Japanese Saving: An Economics Puzzle

Here's an observation on Japan that perhaps represents my best attempt ever to win a Nobel Prize in economics. It's about risk, and savings, and "economic man."

Start with a question: why do people buy casualty insurance? It can't save you any money. Suppose a loss will cost $1 and that the chance of loss is one in four. Then the premium must be 25 cents plus the cost of administration. Granted, people do self-insure some risks, particularly small ones (lots of people turn down the "extended warranty" coverage, for example). But consider bigger risks--fire, theft and casualty on the family jalopy, for example; or trip insurance on your vacation: lots of people could cover these losses on their own, but they'll pay out good money to pass them on.

Why? The conventional wisdom among economists is that people are "risk averse"--that they value certainty more than uncertainty, and will pay a positive sum just to smooth out their flow of wealth. This isn't an "explanation," of course; just an "observation"--at best an empirical observation, either true or not true as the evidence may disclose, just like the assertion that "all bachelors wear bow ties."

But in standard economic discourse, people tend to ignore the empirical part. They tend to treat it as an analytical, definitional ("all bachelors are single men"). I've done it myself, and I forgive myself: as a matter evidence, I think the statement is pretty wellsupported, and it is easy just to treat it as a universal.

Okay, jump cut to Japan--famous for having one of the highest savings rates in the world--down from its peak of a few years back, but still perhaps 10-11 percent of income, which is astronomic, at least by comparison with the US. Traditionally they've also received lousy returns. Why do they accept so much for so little? My friend Kagawachi-san explains:

Japanese face many risks. You may lose your home to an earthquake, for example, or a typhoon. You need to have money on hand for an emergency.

So, why don't they buy insurance? Kagawachi-san continues:

So, why don't they buy insurance? Well, they could buy insurance. But then what if they paid premiums all their life than never had a loss? They would have nothing to show for it. Japanese would rather save and hope to avoid the loss, and and enjoy the opportunity of having something to show for their efforts at the end.

In other words, the Japanese attitude to risk seems to be just the opposite of the American: they'd rather not trade uncertainty for certainty: they'd rather bear the risk of a downside loss to keep the upside opportunity. Fine so far; but recall, risk aversion is built into standard economic thinking as a quasi-analytic proposition. If Kagawachi-san is right, then it is just another empirical hypothesis, leaving the underlying issue--why do people (ever) buy casualty insurance?--unanswered.

Afterthought: As I write, I can think of a couple of complications. One, I can think of one area where Americans tend to think like Japanese. That is pension planning: most folks figure out sooner or later that they need to provide for their old age. They could buy annuities, and some few people do. Burt most do not; why not? One possible reason: returns on annuities always strike me as unrealistically low, which might be reason enough to look for another choice. But another reason is that people seem to find it unbearable that they might have to give up all "their" money: no matter how much they need, they want to be able to leave some kind of estate for their survivors.

Another complication: traditional life insurance. Traditionally, life insurance has usually come packaged with some kind of "investment/savings" paackage. For many potential customers, this never did make any sense: insurance is one thing, savings another, and no need to mix them. People who do want to mix insurance and savings are probably saying something just like the Japanese.

A Disappointment::The Great Risk Shift

Here’s another one I got around to late: The Great Risk Shift, by Jacob S. Hacker (Rev. ed. 2008). But I must say it’s a disappointment. This is a shame. Hacker is basically on the side of the angels: Ordinary Americans do, indeed, bear more risk than they experienced 30 years ago.* They haven’t shared fairly in the great explosion in productivity. And they have lived through a revolution in the management of risk.

Strong start, no follow through. Hacker very quickly plunges into a porridge of soft leftism that succeeds in ignoring, sidestepping or muddling just about every difficult issue.

Here’s a central difficulty: Hacker muddles risk with privation. Some Americans are just too poor. They need handouts—either from the state, or from private charities, or from the person who drops change in their cup. Lots of people are not too poor, but are at risk: they are at risk of losing their job, or suffering a health calamity, or outliving their money. They don’t need handouts. They do need effective means to smoothing their cash flow.

