Will Japan, which has been viewed as a country with huge surpluses, become a nation with twin deficits (budget and current account deficits)? Overseas investors have been asking this question frequently in recent years, in addition to arguments on the same point coming from Japan.
Japan’s prominent external surplus received criticism and created pressure on the country to cut the surplus in the 1980s when trade and economic friction between Japan and the United States were at a peak. Measures for expanding domestic demand, which were taken to address the situation, went too far and produced a bubble economy. It is quite the problem to make a correction in the current account surplus or deficit a policy goal by attaching importance to the balance of payments only. This is undoubtedly a lesson learned from that experience.
In the author’s view, it is essential for Japan to keep an eye on what is happening to economic and industrial structures, as well as the state of business administration at home that is causing its current account balance to change, and to advance reforms that are necessary for solving internal structural problems. Japan should first direct its attention towards domestic issues for securing sustainable economic growth. The country does not need to adopt as its policy goal a current account balance, which is really an outcome or a symptom.
Current account imbalances surfaced as a global problem at the time of the world economic crisis in 2008. In the 2010s, the budget deficits and current account deficits of countries in Southern Europe became complications in the financial crisis that hit Europe. Meanwhile, the current account deficits of emerging economies have been discussed as a factor in the background of unusual conditions in economies that have recently emerged with an adjustment to the quantitative easing undertaken by the United States. Additionally, changes in current account balances on a global scale have acted as the cause of sudden shifts in international flows of capital.
Nakamae Tadashi of Nakamae International Economic Research, who has always appropriately discussed structural economic problems from a long-term perspective, is paying attention to the dramatic shrinking of the current account surplus of Japan in contrast to the decline in the current account deficit of the United States which could be called the source of a global problem known as current account imbalances. The current account deficit of the United States came to US$713 billion in 2007. The deficit equaled 4.9% of the country’s gross domestic product (GDP) for the same year. The U.S. current account deficit fell to US$451 billion, or 2.7% of its GDP in 2013 (according to a forecast by the International Monetary Fund). Over the same six years, Japan’s current account surplus shrank from 4.9% to 1.2% of its GDP. Nakamae points out that Japan’s current account balance degenerated the most during these six years.
Why has an abnormal situation emerged in Japan’s current account balance? What does this direction mean? There seems to be a need for Japan to examine these points with a cool head now that this abnormal situation is attracting the attention of overseas investors.
Arguments in Japan about this problem have been a little confused, probably because the country’s trade deficit, which is the greatest cause of the dilemma, is expanding too quickly.
A current account balance shows the overall state of transactions in goods, services, and the like, with parties overseas. The balance is a sum of items, such as a trade balance which consists of exported and imported goods, a service balance which includes fares, traveling costs and charges for patents and other intellectual properties, a balance of payments such as interest and dividends involved in overseas investment, and support in kind, including pharmaceuticals provided through Official Development Assistance (ODA) programs.
Since 1981, Japan’s current account balance has consistently stayed in the black and averaged 2.6% of the country’s nominal GDP in the period from 1981 to 2013. However, the current account surplus decreased in an accelerated manner for three consecutive years after reaching a peak of 17.9 trillion yen in 2010. In 2013, the surplus fell to 3.3 trillion yen, the smallest retroactive amount since 1985 when current statistics began.
On a monthly basis, Japan’s current account balance resulted in a loss for four consecutive months from October 2013. Concerns have risen in Japan and abroad that the current account deficit may add to the country’s budget deficit, which shows absolutely no sign of recovery, and turn Japan into a nation with twin deficits. Japan would then become unable to finance its budget deficit with domestic savings alone and the nation may become structurally dependent on foreign lenders. In addition, the government bond and foreign exchange markets in Japan might destabilize with the continued current account deficit as a trigger.
Now, let’s start by examining the chief causes of the reduction in Japan’s current account surplus. Needless to say, what is attracting the greatest attention at this point is the rapid expansion of the trade deficit. Japan’s balance of trade, which plunged into the red partly under the adverse effects of the Great East Japan Earthquake in 2011, resulted in the largest deficit in history of 11,474.5 billion yen in 2013 (on a customs clearance basis).
A trade deficit, however, is not necessarily all bad. The word “deficit” has a negative nuance, but it refers to the differences between the value of exports and imports. The consumption of imported goods works to raise living standards, while there are also loss-producing exports that do not pay. A balance of trade requires a perspective of sustainability instead of discussions on a single-year basis. When applying the proper perspective analysis from many angles, including temporary and structural factors as well as overseas market and domestic economic factors, are essential.
Japan’s trade balance moved into the red the year the Great Earthquake occurred. There is an argument that a sharp increase in exported fossil fuels needed to increase thermal power to deal with the suspension of nuclear power was a particular cause of this outcome. This view leads to the argument that the balance of trade will improve when the operation of nuclear power plants is resumed. However, the problem is not that simple. While the volume of imported fossil fuels surely grew, a resumption in the operation of nuclear power plants will only improve the trade balance by several trillion yen. The overall trade deficit for Japan will still remain at the highest level in history.
