consumption increased so much in 1992, 1996, and 2001 even though the growth rates of bothhousehold disposable income and household wealth were relatively low in those years (and bothwere even negative in 2001).

It thus appears that household disposable income and household

wealth are not the only determinants of household consumption.

For this reason, I turn now toother possible determinants of household consumption.

(3) Increased Uncertainty about the Future
If the stagnation of household consumption were due to increased uncertainty about
the future, we would expect the household saving rate to have increased, but in fact it has
declined steadily and sharply during the 1991-2002 period (except during the 1996-98
period)--from 15.1% in 1991 to 6.4% in 2002 in the case of the unadjusted rate and from 13.3%
in 1991 to 5.4% in 2002 in the case of the adjusted rate, a decrease of more than 50% in bothcases (see Table 5)!3 4

This suggests that the stagnation of household consumption is not due

to increased uncertainty about the future, except possibly during the 1996-98 period, when thehousehold saving rate increased from 9.9% to 11.1% in the case of the unadjusted rate and from
8.5% to 9.6% in the case of the adjusted rate.

It is not surprising to find that the householdsaving rate showed a temporary upturn during the 1996-98 period because it is during thisperiod that a spate of bankruptcies (most notably the bankruptcies of Yamaichi Securities andHokkaido Takushoku Bank in November 1997) occurred in the financial sector.

Thesebankruptcies caused increased uncertainty not only about the health of the financial sector but

9also about the employment situation because the bankruptcies entailed large-scale layoffs ofworkers.
Additional verification of the importance of uncertainty about the future can beobtained from data on saving motives, etc., from the Public Opinion Survey on Financial Assets
and Liabilities, conducted annually by the Central Council for Financial Services Information.
As Table 6 shows, the proportion of respondents saving for illness and unforeseen emergencies
has not shown a clear trend over time, and the proportion saving for peace of mind has increased
only moderately over time, but the proportion of respondents saving for old age has increased
sharply over time (from 50.5% in 1991 to 60.4% in 2003).

Moreover, as Table 7 shows, theproportion of under-60 respondents who are worried about old age has increased sharply overtime, from 63.7% in 1992 to 87.9% in 2003, and the proportion of these respondents who areworried about old age because pensions and insurance are not adequate increased from 55.5% to72.2% over the same time period, making it the reason that increased the most in importance.
This is not surprising because Japan’s public pension system has been periodically reformed tokeep it solvent in the face of rapid population aging—with contribution rates being increased,
benefit levels being reduced, and the pensionable age being increased over time.
In a related line of research, Horioka and Watanabe (1997) and Horioka, et al. (2000)
calculate the amount of saving for each motive and find that the retirement and precautionary
motives are by far the most important motives for saving and that they are far more important inJapan than they are in the United States.

Similarly, Horioka, Murakami, and Kohara (2002)

and Horioka, Kohara, and Murakami (2004) find that dissaving is the most common way inwhich the Japanese deal with unforeseen emergencies, which corroborates the importance of the
precautionary motive as a motive for saving in Japan from the other side of the ledger.
A number of studies have analyzed the importance in Japan of precautionary saving
arising from various types of uncertainty. For example, Ginama (1988), Ogawa (1991), Doi(2001), and Zhou (2003) analyze the importance of precautionary saving arising from income
risk.

Ginama (1988), Ogawa (1991), and Zhou (2003) find that precautionary saving arisingfrom income risk is relatively unimportant except at the time of the first oil crisis and except for10the self-employed and farmers, and Doi (2003) finds that it is of some importance in the case ofsalaried worker households but that employment risk is not important (but see also the next
subsection).

Murata (2003a, 2003b) looks at the importance of precautionary saving arisingfrom uncertainty about overall economic conditions and from uncertainty about public old-age
pensions and finds that the former is not important but that the latter is.

