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FRBSF
WEEKLY LETTER
June 27, 1986
A New Direction For Japan
The extraordinary economic gains made by
Japan since World War II have transformed it
into a major economic poweLJapan currently
ranks second among industrialized nations in
the size of its gross domestic product (GDP), and
third in its share of trade among major industrial
countries, behind the u.s. and West Germany.
Japan's success has, however, led to increased
tension in the international trading system. In
particular, there is a widespread perception that
japan's aggressive export growth and its reluctance to expand imports have contributed to the
loss of jobs among its trading partners. Reactions
to Japan's massive trade surplus, which soared
from $2 billion in 1980 to a record $56 billion
in 1985, include rising protectionist sentiment in
the United States and Europe that threatens the
free trade system painstakingly nurtured over the
past four decades.
Japan has responded to these pressures by
lowering tariffs and liberalizing other types of
import restrictions, by encouraging its citizens to
purchase foreign consumer goods, especially
those from the United States, and by enacting
policies designed to increase access by foreign
financial institutions to domestic finance. Yet
despite these measures, japan's external
imbalance continues and protectionist sentiment
abroad is stronger than eveL
Its continued trade imbalance has prompted
Japan to change the focus of its macroeconomic
policies toward increasing domestic spending.
"The Report of the Advisory Group on Economic Structural Adjustment for International
Harmony," otherwise known as the Maekawa
Report released April 7, 1986, calls for a major
restructuring of the Japanese economy. Its issue
has raised the expectation that japan is seriously
considering policies that will fundamentally
change its postwar economic philosophy. This
Letter discusses the Maekawa report, its potential
implications, and the likelihood that Japan will
fundamentally restructure its economy to reduce
its trade surplus.
The Maekawa Report
In late October 1985, Prime Minister Yasuhiro
Nakasone asked that a nongovernmental
advisory committee, chaired by ML Haruo
Maekawa, the former Governor of the Bank of
Japan, formulate a set of medium and long-term
policy recommendations concerning Japan's
economic and social structure that would,
among other things, reduce trade frictions with
the rest of the world.
Whereas Japan's post-war policies were
designed to support industrialization, export-led
economic growth, and a high household saving
rate, the Report recognizes that the goals established soon after the war have been achieved.
According to the Report, japan has reached a
stage of economic maturity that now requires a
reduced dependence on exports, more imports
from the rest of the world, a greater allocation of
resources to improve the quality of life, and a
greater contribution toward solving major world
problems such as the debt problem of developing countries. Achieving these goals would
lower Japan's large trade surplus and foster more
harmonious relations within the world economy.
The Report offers a set of policy recommendations to achieve these goals. First, it calls for
expanded domestic demand to replace exports
as the major driving force of the economy. Specifically, it recommends stimulating domestic
demand by increasing government expenditures,
reforming taxes (to stimulate housing and to
lower the savings rate, in particular), and
restructuring labor market conditions, such as
reducing working hours to increase leisure time
and hence consumption.
Second, the Report recommends a restructuring
of production away from manufacturing toward
the service sector, increased reliance on foreign
suppliers to contribute more than raw materials
to domestic production, and increased direct
investment by Japanese firms in other countries.
In addition, it states that import restrictions on
agricultural products should be relaxed so that
FRBSF
existing land use may be shifted from agriculture
to housing.
Third, to improve market access by foreign producers further and to encourage imports of manufactured goods, the Report calls for restructuring the complex set of tariffs, import quotas,
standards and certification, and government procurement policies now in existence.
Fourth, the Report states that Japan and the other
major trading countries must make greater
efforts in their domestic policies - improving
the coordination of their monetary and fiscal
policies in particular - to ensure that exchange
rates remain stable and in line with economic
fundamentals.
Fifth, fiscal policy in the major industrial countries, according to the Report, should be balanced over time, with governments making
efforts to reduce their reliance on debt-financing. Sixth, the Report reaffirms the commitment
to international liberalization of Japanese
finance and the need to implement more policies that provide a more direct connection
between international and domestic finance.
Finally, the Report urges Japan to take a more
active role in the world economy to alleviate the
debt problem of developing countries and to
promote economic and technological cooperation, especially with developing countries.
Implications
The Maekawa Report is of interest to foreign
observers principally because of its potential
effects on economic relations with Japan. We
will focus on the recommendations that seek to
reduce the Japanese trade surplus.
The net exports of Japan, or any other country,
reflect, among other things, the balance between
the domestic supply of savings on the one hand
and the demand for those savings to finance
domestic investment and deficits in the public
sector on the other. When the supply of savings
exceeds domestic demand, the excess savings
are invested abroad. This is true for Japan at
present, and it means that Japan must be a net
exporter. As a net saver, Japan buys fewer goods
from abroad than foreigners buy from Japan. The
counterpart to Japan's excess supply of savings is
the excess demand for those savings among its
trading partners. When the demand for domestic
savings exceeds the supply, as in the United
States, the country in question incurs an external
deficit.
