Daniel Ooi explores the socioeconomic and historical forces that have shaped Japan’s risk aversion.

‘Unless you enter the tiger’s cave, you will not get its cub.’ – Japanese proverb

AN IMPOSSIBLE PARADOX
It is ironic that the nation synonymous with risk aversion should also expound the basic principle of risk and return. Japan of the past survived a world war and engineered economic growth so impressive it was dubbed the Japanese growth miracle. But Japan today is known for its obsession with the avoidance of risk. It is Japan’s creativity, innovation and discipline that earned its place as a developed country, and yet today it seems impossible to comprehend, how Japan with its risk aversion, could be the great and thriving economy it once was.

A good deal of Japanese risk aversion can be explained by the domestic labour market, namely the annual hiring process where companies recruit large quantities of new graduates simultaneously. Competition is massive due to the large number of candidates with similar qualifications. Students begin job hunting in their second-last year of university and by the start of final year, informal job offers are sent out. Hence, attaining a good position on a regular job at any other time is extremely difficult as firms rarely hire outside of the aforementioned window. Thus, being sacked or leaving a job may lead to lifelong unemployment. This explains surveys that show less than 10% of Japanese workers are interested in taking a job elsewhere, indicating a refusal to enter risk-bearing ventures such as entrepreneurship. In turn, this stems from the absence of backup plans, such as returning to a low-risk career in the event the enterprise fails to materialise. Entrepreneurship is further discouraged by the permanent employment system. Why bother setting up an uncertain enterprise when you can have an unbreakable rice bowl?

Furthermore, it is common for Japanese companies to prioritise seniority over merit in employee promotion decisions. This incentive system promotes risk-averse workplace behaviour where employees seek to remain in their positions as long as they can rather than undertaking risky endeavours to prove ability. This also applies to Japanese entrepreneurship, where Prime Minister Shinzo Abe has identified Japanese risk aversion as the cause of Japan’s failure to replicate Silicon Valley. This stems from the shortage of entrepreneurs and investors, which is due to culture that does not tolerate risk-taking as a by-product of innovation. Furthermore, risk-aversion translates into social preferences and norms, such as mothers generally preferring individuals with ‘stable’ careers such as doctors and company employees over entrepreneurs as son-in-law candidates. Hence, individuals are pressured to be risk-averse, and by self-selection the Japanese labour force becomes increasingly averse to risk in general.

The Japanese aversion to risk is just as conspicuous among firms as it is ubiquitous among the Japanese labour force. Since Japanese business culture is based on trust, firms are socially incentivized to prioritise stable relationships with clients to maintain long term growth. Thus, firms are unwilling to undertake ventures that involve uncertainty since they are viewed as too risky. Due to cross-shareholding between firms and creditor banks, Japanese firms are strongly influenced by their respective banks in terms of company policy. Historically, banks under the keiretsu system have pressured firms to maximise sales rather than profits. This decreases incentives to undertake risky ventures with the goal of profit maximization, as this may require changing business structure and hence risk upsetting relations with clients, which Japanese firms are not eager to do. Similarly, due to significant trade unions and the importance of trust in the employer-employee relationship, firms are unwilling to undertake investments that lead to reorganizing of the production process.

THE SHADOW OF THE PAST
Another interesting avenue to explore is the economic history of Japan. Japan rose from the ashes of World War II and swiftly built a powerful economy, creating the Japanese growth miracle that saw its rise to the world’s second largest economy behind the United States. Unfortunately, the miracle growth period ended as the asset price bubble burst in 1991 causing sharp declines in asset prices and bank failures. This in turn led to the period of stagnation known as the Lost Decade.

The Japanese economy before and after the economic crisis changed significantly from the optimism and exuberance of the miracle growth era to the pessimism and risk aversion of the lost decade. Households that banked their hopes on the skyrocketing real estate market saw their savings and assets wiped out as the bubble burst into a shower of broken dreams. Drawing on the dramatic shift in expectations before and after the economic crisis, Japanese households radically shifted toward modern risk aversion. The baby boomer generation experienced the economic crisis first-hand while generation X lived through the immediate aftermath. Since risk-averse parents are likely to raise risk-averse children, the phenomenon perpetuates itself. This is clearly displayed in Japanese saving behaviour. In addition to having the highest saving rate in the world, Japanese households show a clear aversion to saving in the form of stocks, opting for safe haven assets with low volatility such as gold and government bonds despite the low returns. The high savings rate may be due to factors other than risk aversion such as an ageing population, but this preference for largely riskless forms of saving can be mainly attributed to risk aversion. This stems from the fact households witnessed large losses of wealth when stock prices declined sharply at the bursting of the asset bubble. Hence, due to loss aversion, they are reluctant to put their faith in equities as a store of wealth.

AN UNCERTAIN WAY FORWARD
The Japanese risk aversion is not constrained to the domestic market and manifests itself in dealings with the world. Japanese culture centers on conflict avoidance, and places great importance on concession. There is also the culture of dealing with the easy problems before the hard ones. For example, while Sino-Japanese relations are historically strained, political analysts suggest that despite radical nationalists in the political circles, there is no risk of Japanese nationalism going unhinged due to the culture of conflict avoidance as well as risk aversion. In addition, Japan hypothetically has options of provoking a full-blown conflict with China, for example on the issue of comfort women, or making an outright apology to reconcile the nations. Both actions are risky – provoking China is costly, while reconciliation risks riling up Japanese ultra-nationalists that revise the national history for their own benefit. Thus, risk aversion has led to Japan maintaining the status quo for Sino-Japanese relations, despite the strain.

From a national defence perspective, Japan ranks eighth in the world for size of defence spending, despite Article 9 in the Japanese Constitution prohibiting declaration of war. Rather than an indication of risk-seeking behaviour, the defence build-up indicates risk aversion. Japan’s defence build-up is insurance to avoid running the risk of being undefended in the event of war, even when it cannot, ironically, declare war.

Considering current global uncertainty, Japan’s risk aversion could benefit its economy in the short term. Japan’s massive current account surplus makes it one of the world’s largest creditors, thus providing a steady stream of income. However, as economies become increasingly isolationist in the face of protectionism and populism, it remains to be seen how Japan avoids another recession since weak domestic demand is unlikely to substitute export-led growth. In the long run, Japan’s ageing and shrinking population will not sustain the engine of growth, considering Japan’s isolationist immigration policies. Japan’s aversion to risk may become a bane rather than a boon to its economy as the start-ups of today will be driving economic growth in the future.

For the rest of the world, it is clear that despite Japan’s economic miracle in the past, its current aversion to risk cannot be emulated. While western economies may benefit from some risk aversion, especially considering the financial crisis of the not-too-distant past, it is unwise to adopt Japan’s affinity for risk aversion as a guide to policymaking in in the presence of global uncertainty. Japan’s risk aversion is unique to itself, a product of its economic history and culture, which cannot be replicated. The days ahead are uncertain, but playing safe is certainly not a risk-free option.


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