Nakagawa (1999)

analyzes the importance of different types of uncertainty on the household saving rate in Japanby age and income and finds that different types of uncertainties are important for different age
and income groups: he finds that income risk is important for the low- to middle-income, that
employment risk is important for the middle-aged and aged low-income, that uncertainty aboutpublic old-age pensions is important for the young, and that the risk of becoming bedridden isimportant for the aged. Finally, Saito and Shiratsuka (2003a, 2003b) analyze the impact ofvarious types of uncertainty on the household saving rate and find that uncertainty about
employment and price deflation and, to a lesser extent, overall uncertainty and uncertainty about
income exert upward pressure on the household saving rate.5
Thus, the available evidence is not always consistent, but it suggests that precautionarysaving arising from income risk or employment risk has generally not been all that important
nor has it increased over time but that precautionary saving arising from uncertainty about old
age in general and about public old-age pensions in particular is important and has increased
over time and hence that it may have contributed to the stagnation of household consumption
during the 1991-2002 period.

(4) The Deterioration of Future Prospects
In the previous subsection, we discussed the impact of increased uncertainty
concerning the future, but a closely related factor is the deterioration of future prospects.

Ifhousehold expectations concerning future incomes, future employment prospects, etc.,
deteriorate, this should cause them to reduce their current consumption.

In addition to looking

at the impact of income and employment uncertainty, Doi (2001, 2003) also looks at the impactof the deterioration of income and employment prospects on the household saving rate in Japan11

and finds that reduced employment prospects have had a negative and significant impact on
Japan’s household saving rate but that the impact of reduced income prospects is marginal at
best.

Japan’s unemployment rate has increased steadily throughout the 1990s, reaching its

highest level ever (5.5%) in August 2002 and remaining at or near this level ever since.

Thus,

Doi’s finding that reduced employment prospects have induced Japanese households to savemore and consume less is not at all surprising.

(5) Other Factors
Turning finally to other factors that may have influenced the level of household
consumption, (1) the profits of individual proprietors have been stagnant during the current
recession, putting a damper on the consumption of individual proprietors and (2) deflationary
expectations concerning consumer prices may have depressed household consumption because
consumer prices have been falling since the mid-1990s (with the exception of 1997) andbecause price deflation means that the longer one waits, the cheaper one can buy a given item.
By contrast, (3) price deflation might actually stimulate household consumption because it
increases the real value of household asset holdings; (4) near-zero interest rates may havedepressed household saving and boosted household consumption to the extent that the interest
elasticity of saving is positive, (5) the rapid aging of the population may also have boosted
household consumption because the elderly typically finance their living expenses in large partby decumulating their previously accumulated savings, as a result of which their propensity toconsume is typically higher than that of the working-age population, and (6) the introduction of apublic long-term care insurance program in 2000 may have weakened the perceived need to save,thereby boosting consumption.

Thus, there are factors working in both directions, and the factorsthat exert upward pressure on household consumption have presumably prevented the stagnation ofhousehold consumption from becoming worse than it already was.

(6) Summary
In sum, the evidence suggests that the stagnation of household disposable income and12the decline in household wealth (the latter of which was due primarily to the collapse of landand equity prices) appear to have been the main causes of the stagnation of household
consumption during the 1990s and early 2000s.

Increased uncertainty about the future does

not appear to have been a major cause of the stagnation of household consumption during thedecade as a whole, but it does appear to have been of some importance during the 1996-98
period, and increased uncertainty about old age in general and about public old-age pensions inparticular may have contributed to the stagnation of household consumption during the period
as a whole.

Finally, the deterioration of future prospects and deflationary expectations

concerning consumer prices may also have contributed to the stagnation of household
consumption, whereas near-zero interest rates, the rapid aging of the population, and theintroduction of a public long-term care system may have worked in the opposite direction.

4. Conclusion
In this paper, I considered the extent to which the stagnation of household
consumption is responsible for the decade-long recession in Japan during the 1990s and theearly 2000s and the reasons for the stagnation of household consumption during this period andfind that the stagnation of private investment (and inventory investment) rather than that ofhousehold consumption was the major cause of the decade-long recession, that household
consumption was nonetheless relatively stagnant during this decade, and that the stagnation ofhousehold consumption was due primarily to the stagnation of household disposable income,the decline in household wealth (which in turn was due primarily to the collapse of land andequity prices), and to a lesser extent, increased uncertainty about the future (especially about old
age in general and public old-age pensions in particular), the deterioration of future prospects,
and deflationary expectations concerning consumer prices.
Turning to policy recommendations, my findings suggest that the best way to bring theJapanese economy out of recession would be to stimulate private investment in housing andplant and equipment as well as household consumption, and in my opinion, the best way of
doing so would be to introduce temporary and targeted tax breaks for housing and plant and13equipment investment, household consumption, etc.