How has the depreciation of the yen affected Japan’s trade balance? The yen’s exchange rate against the U.S. dollar weakened about 22% in 2013. The converted yen value of imports denominated in U.S. dollars swelled as a result. This change in the value of the yen seems to have affected the trade balance more than imported fossil fuels. The value of imported fossil fuels also increased as a result of the yen’s depreciation.
Greater attention needs to be paid to the connection between the yen’s depreciation and exports. The value of Japan’s exports rose about 10% on a yen basis in 2013. However, the export volume index fell 1.5% in the same year. Japan’s exports reached a peak value of approximately 84 trillion yen in 2007, and imports rose to an apex of a little more than 81 trillion yen in 2013 when its current account deficit set a new record.
Generally speaking, a balance of trade worsens temporarily with a rise in prices of imported goods and an increase in the value of imports when exchange rates decline. However, the overall trade balance improves gradually as the price competitiveness of exports, in due course, rises and the value of exports grows. A J-curve effect—an improvement after an initial and temporary aggravation—is cited with the balance of trade. For that reason, intentional guidance to low exchange rates aimed at bettering a balance of trade (exchange manipulation) has been called a “beggar-thy-neighbor” policy practiced at the cost of other countries. Competition to lower exchange rates among nations has been viewed as a problem, and the need to avoid such a policy has been frequently stressed in international discussions.
However, the yen has been continuing to depreciate for more than a year owing to the rapid correction of its high value since the around the introduction of Abenomics. In spite of this situation, export volumes have failed to expand, causing the value of imports to increase in a one-sided way. Still, it may be that the J-curve effect has not yet occurred.
Let’s examine the reason why the J-curve effect has yet to appear. Among Japan’s imports, mineral fuels, foodstuffs and raw materials such as iron ore comprise the three main categories. The import of mineral fuels and raw materials such as iron ore is indispensable for Japan, a country with scarce natural resources. However, the value of imported smartphones and other communication devices totaled close to 2.8 trillion yen in 2013. Their value was far greater than the value of imported iron ore, which was a little less than 1.7 trillion yen in the same year. These figures wipe out the image of Japan as a country that imports raw materials and exports manufactured goods.
The value of the communication devices Japan exported in the same year came to only about 530 billion yen. The trade deficit in communication devices exceeded 2 trillion yen. This situation may suggest a deterioration in the competitiveness of Japan’s electronics and electric industries. If this is the case, Japanese companies must distribute their resources more to the development of new products with higher added value and non-price competitiveness instead of competing with low-cost, low-price products from emerging nations.
Business administration for developing new technologies, new products and new services able to secure competitiveness dynamically in new fields is essential at this stage, when the pace of technological progress is high and the speed of technological transfers abroad is rising.
Since the 1990s, when the country’s economic bubble collapsed, Japanese companies have shown an excessive inclination toward passive management by stressing the need to save money. It is this kind of passive management that single-mindedly avoids risk taking. It is herbivorous management that retains profits gained through economizing and neglects aggressive investment in research, development, plant and equipment. How many new products that attracted global market attention have Japanese manufacturers been able to develop in the last 20 years? Both the trade deficit and the current account deficit are the results and symptoms of exactly this kind of management approach. In my observation, the important things are the conditions of industries and management in Japan that have produced such results and symptoms.
We must examine the theory of stages in the structural development of the balance of international payments as another perspective for considering the issue of a current account balance.
The current account balance for Japan has managed to stay positive in spite of the country’s record-breaking trade deficit because Japan possesses the largest net external assets in the world and its balance of payments, which corresponds to the receipts and disbursements of interest and dividends in connection with external assets, has resulted in a large surplus. Japan’s balance of payments was a surplus of just over 14 trillion yen in 2012. This same balance had a surplus of 16.5 trillion yen in 2013.
A current account balance accumulates to produce net external assets. In this theory of development in stages, Japan is currently at the stage of an immature creditor nation. A surplus in the balance of payments keeps increasing even if a trade deficit expands with aging and other developments. This excess enriches people’s daily lives as consumers. For nations with assets, the conditions represent the stage of a mature creditor.
Japan’s structural transition from an immature creditor nation to a mature creditor appears to be a major trend in the progress of its balance of international payments. However, lately the pace of trade deficit expansion has been too fast. Correcting the pace and shifting smoothly to a mature creditor nation are challenges for Japan. To do this, Japan must improve domestic industries, accelerate its metabolism and develop new technologies, new products and new services. The current account balance reflects the domestic economy when the economy becomes more dynamic. The third arrow of Abenomics, a combination of growth strategies and structural reforms, is important for that reason. Policy efforts and business administration reforms in response to institutional reforms are indispensable for this shift. New fields capable of filling partial hollows in Japan that resulted from offshore production transfers by automobile and other manufacturers will come about when these responses are adequate.
Moreover, Japan has a challenge of boosting its earnings power, producing earnings (income) from its enormous net external assets. Problems with the trade balance and a current account balance must be discussed from these multifaceted perspectives, including historical and long-term perspectives. It is important for Japan to advance structural reforms from these perspectives before its population ages further, its domestic savings decrease, and the problem of financing its budget deficit begins to emerge.
Translated from an original article in Japanese written for Discuss Japan. [May 2014]