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A Multi-Country Evaluation of Trade Imbalances |
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April 1999
I. Introduction For more than 20 years except for the oil crises, Japan has been consistently running a current account surplus every year (Figure 4.1). And since 1980 from when the IMF's international financial statistics yearbook started to publish the numbers for international investment position, Japan has been always a creditor country (Figure 4.5) and nowadays the international financial assets per capita in Japan is largest in the world. Therefore, Japan definitely fits into the category of a net creditor country running a current account surplus. On the face of it, Japan looks to be in the best economic position any country can think of though, the implication regarding the current account surplus and foreign assets possessed by Japanese are rather complicated. From now on, I will examine whether the trade surplus which is huge enough to create a lot of tension with the other trading partners, is good, bad or benign for Japan by using other statistical data including international investment position and real GDP growth rate as well as trade related statistical data. II. Analysis Current Account Surplus As you can see in three figures 4.1, 4.2 and 4.3, Japan's current account surplus stems from
merchandise trade surplus and income receipts from the overseas investments. If you look at only
the balance on service trade, you can notice that Japan has been always running service trade deficits
and net exports of
merchandise goods are
somewhat offset by net
imports of service goods.
As a result, it has become a
Japan's trade pattern that it
runs a huge merchandise
trade surplus and at the
same time a service trade
deficit. This is illustrating
that Japan is not
necessarily exporting
goods to the foreign
countries all the time, but it
is also importing a large
amount of service goods
from the other countries.
And it means that the Japanese service sector does not have much competitiveness relative to the
other countries.
Real GDP Growth Rate of Japan The real GDP measures how much the country produced in its domestic market in one year eliminating the effects of inflation on the real value of the products. Looking at Figure 4.4, you know that Japan has been recording positive real GDP growth rate since 1975, which means that Japanese economy has been continuously growing from over 20 years ago. But it does not mean that Japan has achieved a stable growth rate for that period. Average real GDP growth rate from 1971 to 1980 was 4.6 percentage point and that from 1981 to 1990 was 4.1 percentage point respectively. In the course of this 20 years, Japanese economy experienced big changes in the growth rates once in a while. Firstly in 1980, the real GDP grew much slower than earlier, mostly because of the second oil crisis and slowdown in the public investment. And secondly, in 1986 the real GDP growth rate again plunged. This time, the culprit for this plunge was the big adjustment of Yen and Dollar exchange rate in the international financial market and following depressed private investment. Through the Plaza Accord, the Yen jumped up by as much as 30 percentage point against the Dollar in a year and it hit the Japanese export and domestic business sector so much that this abrupt huge appreciation of Yen contributed to the drop in the real GDP growth rate in 1986.
When it comes to the assessment of the current account surplus, it is important to take into account the other data regarding to the economic growth over the years in order to see if the economy as itself is also growing in line with the large size of its current account surplus. If the large current account surplus is based on a country's strong economy, reflected by a strong domestic demand, that surplus does not pose any problem. But conversely, if the domestic demand is weak and a current account surplus is too large, its trade imbalance can be seen as a bad sign for the country. Therefore, no matter how much the country is earning foreign currencies from the other countries by export, it does not necessarily show what's exactly going on in the domestic market of the country. In the case of Japan after 1990, the large current account surplus has not corresponded to the GDP growth rate. So, we can not say that the reason for the huge surplus was coming from the excessive supply of the goods over the strong population's demand for them in the domestic market because the real GDP growth rate was slowing. Thus, we can find that during that period, a weak domestic demand has been the source of the huge Japanese current account surplus. In other words, a strong trade figures represents rather weak state of the Japanese economy. Net International Investment Position
Secondly, especially at a time when domestic interest rates are extremely low like now, the Japanese can benefit from the higher interest rates offered abroad and enjoy the higher returns than what they can get in the domestic market. As the people have started to live longer than ever and the birthrates are keeping falling down, currently young generation desperately needs to prepare for their retirement well because public and corporate pension schemes are likely to fail to give them sufficient benefits after they retire. However, the huge amount of investment in foreign countries contains several negative implications as well. One of them is that those investments are very much exposed to foreign exchange movements. Although Yen's appreciation may well contribute to driving people to hold foreign assets because every foreign goods starts to look cheaper than ever, if the appreciation proceeded too much and the currency in which the Japanese investment is denominated depreciated substantially, the value of the assets, after converted to Yen, would get shrunk and even go