A fallacy of composition: saving is good for an individual, yet very harmful for a national economy
"In Japan, a vicious cycle of oversaving," U.S News & World Report, March 19, 2001
For most of us without a significant inheritance, saving (i.e., not spending all of one's earned income) is the only way to accumulate sufficient wealth to pay for large items such as a house, car or higher education. Yet if too many people try to save all at once, this will significantly reduce an economy's aggregate consumer demand, which, in turn, will decrease output and employment. The consequence will be a severe depression in the economy.
The Japanese economy has been stagnant for more than a decade. Many economists attribute this to the excessive frugality of Japanese consumers. For example, the most popular book in Japan is "The Benefits of a Frugal Life" which explains how to recycle resources, such as using bathing water for a washing machine. The average Japanese saves 27 times more than the average American, and each Japanese household has an average saving of $117,000 in U.S. dollars. Japan has 85 trillion Yen in net assets abroad. Many Japanese households keep their savings in terms of real estate, government bonds or foreign stocks. The Japanese government cannot directly invest in the private sector, and residential or commercial buildings themselves do not produce goods; therefore these savings represent basically economically inactive capital. In addition, foreign stocks are investments in the economies of other countries and do not directly stimulate the Japanese economy.
Because of a low aggregate demand in the economy, the general level of price declined significantly in Japan. Since goods are cheaper, average consumers need to spend less money than before, and this further increases the rate of saving. At the same time, the economic stagnation due to lack of the aggregate demand significantly depressed Japanese stock prices. Many people whose retirement incomes were invested in stocks realized a significant reduction in their potential retirement incomes, and this encouraged them to save more to supplement their company-sponsored retirement incomes. This vicious circle continues, and the Japanese economy is in danger of plunging further into a serious recession.
To work less, save less, and spend more, the Japanese government encouraged its people to adopt the system of working five days a week, which is common in all industrialized countries. Yet, many people find two inactive days in a weekend very unnatural to their lifestyles and traditions. In the extremely crowded apartments in the big cities, people prefer to go to work rather than stay at home. However, to stimulate the national economy, it is vital to increase aggregate consumer demands.
In fact, during the great worldwide depression of the 1930s, the famous British economist, John Keynes, advocated an artificial creation of consumer demands. He recommended that the government hire a large number of unemployed workers to dig a big hole in a mountain. Once dug, the government would continue to employ them to fill up the hole. In the meantime, these workers are gainfully employed, and with their earned incomes, their demands increase. This, in turn, stimulates production and employment in the economy. Many of Keynes' ideas, including the Social Security System, were adopted by the United States government. The basic idea was for the government to give money to poor people, either unemployed or unemployable, who would spend all the government subsidies immediately for consumption (i.e., their marginal propensity to consume is equal to 1, or 100%).
So remember, the next time you buy an economics textbook, not only is it good for your studies and your grade, but you are also contributing to the economic prosperity of the nation.