Challenges to American competitiveness: a Japanese perspective - The Economy of the Pacific Basin

Business Economics, April, 1994 by Keikichi Honda

THE COUNTRIES of the Asia-Pacific region, especially Japan, are notorious for the presence of structural barriers. Some of these perceptions are based on biased viewpoints, but many are not. If barriers are defined as any structure that interrupts movements of goods, services, or capital based strictly in an economic sense, then recently we have unfortunately observed the emergence of a new kind of barrier: an exchange rate barrier.

THE EXCHANGE RATE BARRIER

Because of this barrier, a big fence against Japanese products has been erected surrounding U.S. and European markets. At the same time, U.S. and European corporations face a high fence blocking further investments in Japanese domestic markets. This exchange rate barrier would not be called a barrier if Japanese domestic demand had not lost its appetite and had not prevented the appreciating yen's triggering explosive import growth for Japan. The present combination of circumstances suggests that it wasn't too good an idea for U.S. authorities to suggest a stronger yen. Indeed, seven months ago Treasury Secretary Bentsen actually preferred a stronger yen rather than a weaker dollar.

He was right to reject a weaker dollar, which makes dollar-denominated financial assets less attractive to overseas investors and adds to selling pressure and pressure for higher interest rates. This effect, combined with a likely correction in stock market prices, would provide a negative impact on the general recovery of the U.S. economy, reduce revenues for the U.S. government to meet President Clinton's admirable and ambitious effort to cut the budget deficit, and raise refunding costs for the government. A weaker dollar could also contribute to pressure on import prices.

Thus, Mr. Bentsen rightly preferred a stronger yen and a weaker dollar against only the yen. As a matter of fact, the dollar has appreciated substantially against European currencies since September 1992 when the ERM faced its major crisis.

The hope that the stronger yen would lead to an advantage for the U.S. in the world export markets, in particular a boom in U.S. exports to the Japanese markets and a disadvantage for Japanese exporters to the U.S., has been based on two important assumptions:

1. Japanese exporters pass through higher yen costs to dollar-denominated export prices;

2. Japanese importers symmetrically pass through lower dollar costs to yen-denominated domestic prices.

Unfortunately, neither has happened to the extent it was hoped. The most important consequence has been the creation of large-scale, widespread, and unprecedented layoffs in Japan, as exporters find that their margins cut, and even experience losses.

The layoffs are not exactly like American-style labor-force reductions. Rather, Japanese-styled layoffs have created enormous numbers of in-house unemployed, a severe loss of overtime income, and layoffs of part-time workers, factors which together have suddenly instilled a fear of unemployment among regular employees. This environment is actually an unprecedented situation for the Japanese economy.

Western businesspeople may laugh at this observation, which suggests that Japanese capitalism remains at a somewhat immature stage of development. Nevertheless, it is true that the Japanese economy has been managed fairly successfully over the past four decades without the bitter experiences of unemployment.

The significance of this unique environment has been the effects on domestic household spending. The changed environment has brought back an inherent virtue of the Japanese people: frugality. The virtue was long forgotten, particularly during the years of the bubble economy, but has now revived like a phoenix. Uncertainty over future employment prospects has dampened consumer spending, reflected in the decline in the propensity to consume of the household sector. This has been the most important factor dampening the Japanese economy, resulting in negative growth in spite of its potential growth rate of 3.5 percent.

In short, Mr. Bentsen's expectations have been betrayed.

JAPANESE CAPITAL OUTFLOWS

Before discussing the microeconomic situation, I will touch briefly on Japanese capital outflows, a subject that will remain in the spotlight as Japanese current account surpluses continue for the next several years.

The saving-investment gap within the Japanese economy is such that the household sector ends up with consistently high surplus saving. During the past two decades, this sector's saving has averaged around 8 percent of GDP and has been more or less totally absorbed by private business sector capital spending; total private sector saving and investment have been in balance. Yet, the general government sector has shown a net surplus in saving, and as a result the total economy has shown a surplus. Currently, the net surplus of saving over investment amounts to approximately 3.5 percent of GDP. Needless to say, the current account surplus corresponds to the net surplus gap of saving over investment in the domestic economy. What it means is that total output is not fully consumed within the domestic economy, resulting in the outflow of excess output and thus the outflow of capital. What is interesting about Japan's capital export during the 1980s are the dynamics of the outflows and the consequences for the 1990s.