below the initial investment unless you hedge and capital gains are big enough to offset the exchange losses. In fact, from 1985 when the Yen- US dollar exchange rate was adjusted in the Plaza Accord, Yen significantly appreciated especially to the US dollar (Appendix 1). Because considerable amount of the Japanese Yen invested in the foreign financial assets was denominated in the US dollar, this excessive appreciation clearly reduced the value of the Japanese foreign assets to a great extent. Secondly, the foreign assets contain risks of price drops caused by the foreign financial market turmoil. If you don't diversify your investment portfolio into different kinds of assets and different currencies, you may incur financial losses from the foreign countries' financial problems. The same caution applies to the foreign direct investment as well. In this context, the huge investment assets abroad can make Japan's financial asset position fragile under some circumstances, exposing it to a lot of foreign factors which Japan can not manage on its own. In the end, increasing international investment, especially foreign direct investments abroad has the risks of hollowing the Japanese industries. Because investment is one of the main sources of future prosperity for the country, if many companies keep getting out of Japan through FDI, Japan may end up with fewer private investment in its domestic market and it will lead to less potential for the future economic growth based on that investment. Investment Rate toward GDP after 1973
During the bubble era, companies were scrambling to invest much money only to increase the already large production capacity and to increase the values of the property and securities which ended up with well above the fundamental values afterwards. Therefore, we need to be careful that the mere incident of large amount of domestic investment relative to GDP can not guarantee you anything about the economic growth that the country can enjoy in the long run, unless those investment are made in the right places. Private Consumption ( C ) and Government Spending ( G ) per Capita The first and foremost reason for this long lower real growth rate of private consumption is that the current recession was triggered from the very domestic factor which is failure to tackle with the fallout from the burst of the asset bubble by strong determination, not from the foreign factors such as oil crises and the rapid appreciation of Yen Japan had experienced in the history. That is, it has much to do with the Japanese economic structure as itself and unless the problems incorporated in the structure are solved, the economy does not recover and then, the private consumption can not increase, either. The examples of the problems regarding the Japanese economic structure are reluctance of the Japanese government to take necessary drastic measures to pull the country out of this recession, many regulations hampering innovation and bureaucratic system still wielding a strong influence in the markets and so on. Illustrated by the fact that despite a string of stimulus packages launched by the Japanese government, the private consumption does not seem to recover easily, Japan clearly needs to implement other measures to revive its economy not only from the demand side, but also from the supply side. III. Conclusion In 1997, Japan had real growth rates which were lower than those in 1996 in all domestic demand categories such as private consumption, private investment and government spending and in GDP.(1) As for private investment and government investment, the real growth rates were even negative. Therefore, in the short term, it is clear that Japan is facing a lot of difficulties to stimulate the domestic demand. If we regard the domestic demand as a yardstick of standard of living in the country, no matter how big the figure of the Japanese current account surplus is, it does not mean that Japan is enjoying a high level of standard of living at that period. But in the long term, the currently large current account surplus can be expected to play a big role. For, as I mentioned earlier, Japan is going to face a critical change of demography relatively soon, caused by lowering birthrates and longevity, therefore, high level of domestic saving represented by a huge current account surplus is very necessary for Japan to keep a standard of living at a reasonable level when the current workforce starts to retire. Since retirees tend to spend more than the workforce does, it may become real that Japan finally runs trade deficits. If this happens, Japanese may need to break up their savings they have been accumulating from the trade and rely on them to avoid lowering their standard of living. Therefore, the fact that Japan has been running a large mount of current account surplus right now can work very positively for the Japanese population in the long term. Summing up the favorable and unfavorable effects of the Japanese huge current account surplus, I would say that the surplus can be a positive and negative indicator for the Japanese economy, depending on the domestic economic situation in the short term. If the domestic demand, composed of private consumption and government spending and private investment, and real GDP growth rate are strong enough, the large current account surplus is nothing to worry, although there are several problems depending on which country you are looking at because for Japan, the real return for the domestic investment is not so high. But if the country is suffering from recession or ailing economy which is the case for Japan at this moment, the surplus is indicative of the low level of standard of living and therefore, the large size of current account surplus can be a problem. On the other hand, in the long term, the Japanese long running current account surplus is a good thing, considering forthcoming serious demographic change.