There are those who oppose tax breaks ofany kind because Japan already has the highest government debt-to-GDP ratio of any majorindustrialized nation in the world, but I favor temporary and targeted tax breaks for thefollowing reasons: (1) the Japanese economy is unlikely to recover fully without further
stimulus, and as long as the economy does not recover, tax revenues will decline further,
causing the government debt to increase further, (2) temporary and targeted tax breaks will
increase the government debt far less than would more permanent and/or broad-based tax cuts,and (3) the tax breaks will be more effective if they are temporary because temporary tax breaks
will induce firms and consumers to accelerate their purchases of the goods and services being
targeted in order to take advantage of the tax breaks before they expire.

Two specificproposals I have are to introduce a temporary investment tax credit for investment in plant andequipment and to temporarily reduce or abolish the consumption tax (currently 5%).

A tax

break for housing investment is already in place but is scheduled to be phased out so anotheroption would be to extend or expand this tax break temporarily.
My analysis suggests that an alternative way of stimulating household consumption
would be to reduce uncertainty about the future, especially about old age in general and aboutpublic old-age pensions in particular--for example by fundamentally reforming the public
old-age pension system to make it solvent as well as equitable.

A major reform of the public

pension system is scheduled for 2004 so what better time could there be for implementing afundamental reform of the public old-age pension system?

If increases in public pension

contributions are needed to keep the system solvent, they should be collected in a way that is
equitable to all cohorts, and that means collecting more from those who currently stand to getback more than they put in (namely, those born in 1962 or earlier) (see Hatta and Oguchi (1999)
and Horioka (2001)).

The current proposal to reduce the earnings replacement rate to 50% andto raise the contribution rate to 18.5% will probably not be enough to make the system solvent,but more importantly, it does not pay any heed to the important issue of intergenerational equity.
In 2003, there was a sharp increase not only in the proportion of people saving for old age but
also in the proportion of people who are worried about old age because of the inadequacy of14pensions and insurance (see Tables 6-7).

Thus, there is an urgent need to allay people’s fears

about public old-age pensions, and doing so will have the added benefit of stimulatinghousehold consumption.
Finally, I wish to note the limitations of my analysis.

In this paper, I have focusedentirely on the demand side of the economy, whereas, for example, Hayashi and Prescott (2002)
focus on the supply side.

Hayashi and Prescott (2002) find that the decade-long recession in

Japan during the 1990s and early 2000s was due primarily to the decline in the growth rate of
total factor productivity and to the reduction in working hours from 44 hours per week to 40
hours per week during the 1988-93 period pursuant to the revision of the Labor Standards Law
in 1988 and that it was not due to the breakdown of the financial system (except during the
1996-98 period).

The decade-long recession was undoubtedly due to both demand-side factors

and supply-side factors, and thus Hayashi and Prescott’s (2002) analysis complements thepresent paper nicely.

As for policy recommendations, Hayashi and Prescott’s (2002) findings

imply that subsidies to inefficient firms and declining industries should be discontinued since
they presumably lower the overall rate of productivity growth.

Such a policy would bringabout an improvement in government finances in addition to enhancing productivity growth andhence would kill two birds with one stone.

I am thus all in favor of making use of

demand-side policies and supply-side policies simultaneously.

Acknowledgements
I am grateful to Sheldon Garon, Takeo Hoshi, Michael Hutchison, Akira Nagae, Shinpei Sano,
Shizuka Sekita, Dong Shen, Dariusz Stanko, Midori Wakabayashi, Junmin Wan, FrankWestermann, Keiko Yoshida, Yanfei Zhou, participants of the CESifo Venice Summer Institute(VSI) Workshop on “Economic Stagnation in Japan,” which was held July 25-26, 2003, in
Venice, Italy, and especially Bernadette Andreosso-O’Callaghan (the designated discussant) and
Keunkwan Ryu for their helpful and insightful comments.

