Sunday, February 22, 2009

When Consumers Cut Back: A Lesson From Japan

"As recession-wary Americans adapt to a new frugality,
Japan offers a peek at how thrift can take lasting hold of a consumer society, to disastrous effect," writes Hiroko Tabuchi in yesterday's New York Times. The article offers examples of how the Japanese are cutting consumption:
Today, years after the recovery, even well-off Japanese households use old bath water to do laundry, a popular way to save on utility bills. Sales of whiskey, the favorite drink among moneyed Tokyoites in the booming ’80s, have fallen to a fifth of their peak. And the nation is losing interest in cars; sales have fallen by half since 1990. . . . a survey last year by the business daily Nikkei found that only 25 percent of Japanese men in their 20s wanted a car, down from 48 percent in 2000, contributing to the slump in sales. Young Japanese women even seem to be losing their once- insatiable thirst for foreign fashion. Louis Vuitton, for example, reported a 10 percent drop in its sales in Japan in 2008.
The premise is that all this thrift is hurting Japan's ability to weather the global recession. "Japan’s economy is in free-fall because it cannot rely on domestic consumption to pick up the slack," Tabuchi writes. Saving instead of spending could lead to deflation, the author warns.

Yet the article, published in the Business section, does little to explain exactly what "disastrous effect" this frugality might have other than to spur deflation. Deflation, in which the prices of goods and services drop, and the value of a dollar (or yen) increases, can be self-reinforcing, possibly leading to what economists call a deflationary spiral, in which production and demand fall together. It is this potential for shrinking GDP--and the accompanying loss of jobs--that worries economists.

While deflation's potential to negatively impact individuals, especially those who haven't saved, is very real, let's look at it in a different way. Given what we now know about the earth's limited ability to provide the raw materials and energy for human consumption (and absorb its wastes), it is very likely that we will have no choice but to curb our consumption in the future, especially since there will be more and more people vying for limited resources. In other words, whether we like it or not (and there is much not to like), consumption cannot expand exponentially forever. Perhaps a shift from borrowing and spending to saving is a rational, sometimes even a desirable trend.

“As the world becomes full of us and our stuff, it becomes empty of what was here before," writes economist Herman Daly. In other words, "When the economy’s expansion encroaches too much on its surrounding ecosystem, we will begin to sacrifice natural capital (such as fish, minerals and fossil fuels) that is worth more than the man-made capital (such as roads, factories and appliances) added by the growth"

The result is
uneconomic growth. The question is not if we will reach that state if we keep growing, but when. Not surprisingly, the answer is subjective and depends on the value we place on “what was here before”—all those fish, minerals, and fossil fuels, not to mention ecosystems, familiar weather patterns, forests, biodiversity, and so on.

While we're used to measuring the well-being of a nation by how fast its economy grows, it is becoming apparent that at least some of this growth in GDP--which depends largely on rising consumption--is uneconomic in nature. That is, after we balance the benefits of our consumption with its deletrious effects, our quality of life may actually be diminished.

is telling that the goods Tabuchi reports the Japanese are giving up are largely luxury items--designer handbags, expensive whiskey, personal automobiles, and the like. That highlights how dependent the world economic system is on what might be considered superfluous consumption. We make every effort to direct our economies to grow not merely to meet our needs, but for the sake of growth itself, doing so because we worry about the "disastrous" effects if we don't: mainly that the economy will contract.

But rarely do we consider the truly disastrous effects if we
do continue to measure success only by growth. In a world running out of cheap energy and filling up with heat-trapping greenhouse gasses, the more sensible approach would be to strive for a more sustainable level of consumption. That's not to suggest that we should embrace the deflationary spiral. Rather, we must redefine the way we measure success--not by more Louis Vuitton handbags and cars but by quality of life and intact ecosystems.

My bet is that the future is going to be defined by limits, and the sooner we can start figuring out how to live comfortably and happily within them, the better chance we have at avoiding real disaster. So instead of brashly calling the reduced consumption in Japan, or anywhere else, "disastrous," we'd do better to keep an open mind and try to learn about how they're adapting. In the wake of our own big bubble popping and the collapse of the financial system as we know it, the spending and saving habits of disenchanted Americans may start to look a lot like those of the Japanese.

In the Times article, Tabuchi quotes a twenty-year-old Tokyo college student: “I’m not interested in big spending. . . . I just want a humble life.” It's an attitude that's certainly not as sexy as that of our recent pre-recession, high-rolling, ultra-leveraged past, but it's one that's much more grounded in reality.


b-dog said...


You have officially reached must read status. Great Post.

Bob F

Anonymous said...

Great article!

Alexandra said...

Very well written, Eric! You have put a hopeful spin on an article that is saturated with 'glass half empty' mentality. I think the article shows and proves how truly adaptable human beings can be. It is this adaptability that makes the future look a little brighter, like the glass is actually half full.

Eric said...

A reader forwarded me this article by Paul Kasriel. As I understood it, the article argues that thriftiness among consumers doesn't necessarily hurt growth in the long term because much of the money individuals "save" gets reinvested into the economy, tipping the balance toward more spending on infrastructure and away from (mostly imported) consumer goods. While I don't agree with all of Kasriel's conclusions, I think the article does a good job highlighting how blunt a measuring tool GDP is.


Commentary - Paradox Squared
Author: Paul L. Kasriel
Date: Tuesday, February 24, 2009

Mainstream economists and the mainstream media continue to embrace John Maynard Keynes’ notion of the “paradox of thrift.” While most economists subscribe to the view that the pace of long-run economic growth is a function of productivity and thrift (saving), short-run growth can be retarded by too much thrift.

