CHAPTER NINE

Japan’s Great Postwar Weapon

“WHAT MAKES JAPAN SUCCEED?” is the hottest discussion topic today. But what few mention is Japan’s cost of capital.

American and other Western companies pay between 10 percent and 15 percent for money, whether short-term borrowings, fixed debt, or equity. The large Japanese firm has been paying 5 percent at most. And a capital-cost advantage of 200 percent or 300 percent is almost unbeatable. Neither “culture” nor “structure”—the factors most often invoked to explain Japan’s success—underlie Japan’s low cost of capital. The American Occupation gave it to Japan, 40 years ago.

It’s common knowledge that the Japanese savings rate is twice as high as the American, and is, indeed, the developed world’s highest. But only a few historians note that before World War II Japan had one of the lowest savings rates among major countries. After Japan’s defeat, this rate plunged even further and in fact became a dissavings rate, with inflation and violent labor strife rapidly eating up whatever savings had survived confiscatory taxation and destruction during the war.

With cities and factories largely reduced to rubble, the country needed massive capital investment—and there was no possibility to borrow abroad and no Marshall Plan. In this crisis the Americans brought in a Detroit banker, Joseph Dodge, as the Occupation’s economic adviser. He decided that only a radical shift to an investment-driven economy could stave off disaster. He proposed a very sharp increase in income-tax rates even on fairly low incomes; to this day tax rates, especially marginal rates on large incomes, are a good bit higher in Japan than in the U.S. But he also proposed exempting from all taxes the interest earned on Postal Savings Bank deposits of up to 3 million yen per person.

The Experts Howled

In 1950, 3 million yen was equal to only a little more than $8,000. Yet in 1950 Japan that was an astronomical sum—25 times the annual income of the average Japanese, and more than any but the top 2 percent of the population earned in a year.

All the experts howled: the Japanese because of the horrendous loss of tax revenue to an already deficit-wracked treasury; the Americans (especially Washington’s “liberal” economists and politicians) because of the horrendous giveaway to the rich. But Dodge succeeded in persuading a new, young Japanese Minister of Finance, Hayato Ikeda (10 years later to become prime minister) of the merits of his plan. Ikeda pushed it through a skeptical cabinet and an openly hostile Diet.

Inflation disappeared within weeks. Six months later the savings rate turned up and kept on climbing. But tax revenues also began to rise almost immediately. And when the tax-exempt accounts, having done their work, were finally scrapped in 1988, practically every Japanese—poor, middle-income, or affluent—had one. (Some had as many as 20; the limit of one account per person was ignored.) And the highest concentration of tax-exempt accounts was among fairly low-income earners.

These savings financed the explosive growth of the Japanese economy and the export drive. They explain why—almost unprecedented in economic history—a rapidly growing Japan has not had to borrow abroad. And, of course, these tax-free savings explain Japan’s low-cost capital and the tremendous competitive edge it provided.

But that the investment-driven economy worked in Japan is not nearly as important as that America’s and Britain’s alternative—the consumption-driven economy—has not delivered what it promised: investment and low capital costs. Yet the consumption-driven economy still dominates economic theory and economic policy in both the U.S. and the U.K.

Despite their differences, Keynesians, monetarists, and supply-siders all accept a few basic Keynesian postulates: “Oversaving” is an ever-present danger, causing underconsumption and depression. Saving should therefore not be encouraged and might even be penalized safely. If consumption drives the economy, the necessary and productive investment will take care of itself. Rising consumption will create demand for new and profitable production and productive capacity. It will act as the “multiplier” for investment. Fostering and promoting consumption will thus automatically generate both rising incomes and high capital formation.

That there are serious flaws in these postulates was immediately noted by such eminent mid-1930s economists as Lionel Robbins at the London School of Economics and Joseph Schumpeter at Harvard.

No oversaving, they showed, had ever been documented. Nor is there the slightest evidence that, as John Maynard Keynes asserted, oversaving had caused the Great Depression. Worse, Keynes’s own theory rules out the multiplier on which his consumption-driven economy depends. For at the heart of all of Keynes is the postulate that businessmen will invest only if they have “confidence,” which in Keynesian theory is a function of low interest rates and low costs of capital. To play down saving, let alone to discourage it, must drive up interest rates and thus undermine confidence.

The consumption-driven economy triumphed—though mainly in English-speaking countries—because it perfectly fitted the political mood of the postwar period. To penalize saving “soaks the rich.” And to promote consumption “spreads the wealth.” Politically, Keynes himself was pretty much what we now call a “neo-conservative” (then called a “Liberal” with a capital L). He had nothing but biting contempt for Progressives and “bleeding hearts.” Yet, in superb irony, the Progressives accepted his theories and gave them dominance. These theories bestowed legitimacy on their political agenda.

By now we know, however, that to promote saving does not favor the rich. Any country that has given a tax exemption or tax deferment to saving has had the same experience as Japan: middle-and lower-income earners take the most advantage of these opportunities. This has, for instance, been the experience with whatever meager tax deferments have been offered for saving in the U.S. (e.g., in individual retirement accounts or in Keogh plans).

We also know that a consumption-driven economy does not “spread the wealth.” There is far more equality of income in investment-driven Japan than in consumption-driven America or Britain. In addition, though the Internal Revenue Service still refuses to accept this, tax revenues are higher within a few years when saving is favored.

We have learned in the 40 years since Joseph Dodge that nothing works as well in a developed country as legalized tax-avoidance. His tax-exempt accounts in Japan paid laughably low interest—never more than 2 percent a year. Yet the Japanese could not get enough of them. The money savings in America’s IRAs and in its Keogh Plans for the self-employed are often more nominal than real. Yet they are always highly popular. And as attorneys and accountants will attest, people rush into the most dubious “tax shelters” just because they want to beat the tax collector.

The “Incidence” of Taxation

We know, in other words, how to jack up America’s dismal savings rate and how to bring down America’s prohibitively high cost of capital. It is less a matter of the level than of the “incidence” of taxation—which is economists’ double-talk for a chance legally to avoid taxes. And we also know that Keynes was right when he said that high costs of capital destroy “confidence” and inhibit investment. Few investments will earn enough to repay capital costs of 15 percent—but many can easily turn 5 percent, which is what the Japanese pay.

There are indeed profound differences between Japan’s society and the West, especially the U.S. But there is little or nothing that the U.S. and the West as a whole can do about whatever Japanese differences there are. We can, however, do quite a bit to get rid of, or at least to assuage, the enormous competitive disadvantage we suffer vis-à-vis the Japanese through our prohibitive cost of capital. It is not “structural”; it is the result of an inadequate savings rate caused in the main by our clinging to the belief in the consumption-driven economy against our own experience and against all the evidence.

[1990]