The author is also grateful to the

Ministry of Education, Culture, Sports, Science and Technology of the Japanese Government for
Grant-in-Aid for Scientific Research number 12124207, which supported this research.

15

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19

Table 1: Average Annual Real Growth Rate of Each Component of GDP, 1991-2002
Average Annual Real Growth Rate (percent)Component of GDP
1991-2002
1991-1997
1997-2002
Final consumption expenditure of households
1.35
1.94
0.65
Final consumption expenditure of private non-profit
institutions serving households
4.55
4.64
4.44
Government final consumption expenditure
3.07
2.82
3.38
Private gross domestic fixed capital formation
-1.19
-0.96
-1.47
Housing(-2.58)(-0.72)(-4.76)
Plant and equipment(-0.84)(-1.02)(-0.63)Public gross domestic fixed capital formation
0.71
4.00
-3.09
Dwellings(-0.23)(6.19)(-7.42)
Plant and equipment(0.16)(4.02)(-4.28)General government(0.91)(3.89)(-2.54)
Changes in inventories (inventory investment)-193.06
2.18-183.19
Private sectors(-192.66)(0.24)(-184.32)
Public sectors(-170.10)(na)(-57.31)
Net exports of goods and services
4.55
3.09
6.32
Exports of goods and services(3.74)(4.82)(2.45)
Imports of goods and services(3.52)(5.25)(1.49)
Gross domestic expenditure (product)
1.03
1.58
0.36
Note: The average annual real growth rate of component X between year t1 and year t2 was calculated
as [(X(t2)-X(t1))**(1/(t2-t1)) - 1]*100. "na" denotes "not available."
Source: Naikakufu Keizai Shakai Sougou Kenkyuusho (Economic and Social Research Institute,Cabinet Office, Government of Japan), ed., Kokumin Keizai Keisan Nenpou (Annual Report on
National Accounts), 2004 edition (Tokyo: Dokuritsu Gyousei Houjin Kokuritsu Insatsu-kyoku(Government Printing Bureau), 2004).

20

Table 2: Contribution to Real GDP Growth of Each Component of GDP, 1991-2002
Contribution to Real GDP (percent)Component of GDP
1991-2002
1991-1997
1997-2002
Final consumption expenditure of households
70.30
64.95
96.70
Final consumption expenditure of private non-profit
institutions serving households
4.34
2.58
13.00
Government final consumption expenditure
44.60
24.65
143.02
Private gross domestic fixed capital formation-25.30-13.82-81.94
Housing(-10.95)(-2.25)(-53.85)
Plant and equipment(-14.35)(-11.56)(-28.09)
Public gross domestic fixed capital formation
4.40
17.26
-59.00Dwellings(-0.05)(0.97)(-5.04)
Plant and equipment(0.21)(3.86)(-17.77)
General government(4.24)(12.43)(-36.19)
Changes in inventories (inventory investment)
-7.54
0.86
-49.01
Private sectors(-7.81)(0.10)(-46.83)
Public sectors(0.27)(0.77)(-2.19)Net exports of goods and services
9.20
3.51
37.24
Exports of goods and services(35.54)(28.08)(72.33)
Imports of goods and services(26.34)(24.57)(35.09)Gross domestic expenditure (product)
100.00100.00100.00Note: The contribution of each component to real GDP growth is calculated as the ratio of the realchange in that component over the period in question to the real change in GDP over the same period.
Source: The same as Table 1.