I’m not at all sure how exactly to draw the line between these two groups but I didn’t write the book. To be persuasive, to be analytically coherent, Hacker has to draw it, and then to address the issues as appropriate.

I think there is good reason why Hacker muddles this distinction. That is: he’s part of a discourse in which everybody muddles the distinction. The reason is that everyone—more precisely, both left and right—has a stake in the muddle.

A classic instance is Social Security. From the beginning, Social Security was at least in part a wealth transfer—from prosperous to poor, or at least from young to old (which may or may not be the same thing). The left didn’t want to admit it, because once your program gets tagged as wealth transfer, you lose. So they sold it as “your” savings for “your retirement.”

In time the right figured out that the left could be treed with its own hounds. Okay, so the critics, if it’s just investment, there’s no reason why the government should do it. Of course, the right knows perfectly well that it’s not “just investment,” but they know that the left won’t blow the whistle.

Perhaps an even telling example is the history of private pension plans. Hacker hates 401ks: he thinks they are a cheat, and they never will provide the kind of security that investors need in old age. He treats it as if it is a problem of insurance. But insofar as it is just a problem of insurance, it is a problem that is solvable (we’re even—at last—beginning to see the outlines of a decent annuity market).

The real point—you would think Hacker might have noticed this—is that the shift from company pensions to 401k’s is not just a risk management problem---it’s a shift in wealth. The kind of employer who bore the cost of a company pension simply isn’t bearing the cost any more, and it isn’t giving the money to employees either.

A different issue is the matter of middle class wealth per se. As I say above, I think Hacker is basically right that the middle class is more insecure than it was a generation or so. But less wealthy? I can see at least two problems here.

One, our standards have gone up. We drive bigger, fancier cars. We live in bigger houses with more bathrooms. We take fancier vacations. And we’ve got an infinity of cool toys.

But relatively, we feel pushed. We feel pushed because some of us have become super- (okay, “obscenely”) rich. I get it, I’m pushed; I feel no need to protect or legitimatize the super-rich. But we also feel pushed because the rest of the world is catching up with us. Not just Japanese and Germans but Koreans, Thais and Indians—Indians for crying out loud—are enjoying a life style we once thought reserved for ourselves. Feeling pushed because your neighbor is doing better—it’s a human response, but not edifying. There is simply no reason in principle why Thais and Indians should not live as well as we do. And if it makes us cranky, why so much the worse for us.

There’s also the issue of money. Hacker clearly supports an increased level of public funding for “security” programs. There’s nothing shameful in embracing this view. But he owes us the courtesy of showing us how he is going to pay for it. Conservatives usually blow us off with platitudes about “cutting government waste,” which is of course bollox. But Hacker doesn’t even offer much by the way of bollox.

I can suggest at least one reason why he is reluctant to go after the issue of spending. The reason is that we already have a fairly liberal budget for public services—but a good deal of the money already goes to salaries and benefits for present (or former) public employees. They’re certainly not the super-rich but they are secure and comfortable—often much more so than most of the readers whose cause Hacker presumes to advance. Hacker isn’t likely to make a lot of headway unless he finds some way to persuade the mass of the insecure that it is in their interest to expand a class that is already much more comfortable than themselves.

There is another 800 pound gorilla here—the third rail of liberal politics in this generation. And that is the question of immigration. There’s a large segment of the “insecure” who believe that their problems would be over (or at least more manageable) if only we could make those 12 million illegals go home. I’m not one of that segment; I tend to think that on the whole, immigrants probably do more to enhance the economy than to retard it.

But if the government is to act as provider, there has to be some way of defining the limit of the pool of those to whom the benefits may be available.

In a way it is no surprise that Hacker doesn’t talk about these issues. No “reformist” politician talks about them and with good reason: they’d be blown out of the water if they did. But Hacker is not a politician, he’s a scholar. And a scholar can do better.

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*In response to the original issue of the book, a number of conservative critics challenged Hacker’s assertion about the riskiness of ordinary people’s lives. In this current revised edition, Hacker responds to his critics and sticks to his guns. See the five-page footnote/essay beginning at page 203. The discussion gets pretty arcane on this point, but I’d say on the whole, it looks like advantage Hacker and I don’t think we need to be much distracted by the criticism.