Rising external imbalances: a comparison with the mid-1980s - trade imbalances of OECD countries

OECD Economic Outlook, June, 1993

There was a marked increase, to 3.2 per cent of GDP, in the Japanese current-account surplus in 1992. The main factors behind this rise -- some of which were quite different from the forces behind the sharp increase in the mid-1980s -- were: favourable terms-of-trade developments, sluggish import volumes and strong export market growth, in particular originating from the dynamic Asian economies (DAEs) and China. Counter-factual simulations using the OECD's INTERLINK model suggest that unchanged terms of trade since 1991 or stronger domestic demand growth in Japan at rates similar to those observed in the mid-1980s would have broadly stabilised the Japanese current-account surplus at about 3 per cent of GDP over the 1992-94 period but with higher inflation.

In the mid-1980s, the rising imbalances on current account in both dollar terms and relative to GDP, as between the United States, with its large deficit and Germany and Japan, with their large surpluses, were of unprecedented size in post-war history.(1) These imbalances posed two particular concerns to policy makers. First, large surpluses tended to arouse protectionist pressures. Second, it was argued that financing these imbalances TABULAR DATA OMITTED would sooner or later place intolerable strains on the international monetary system. A further concern was that such large imbalances could become self-sustaining, because of the induced changes in external debt and asset positions and their impact on investment income flows. In the event, changes in real exchange rates and relative cyclical positions -- in part resulting from internationally-coordinated policy moves -- caused the imbalances to narrow during the remainder of the decade.

The U.S. current-account deficit widened sharply in 1992, but this mainly reflected the end of large transfers to the United States from its Gulf war allies. Indeed, the 1992 deficits on trade and current accounts for the United States were smaller than in 1990 and, as a percentage of GDP, far smaller than in the mid-1980s. As a result of unification, Germany is now running a current-account deficit (1.3 per cent of GDP in 1992), compared with a surplus of over 4 per cent of GDP through the second part of the 1980s. However, the Japanese current-account surplus widened substantially in 1992 to reach 3.2 per cent of GDP, its highest level since 1986. Thus, in contrast to the 1980s, the imbalance issue is largely confined to Japan in the current episode. This note analyses the proximate causes of the recent increase in external imbalances in the three largest OECD countries and compares the current and previous episode.

An analysis of changing current-account imbalances

Changes in current accounts reflect many factors. An analysis of the impacts of some of these -- terms of trade, trade volumes, initial imbalances and the role of services and transfers -- is provided in Table 14 for the 1985-87 and 1990-92 periods. In both periods, the rise in the Japanese current-account surplus reflected a widening of the trade surplus. In both periods, too, a major factor was favourable terms-of-trade developments, which reflected large yen appreciations, as well as falling oil prices in the mid-1980s. The increase in the trade surplus due to terms-of-trade gains was similar in the two periods (about $35-40 billion), as was the $10 to $20 billion contribution from the "initial imbalance" effect. The latter reflects the fact that the trade balance was in surplus at the start of the period and that this initial imbalance increased in line with trade values.

TABULAR DATA OMITTED

One striking difference between the two periods is the behaviour of trade volumes. In the mid-1980s, there was a negative contribution of $20 billion from net trade volumes to the change in the Japanese trade balance, whereas its contribution in the 1990-92 period was positive. Two important factors, related to the different behaviour of both export and import volumes in the two periods, explain this switch. First, on both occasions, the yen appreciation resulted in a large deterioration in Japan's competitiveness and a very substantial loss of export market shares. In 1990-92, however, market growth for Japanese exports was almost twice as fast as in 1985-87, with the result that export volumes continued to rise despite the negative impact of market-share losses. This illustrates a notable change between the two periods in the geographic distribution of Japanese trade. Since the late 1980s, South-East Asia (the DAEs plus China) has become Japan's largest export market, in part reflecting earlier Japanese foreign direct investment in the region, and it has been a particularly buoyant one. The second important factor is the radically different pattern of import volumes during the two periods. Between 1985 and 1987, Japanese import volumes rose by 20 per cent; since 1990 they have hardly grown at all, reflecting the slowdown in domestic activity.

Excluding net official transfers which were affected by the Gulf war in 1991, there has been an underlying fall in the U.S. current-account deficit between 1990 and 1992, as opposed to an increase between 1985 and 1987. On both occasions, there was a negative contribution of trade volumes (of the order of $10 to $20 billion) to the change in the trade balance, but unfavourable terms of trade played an important role in the first period, when the dollar depreciated by 27 per cent in effective terms, compared with just 3 per cent between 1990 and 1992. The U.S. surplus in non-factor services widened substantially between the two periods, mainly because of improved competitiveness, and made a substantial positive contribution of over $20 billion to the change in the current balance in the most recent period.