Work Cited International Financial Statistics Yearbook Vol. LI, 1998 Washington,DC : IMF Statistics Department, International Monetary Fund Balance of Payments Statistics Yearbook Volume 48, Part 1 : Country Tables, 1997 Washington,DC : IMF Statistics Department, International Monetary Fund Comparative Economic and Financial Statistics, Japan and Other Major Countries, Tokyo : International Department, Bank of Japan, 1994 Currency Indices : JP Morgan & Co. Incorporated, 1999 Toyo - Keizai Tokei Geppo, Tokyo : Toyo - Keizai Shinpo - sha, 1998, 1999 Shukan Toyo - Keizai, Tokyo, Toyo - Keizai Shinpo - Sha, 1997 OECD Economic Outlook, Paris, OECD Publications, Organization for Economic Co-operation and Development
1. OECD Economic Outlook, December 1997, p67
©1999 The Elliott School of International Affairs, The George Washington University, ALL RIGHTS RESERVED Last Updated on 10/9/99 |
As for income receipts, which is another category of current account, Japan has
been running a similar size of surplus to service trade deficit. Usually, in order for the country to
record the positive income receipts, it has to own a reasonable amount of international financial
assets. Those assets are owned by the Japanese in the form of foreign portfolio investment and bank
deposits in foreign banks and they create income and dividends to the Japanese investors to be
incorporated in the current account balance. Overall, as of 1997, its current account surplus is 121
billions of US$ and this large surplus means that Japan earned this amount of foreign currencies from
the trade of goods and services and from the income receipts for the most of the part. And the flip
side of this current account surplus is the capital account deficit. Therefore, almost the same amount
of money Japan earned in the current account goes out of Japan as foreign direct investments, foreign
portfolio investments and other type of investments every year.
Although the large current account surplus tends to be seen as a symbol of a strong economy
and something any country wants to have, it can sometimes be problematic depending on the size of
the surplus. Remember the following national income identity equation. Y (GDP) = Private
Consumption ( C )+ Government Spending ( G )+ Domestic Investment + (Export - Import). The
three former terms in the right hand side of this equation represents the domestic demand and the rest
of (Export - Import) is the net export, representing the foreign demand. From this equation, you are
convinced that the larger the net export is, the smaller the domestic demand has to be. Because the
domestic demand shows you how much the people in that country consumed in one year, which is
one of the ordinary ways of measuring the standard of living of the country, the small number of
domestic demand is something to worry. If the larger the net export is, the less the population can
consume and the lower the standard of living is.
Suppose that the net export in this equation is the same with current account surplus in the
Japan's balance of payment, you may be able to conclude that Japanese are not enjoying high standard
of living because of its huge current account surplus. But this interpretation of the current account
surplus can not be true in every case. For if the country is producing much more than it can possibly
consume domestically, it has
to export the excess
products to the foreign
countries and as a result it
will run the current account
surplus. Obviously, this
case does not mean that the
country's domestic demand
is weak enough to create a
problem about the standard
of living. Instead, it is
basically saying that this
country's economy is just
strong to enable the country
to generate more than the
needs of the population.
