No. 5 — February 9, 1996


Weekly Review

--- by Douglas Ostrom

The scriptwriters on either side of the Pacific hardly could have asked for statistics that fit their respective stories better. The Ministry of Finance's customs-clearance trade figures for 1995 conformed with both the Clinton administration's apparent argument that its trade policy vis-a-vis Japan has been a great success and a common argument of Japan's public- and private-sector analysts that the nation's trade is shifting dramatically to Asia. The statistics also indicate that future developments could compel a rewrite of both stories, however.

The starting point for both arguments is the fact that Japan's 1995 trade balance declined 11.4 percent on a preliminary basis as measured in dollars (see Table 1). As such, the surplus fell to the lowest level since 1992. The decline as measured in yen, a yardstick increasingly favored by Japanese analysts, was an even sharper 19.3 percent, putting the imbalance by this measure at the lowest rung since 1990 (see Table 2). In both cases the drops were even greater in the fourth quarter than for the year as a whole. However, these overall trends concealed sharply divergent regional movements. Japan's dollar-denominated trade surplus with the United States fell 17 percent last year to $45.6 billion (see Table 3). Given that most American attention is focused on this number — and the corresponding figure from the Department of Commerce to be released in mid-March, which is likely to show a similar trend — Washington's arguments that its Japan trade policy has borne fruit would appear to gain some statistical support.

In contrast, Japan's trade surplus with Asian nations grew 14.9 percent in 1995 despite the drop in the overall imbalance. At $70.7 billion the regional surplus was larger than that with the United States and the European Union combined. Japanese analysts explained that the high yen, which appreciated 9.2 percent in 1995 using either export or import prices, resulted in a shift of production capacity to relatively low-cost Asian locations. In the short term the consequence was to boost the regional imbalance, as Japanese firms shipped capital equipment from home to get the new facilities up and running and also supplied them with inputs, the argument continued. Once the plants become operational, however, the long-term effect is likely to be higher Japanese imports from these Asian nations. One way or another, Japan would appear to be increasingly intertwined economically with Asia and less linked to the United States.

This interpretation of Asian developments would appear to give Japanese policymakers two debating points for future use with their American counterparts, should they decide to use them. First, Japan's economic fate increasingly is tied up with Asia rather than North America or Europe, a view suggesting that Tokyo can bypass Washington and its trade demands if need be. Second, Americans should stop bellyaching about the U.S.-Japan trade imbalance inasmuch as the larger surplus with Asia has not attracted comparable criticism. (In some countries, such as South Korea, however, the chronic deficit with Japan exerts a significant impact on trade policy. See JEI Report No. 37A, October 6, 1995.)

Analysts in Washington and Tokyo write a good deal more into their stories than these brief summaries suggest, of course. Some of the apparently minor themes deserve top billing, however. The yen-dollar exchange rate is a prime example. Given lags of as much as two years between currency changes and their impact, the yen-dollar relationships of 1993 and 1994 are relevant to the 1995 trade figures. Early in 1993 the dollar was trading for more than 120 yen, but by the summer of 1994 the U.S. currency had depreciated to less than 100 yen and to just over 80 yen last spring. In the last four months of 1995 the dollar rallied to more than ¥100=$1.00, but this movement came too late to have any real effect on investment decisions. As a consequence, for all practical purposes 1995 trade took place in the context of an ever-weaker dollar.

Econometric studies suggest that these currency fluctuations are behind the shifting trade numbers more than any individual series of trade negotiations or even all the trade talks taken together that Japan has had with the United States and other countries. The latest trade figures support that conclusion. For example, the volume of exports, which have not been the subject of widespread negotiation, rose a mere 3.4 percent last year, a sizable gain to be sure but a smaller rate of expansion than economic growth rates in many of Japan's most important trading partners, especially those in Asia. By contrast, import volume grew 12.5 percent, a remarkable jump in light of the fact that the Japanese economy spent much of the year dead in the water. Trade negotiations did not cover a broad enough range of economic activity to begin to explain an import expansion of this magnitude. By contrast, exchange rate fluctuations could be predicted to cause changes in both exports and imports in the direction and more or less on the schedule implied.

Whether the Clinton administration deserves credit or blame for the yen-dollar exchange rate's fluctuations is open to debate. The beginning of the yen's run-up does coincide more or less with the advent of the new administration in January 1993. Furthermore, probably a majority of Japanese analysts believe that currency market developments between 1993 and 1995, which they typically deplored, should be put at Washington's doorstep. Yet, U.S. economic policymakers downplay their own role, a view in broad accord with independent American analysts who believe that, in the absence of other macroeconomic changes, government action to target exchange rates is not likely to have a lasting impact.

The argument that the yen-dollar exchange rate was a factor in investment and trade with Asia does not mesh well with the implicit argument that Japanese dependence on the United States will be less to the extent that Asia's importance grows. Asian nations became more attractive investment destinations for Japanese companies in 1995 precisely because those nations, in turn, were tied closely to the United States and its currency. This dependence is why Asian exchange rates can be tied more credibly to the dollar than to the yen and why regional currencies have tended, along with the dollar, to depreciate against the yen since 1993. (For 1995 developments regarding the yen and Asian currencies see JEI Report No. 2B, January 19, 1996.)

To the extent that the Washington and Tokyo stories regarding bilateral imbalances and an apparent Japanese shift toward Asian trade actually depend on currency values — as opposed to trade negotiations or historic shifts in the geographic focus of trade — they remain vulnerable to exchange rate fluctuations. In fact, potentially significant changes have occurred already. The yen's recent value of around ¥105=$1.00, coupled with higher rates of inflation in the United States than in Japan, implies that in real terms the dollar in early February was higher against the yen than at almost any time in the past three years. This suggests that most of the lagged changes in export and import volumes resulting from the yen's appreciation are now history. Absent significant additional exchange rate movement in one direction or the other, neither Japan's global trade surplus nor various bilateral figures are likely to move much, other factors equal. The improvement in both Japan-U.S. and overall imbalances as well as the apparent shift of Japanese trade toward Asia could come to a halt and be reversed, if the yen were to continue moving away from the ¥100=$1.00 level.

Those policymakers on either side of the Pacific hoping for a smaller Japanese external imbalance should not get too discouraged, however. In addition to exchange rates, the other big factor affecting trade imbalances is economic growth, which leads to increased imports and reduced trade surpluses. For the past four years the rise in U.S. and Asian economic activity has been significantly greater than in Japan. As such, the effects of exchange rates and economic growth have been partially offsetting. Signs early in 1996 of a pickup in the Japanese economy and a slowdown elsewhere are proliferating, suggesting that further reductions in Japan's external imbalance may be a result. Although analysts in the recent past repeatedly have underestimated the durability of both the Japanese recession and the American expansion, this year their predictions of reversals may be right. The likelihood of a contractionary impact for external imbalances from economic growth rates appears at least great enough to offset the possibility of a currency-induced rise. As usual, though, writers of economic scripts are well-advised to avoid etching their tales in stone.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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