The changing structure of Japan’s trade and current-account balances and a Japanese-style model for establishing Japan as an “investment nation”
May 22, 2012
In 2011 Japan’s trade balance (customs-cleared basis) went into deficit for the first time in 31 years. If this leads, sooner or later, to a current-account deficit, then it is serious cause for concern in the sense that it could trigger a fiscal crisis. This report analyzes the reasons for the trade balance moving into deficit and the outlook for Japan’s balance of payments. On the basis of this analysis, it will examine measures for securing the return of the current account to surplus.
The decline in Japan’s trade surplus since 2008 is due to exports falling sharply while imports have remained at a high level. Exports have fallen largely among capital goods (electrical machinery sector) and automobiles (consumer goods in the transportation equipment sector). These two sectors have suffered from the spectacular rate at which Korean companies have caught up in recent years; they are also sectors in which the production operations are being transferred overseas. A rise in imports of mineral fuels is the main reason for the growth of imports.
Behind the fall in exports since 2008 is the fact that overseas production has begun to have a negative impact on exports. The export ratio (value of exports/sales) in manufacturing industry has leveled off since 2008, and the electrical machinery and transportation equipment sectors, which have until now provided the pulling power to make Japan a “manufacturing and export nation” are showing signs of having reached the limits of their export growth potential. In the general machinery sector, the export ratio is rising and import penetration is declining, so that in some respects, Japan’s manufacturing base is becoming stronger. Meanwhile, there are many sectors in which Japanese products enjoy superiority, such as hi-tech parts and high-functionality materials, and can to maintain a high level of exports.
Japan’s overseas production has now reached a stage where it is beginning to have a strong export replacement effect and has started to have a negative impact on the trade balance. However, overseas production also has the effect of maintaining a surplus on a current-account basis, by boosting the income balance and services balance. In fact, royalties and earnings on direct foreign investment have seen a substantial rise since the second half of the 2000s. In particular, overseas profits in transportation equipment have seen a major rise and there are signs that the sector may be moving from a “domestic production-export” business model to the US model of “overseas production-profit repatriation”.
The transition of Japanese companies to the “overseas production-profit repatriation” model has only just begun, and will take a considerable time. However, Japan’s manufacturing base is strong compared with that of the US and it is likely to be possible to avoid a major trade deficit. It is important that Japan should maintain a current-account surplus by means of a “dual strategy” of strengthening the domestic production-export model in its capital goods and hi-tech parts and materials sectors while pursuing the shift to the overseas production-profit repatriation model in its durable consumer goods sector. It should not be forgotten that shifting to the overseas production-profit repatriation will also keep energy consumption in Japan down, and that reducing imports of fossil fuels will also help to keep the current-account balance positive. Enhancing energy efficiency and keeping energy unit prices low will allow further reductions in fossil fuel imports, helping to curb the trade deficit and maintain a current-account surplus.
Simulations suggest that if the structure of Japanese industry continues to change in line with the present trend (the export-replacement effect of overseas production grows) and the price of crude oil rises at an annual rate of 5%, Japan’s trade balance will initially move into surplus in the mid-2010s, but will then move into deficit once more from 2017. The current-account balance will also move into deficit from 2023. If the price of crude rises by 10% a year, the trade balance will not move into surplus and the current-account balance will move into deficit from 2022. However, if the changes in the structure of Japanese industry curb the export-replacement effect of overseas production, and energy savings neutralize the impact of the rise in the price of oil, it should be possible to maintain a current-account surplus even if the trade balance moves into deficit in the early 2020s.
Japan’s strength lies in manufacturing processes. Given that Japan’s manufacturing base is still strong, it should, rather than seeking to become a “finance-led investment nation” on the US model, seek to maintain a current-account surplus by switching to a Japanese-style model for a “manufacturing-led investment nation” with three main pillars: (1) promoting the overseas transfer of production in the durable consumer goods sector and increasing the income balance and services balance through the overseas production-profit repatriation model, (2) preventing the trade deficit from growing by maintaining the domestic production-export model in the capital goods and high-tech parts and materials sectors and (3) prevent major growth of the trade deficit by reducing imports of fossil fuels, through keeping energy consumption down, enhancing energy efficiency and reducing the unit price of energy. By way of policy issues, Japan should focus on (1) creating an Asia-Pacific free trade zone based on the TPP, (2) measures to attract the headquarters functions of global companies and (3) measures to curb fossil fuel imports.