Because there is no problem
with the strength of the domestic demand, this case is an example of a genuinely strong and healthy
economy. Thus, it is very important to take a look at the other statistical data, not only the size of the
current account surplus in assessing the fact that the country is running a large current account
surplus. Therefore, in the next paragraphs, I will examine which case I put above is more closely
describing the Japanese economy, by looking at the real GDP growth rate of Japan.
The last period in which Japan had unusually small growth rate was from 1992 to 1994. In
fact, from 1990 the real
GDP growth rate was
falling down sharply till
1993. Needless to say, it
owed much to the burst of
the asset bubble in 1990.
The suddenly depressed
asset prices hit the private
consumption and private
investment so much that
after 1990, it took several
years for the Japanese
economy to show the
recovery by 1996.
However, in 1996 the real
GDP grew at a higher rate
relative to the previous
years and Japan looked to be recovering, thanks to the huge increase in the domestic investments
though, in the past 6 years from 1991 to 1997, the real GDP growth rate averaged 1.7 percentage
point which is substantially smaller than growth rates in the 1970s and 1980s. The reason for this
poor growth is attributable to the weakened private consumption and domestic investments caused
by fiscal tightening in 1997.
From 1980 when the international investment position started to be recorded in IMF's
international financial
statistics yearbook, Japan has
been keeping a creditor
position (Figure 4.5).
Including debt and equity,
the net international
investment position amounts
to 19.4 percentage point of
GDP as of 1996. This large
amount of foreign assets held
by the Japanese has some
undesirable problems as well
as desirable ones. As one of
the desirable signs, Japan can
count on this huge financial
wealth accumulated in
foreign countries at a time
when Japan's current
account surplus turns into
deficit in the future. In that case, Japan can pay for the excess import over export which may be
caused by future retirees, by cashing in its foreign assets.
Compared to other countries,
Japan has been investing a larger share
of GDP which is around 30.8
percentage point of GDP on average
from 1973 to 1997 (Figure 4.6). The
domestic investment represents one of
the potentials to enable the country to
grow in the long run because
investment can create more production
capacity, improvement of the
production facility and innovation in
the domestic market which are all
crucial factors for the future economic
growth. Therefore, falling investment ratio against GDP means that the country might risk keeping
expanding its economy in the long run. However, destination of the investments is as important as
the volume of the investments. In the case of Japan, it is sometimes doubtful that all of the domestic
investments have been used for the productive purposes in the history. Because of the quick effect
of the investment on the GDP growth, as long as the GDP kept rising along with the investment,
Japan failed to pay much attention to the real return from that huge investment until the burst of the
asset bubble occurred.
Looking at Figure 4.7 gives us how steadily the real C + G per capita in Japan has been
growing for over 20 years since 1973. Despite several times of economic stagnation during the
period, that the real C + G has been continuously increasing means that the people's standard of living
looks to never fail to improve
year on year. But here, I want
to mention the importance of the
role which the private
consumption is playing in GDP
because especially nowadays
amid the worst recession since
the war, the Japanese private
consumption does not grow as
much as before and its recovery
is a key to get the economy back
on the self-sustaining growth
path from now. From the Figure
4.8, the real growth rate of
private consumption has been
kept at a lower pace than the previous period after the burst of the asset bubble. In fact, Figure 4.8
gives you a different picture of the Japanese economy from Figure 4.7. This difference comes from
the mighty effect of the government spending, in particular, public investment on Japan's GDP.
Appendix 2 shows you the real growth rate of government spending which is composed of
government consumption and government investment. As you can notice, during several years from
1990 after the asset bubble ended when the private consumption started to dwindle, the government
injected considerable amount of money in the domestic market in an attempt to boost the economy.
This enabled the real C + G per capita to grow at a stable pace over the period. Because in Japan,
the government spending sometimes works only in ad-hoc way and its effects do not last for a long
period, it might be better to break down C + G into C and G respectively in order to grasp the real
standard of living for the Japan's population.
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