21

Table 3: Composition of GDP, 1991-2002
Component of GDP
Share of GDP (percent)
1991
1997
2002
Final consumption expenditure of households
52.60
53.71
54.48
Final consumption expenditure of private non-profit
institutions serving households
0.82
0.98
1.19
Government final consumption expenditure
13.43
14.44
16.74
Private gross domestic fixed capital formation
24.38
20.94
19.10
Housing(5.21)(4.54)(3.49)
Plant and equipment(19.17)(16.40)(15.61)
Public gross domestic fixed capital formation
6.43
7.40
6.21
Dwellings(0.22)(0.29)(0.19)
Plant and equipment(1.43)(1.65)(1.30)
General government(4.78)(5.47)(4.72)
Changes in inventories (inventory investment)
0.62
0.64
-0.25
Private sectors(0.65)(0.60)(-0.25)
Public sectors(-0.03)(0.04)(0.00)Net exports of goods and services
1.73
1.89
2.52
Exports of goods and services(8.49)(10.25)(11.36)
Imports of goods and services(6.76)(8.36)(8.84)
Gross domestic expenditure (product)
100.00100.00100.00Source: The same as Table 1.

22

Table 4: Average Annual Real Growth Rate, Share, and Contribution of Each Component ofHousehold Consumption Classified by Purpose of Expenditure, 1991-2001
Average
Share ofContribution
Purpose of expenditure
Annual RealHouseholdto Real Household
Growth Rate,
Consumption
Consumption
1991-2001
in 2001
Growth, 1991-2001(percent)(percent)(percent)
Food and non-alcoholic beverages
0.13
14.36
1.41
Alcoholic beverages and tobacco
0.46
2.95
1.00
Clothing and footwear
-2.35
5.18
-10.49
2.34
24.10
37.57
Housing, electricity, gas and water supply
Imputed service of owneroccupied dwellings(2.48)(17.07)(28.03)
Furnishings, household equipment andhousehold services
1.46
5.04
5.14
Health
2.87
3.63
6.75
Transport
0.69
10.25
5.12
Communication
13.95
3.85
21.19
Recreation and culture
2.25
12.05
18.14
Education
-1.32
1.93
-2.08
Restaurants and hotels
2.42
7.06
11.34
Miscellaneous goods and services
0.70
9.60
4.90
Domestic final consumption expenditureof households
1.43
100.00100.00Note: See the notes to Tables 1 and 2 for a description of the calculation method.
Source: Naikakufu Keizai Shakai Sougou Kenkyuusho (Economic and Social Research Institute, Cabinet
Office, Government of Japan), ed., Kokumin Keizai Keisan Nenpou (Annual Report on National
Accounts), 2003 edition (Tokyo: Zaimushou Insatsu-kyoku (Ministry of Finance Printing Bureau), 2003).

23

Table 5: Trends in the Household Saving Rate, 1990-2002
CalendarYear
Unadjusted Household Saving Rate
Adjusted Household Saving Rate
1990
13.9
12.3
1991
15.1
13.3
1992
14.2
12.5
1993
13.7
12.0
1994
12.6
11.1
1995
11.9
10.4
1996
9.9
8.5
1997
10.0
8.6
1998
11.1
9.6
1999
10.7
9.2
2000
9.6
8.2
2001
6.7
5.6
2002
6.4
5.4
Note: See footnote 3 for the difference between the unadjusted and adjusted rates.
Source: The same as Table 1.

24

Table 6: The Proportion of Respondents Saving for Each Motive, 1984-2003
Saving motive
CalendarIllness andunforeseenYearemergencies
Peace of mind
Old age
1984
75.0
25.7
42.1
1985
77.2
26.4
42.5
1986
75.0
25.3
42.5
1987
76.4
26.1
46.1
1988
77.1
28.0
50.2
1989
80.5
28.7
51.5
1990
74.3
25.7
52.4
1991
73.3
23.7
50.5
1992
68.3
23.0
48.2
1993
70.9
23.5
50.1
1994
69.4
24.2
51.6
1995
71.2
25.2
52.9
1996
69.7
25.9
53.9
1997
69.1
24.9
53.2
1998
73.3
24.5
55.3
1999
71.9
27.5
56.7
2000
67.5
27.1
55.9
2001
69.4
26.2
58.6
2002
69.1
26.9
56.9
2003
73.3
25.4
60.4
Source: Kin'yuu Kouhou Chuuou Iinkai (The Central Council for Financial
Services Information), ed., Kakei no Kin'yuu Shisan ni kansuru Seron Chousa(Public Opinion Survey on Household Financial Assets and Liabilities), 2003
edition (Tokyo: Kin'yuu Kouhou Chuuou Iinkai (The Central Council for Financial
Services Information), 2003).