According to this view, if households in the aggregate decide to cut back on their current spending, i.e., save more, aggregate economic demand will be negatively affected. Hence, the paradox of thrift. A little later in this commentary, I will try to dispel the notion that thrift retards growth in aggregate demand in the short run.

But before getting into this aspect of economic myth-busting, I want to call your attention to a February 19th WSJ opinion article by a member of the paper’s editorial staff, Daniel Henninger, entitled “Obama’s ‘Hair of the Dog’ Stimulus.” Henninger essentially buys into the paradox-of-thrift argument. He cites the “Making Work Pay” element of the new fiscal stimulus plan as a way of giving a tax rebate to households with a lower probability that the tax reduction will be saved. Again, according to Henninger, an increase in saving would mute the stimulative effects of the new fiscal program.

Is Henninger actually endorsing an economic plan that does not include reductions in marginal tax rates? Not to worry. He falls into line with The Journal’s monolithic editorial view that any stimulus plan devoid of marginal tax rate reductions is bound to fail in igniting aggregate demand because American households have rediscovered the virtue of thrift.

To buttress his case, Mr. Henninger cites an authority on the subject of women’s marginal propensity to consume/save, Anna Wintour, the editor of Vogue. Ms. Wintour’s sampling, scientific, no doubt, suggests that ladies of leisure will be cutting back on their current spending. (To be complete, perhaps Mr. Henninger should have consulted Playboy’s octogenarian playboy, Hugh Hefner, as to what we men will be doing with our extra eight dollars a paycheck.)

Moreover, Mr. Henninger says that President Obama has met the enemy of household spending and it is the president himself. You see, President Obama has an “austere persona” that evidently promotes household austerity! I found it paradoxical that anyone on the editorial board of The Journal would embrace anything Keynesian such as the paradox of thrift. Hence the title of this commentary, “Paradox Squared.”

Let’s get economically objective. Thrift or saving does not necessarily mute aggregate demand in the short run or the long run. As any economist of the Austrian school will tell you, saving simply implies one economic agent cutting back on its current spending and transferring its spending power to another economic entity. For example, suppose a household decides to cut back on its current spending in order to purchase an about-to-be issued corporate bond. The household is transferring its purchasing power to the corporation.

Presumably, the corporation does not intend to simply sit on the proceeds of its bond sale. Rather, the corporation likely borrowed funds in order to spend now on some capital equipment or R&D. So, the act of increasing its saving on the part of the household does not lead to a reduction in aggregate spending in the economy, just a redistribution of spending.

There is, however, a special case in which an increase in thrift will result in a fall in aggregate spending. This is the case of “hoarding” money – currency and bank deposits. Hoarding in this sense is the term classical economists used to describe what hip-hop economists refer to as an increase in the demand for money to hold, or a decrease in the velocity of money. If more and more households wish to curtail their current spending and increase their money balances, this will lead to a decline in aggregate spending in the short run if the supply of money is not increased commensurate with the increased demand for it to hold.

The supply of money is created by the new lending actions of banks in cooperation with the central bank, the Fed in the U.S. case. An increased demand for money to hold does not automatically elicit an increase in the supply of money. Let’s say that an employee of XYZ Company decides to save a larger portion of her paycheck in the form of increased money balances. On payday, XYZ transfers into the employee’s bank account the employee’s salary. So, XYZ’s bank account is debited by the same amount that the employee’s bank account is credited. No new money is created in this process. All that has happened is that the ownership of money has changed. No net new bank credit is created in this process. Although the employee’s bank has gained some additional reserves in the process that would enable it to create some new credit, XYZ’s bank has lost reserves, requiring it to extinguish credit, all else the same. Aggregate spending does decrease because the employee cuts back on her spending in order to increase her money balances.

So, the paradox of thrift, which mainstream economists and Mr. Henninger so readily embrace, is only paradoxical in the special case in which the public’s demand for money to hold increases. How do these economists and Mr. Henninger know ahead of time that tax rebates will be accompanied by an increased demand for money to hold on the part of households? Even if the demand for money to hold does increase, I can make an argument that the supply of money available to be held is likely to increase. The Treasury is going to issue securities to finance its new spending and tax rebate programs. If, which is likely, banks and the Fed purchase a large quantity of these Treasury securities, then the supply of money will increase. An increased demand for money to hold matched by an increased supply will not lead to a decrease in aggregate spending.

There is one other tangential economic myth that I would like to bust – that the U.S. economy cannot grow rapidly unless there is a high level of consumer spending. I would ask you to turn your attention to the chart below. The line in the chart is the five-year moving average of the ratio (in percentage terms) of real personal consumption expenditures to real GDP. The bars are the five-year compound annual rates of growth in real GDP excluding federal government expenditures. Notice that in recent years, the consumption ratio has moved up significantly. Notice also that the real GDP growth rate has moved down significantly. The most rapid real GDP growth we experienced in the 1951 through 2008 period occurred in the 1960s, a period when the consumption ratio was relatively low. My bet is that when we come out of this current deep recession (Q4:2009?), the recovery and expansion will be accompanied by a much lower consumption ratio than we have experienced in recent years and higher export and business capital spending ratios than we have experienced in recent years. But most importantly, I expect that these changing ratios will be accompanied by higher growth in real GDP ex federal government than we have experienced in recent years. Why? Because, as I stated at the outset, the pace of economic growth is a function of productivity and thrift. And no less an authority than the editor of Vogue says that thrift is in vogue again!

Anonymous said...

Fascinating stuff. This gives me hope that some long-term environmental good may yet come from our present economic situation.

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