25

Table 7: The Proportion of Respondents Who Are Worried about Old Age, 1984-2003
Calendar Proportion of under-60 respondents
Proportion of under-60 respondents
Year
who are worried about old age
who are worried about old age because pensions andinsurance are not adequate
1984
na
49.1
1985
na
60.6
1986
na
64.5
1987
na
63.5
1988
na
69.6
1989
na
71.0
1990
na
68.0
1991
na
60.8
1992
63.7
55.5
1993
62.0
59.5
1994
69.9
59.1
1995
71.6
56.9
1996
71.3
59.0
1997
78.8
63.1
1998
85.5
67.1
1999
84.1
66.9
2000
84.7
68.1
2001
84.3
66.5
2002
86.6
66.7
2003
87.9
72.2
Note: The denominator in the right-hand column is under-60 respondents who are worried about old age.
"na" denotes "not available."
Source: The same as Table 6.

26

Figure 1: Growth Rates of Household Consumption and Household Disposable Income, 1991-2002

5.00

4.00

Real Growth Rate

3.00

2.00

1.00

0.00

-1.00

-2.00

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Consumption

2.82

2.52

1.32

2.69

1.75

2.43

0.92

-0.33

0.01

1.12

1.64

2002
0.80

Income

4.20

1.54

0.74

1.50

0.90

0.19

1.19

0.82

-0.17

-0.20

-1.35

0.87

Calendar Year

Notes: The line marked “Consumption” shows the annual real growth rate of the final
consumption expenditure of households, while the line marked “Income” shows the annual real
growth rate of household disposable income.

Household disposable income was deflated using

the price deflator for the final consumption expenditure of households.

Source: The same as Table 1.

27

Figure 2: Growth Rates of Household Consumption and Household Wealth, 1991-2002
6.00

4.00

Real Growth Rate

2.00

0.00

-2.00

-4.00

-6.00

-8.00

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Consumption

2.82

2.52

1.32

2.69

1.75

2.43

0.92

-0.33

0.01

1.12

1.64

2002
0.80

Wealth

-4.67

-6.04

-1.34

1.46

-0.44

1.35

-0.25

-1.13

4.06

-0.36

-1.40

-0.95

Calendar Year

Notes: The line marked “Consumption” shows the annual real growth rate of the final
consumption expenditure of households, while the line marked “Wealth” shows the annual real
growth rate of household wealth (net worth) during the calendar year in question.

Householdwealth was deflated using the year-end price deflator for the final consumption expenditure ofhouseholds, where the year-end price deflator was calculated by averaging the price deflator for
the fourth quarter of the calendar year in question and that for the first quarter of the following
calendar year.

Source: The same as Table 1.

28

Endnotes

1This conclusion ignores second- and higher-order effects.

For example, the stagnation of

consumption might have induced firms to cut back on their investment spending.

I amindebted to Keunkwan Ryu for this point.

2

The fact that the real growth rate of household consumption relative to the same quarter of theprevious year was higher in the first quarter of 1996 than it was in subsequent quarters of 1996
(3.3% vs. 2.5%, 1.7%, 2.3%) corroborates this hypothesis.

3

The difference between the two rates is that the latter includes “social transfers in kind,receivable” in the denominator whereas the former does not.

“Social transfers in kind,receivable” are defined as the sum of “social benefits in kind” (the insurance-financed portion of
medical and long-term care services) and “transfers of individual non-market goods andservices” (government consumption that is attributable to individual households such as
government-provided school textbooks).

4

It is, of course, possible that households were not able to save more despite their desire to doso because of declining incomes and wealth.

5 Saito and Shiratsuka (2003a, 2003b) distinguish between precautionary saving (which depends

on the magnitude of risks) and saving as a waiting option (which depends on how long it takes
for uncertainties about the future to be resolved).

They find that precautionary saving has been

more important since the 1980s but that there is some evidence of saving as a waiting option in29

the 1990s.

30