Although Japan has enjoyed external surpluses
during most of the past two decades, the massive surpluses now causing so much concern are
a recent phenomenon. They result from a high
and relatively stable Japanese savings rate along
with a significant drop in the demand for financing domestic investment and the public sector.
Gross savings as a percentage of Japan's GDP
stabilized in the neighborhood of 31 percent
between 1979 and 1984 - the highest savings
rate among the major OEeD countries. In contrast, gross fixed capital formation has fallen
from 32 percent of GDP in 1979 to 28 percent
in 1984, while the general government fiscal
deficit has dropped from nearly 5 percent of
GDP in 1979 to 2.7 percent in 1984. During this
period, the current external balance as a percentage of GDP shifted from a deficit of nearly 1
percent in 1979 to an unprecedented surplus of
3 percent in 1984.
Over the same period, the current external deficit of the United States increased from 0.1 percent to 2.6 percent of GDP because of a decline
in the savings rate and an increase in the government deficit. Thus, a significant portion of the
excess supply of savings in Japan was matched
by an excess demand for savings in the U.5.
The Maekawa Report proposes to reduce Japan's
external surplus by simultaneously reducing the
supply of savings and increasing investment
spending. Saving would be reduced by tax and
labor market reforms that increase consumption
and leisure time. Investment spending would be
stimulated specifically through tax incentives
that favor the housing sector.
While these steps should, in principle, reduce
Japan's trade surplus, there are constraints to
their implementation. For example, the household sector's saving pattern and long-established
cultural attitudes suggest that the Japanese may
not be very responsive to economic incentives
to reduce their rate of savings. In addition, the
availability of only limited social security benefits will remain a great incentive for the Japanese
to save. Although still high in comparison to
other countries, gross savings as a percentage of
GDP in Japan have already declined 9 percent
from a peak of 40 percent in 1970. While the
aging population should generate a further
decline in savings, this will occur too slowly to
rectify the current external imbalance.
On the spending side, Japan is understandably
reluctant to pursue an expansionary fiscal policy
because of the fear that it might increase its fiscal deficit. Due to large deficit spending in the
1970s, the ratio of general gross government
debt to GOP in Japan in 1985 was already a
high 70 percent - second only to Italy's 99 percent among OEeD countries, and well above
the United States' 48 percent.
It may also be difficult to stimulate additional
investment spending in Japan because there has
been an increasing tendency for Japanese capital
toflowabroad since 1973. The first oil price
shock, which adversely affected the productivity
of capital in Japan encouraged the Japanese to
invest abroad. This capital outflow was reinforced by the desire to avoid potential trade
barriers, the liberalization of Japanese financial
markets and, more recently, the appreciation of
the yen. Furthermore, it reflected the demand for
Japanese savings abroad, notably to finance U.s.
federal budget deficits.
Government policy in Japan has traditionally
favored the manufacturing sector, as shown by
the increase in that sector's real share of GOP
from 30 percent in 1970 to 40 percent in 1982.
In contrast, the real share of services and construction in GOP remained roughly the same at
33 percent in 1982 as in 1970. By focusing on
investment in services and housing, the Report
targets areas that have received less attention
and which therefore offer significant growth
potential.
The development of services and housing would
also improve the quality of life in Japan's population. However, while there is a general recognition within Japan that a reallocation of
resources towards housing in particular is overdue, the Report is not necessarily advocating a
full-fledged "u.s. model" in which government
programs and the tax code provide important
incentives to own a home. Budget constraints, as
well as the limited availability of land, may limit
the pace of Japanese housing development.
In addition to issues of feasibility and effectiveness, the Report's recommended policies involve
costs to Japan and the world economy. The
attempt to lower the rate of savings in Japan will
limit the availability of capital to finance invest-
ment spending in Japan and other regions of the
world. This would raise world interest rates,
reduce world economic growth and, possibly,
make resolution of the international debt problem more difficult.
Impact on government policy
The first U.S. accounts of the Maekawa Report
frequently gave the impression that it reflected
new national goals that would soon be implemented. This is incorrect. The Report was prepared by a nongovernmental advisory group. It
did not explicitly involve either the major governmental agencies or parliament. In Japan, it
has already been criticized for being too bold
and for failing to incorporate a sufficiently
representative range of views. Those familiar
with the arduous process of decision-making by
consensus in Japan will recognize that the
absence of an imprimatur, particularly from the
government, makes the Report vulnerable to
criticism.
Second, the Report is viewed in some Japanese
circles as a reaction to U.s. pressure and Prime
Minister Nakasone's commitment to President
Reagan to deal with the trade issue. In the opinion of some observers, this may limit serious
consideration of the policy recommendations
simply because, in their view, direct U.S. pressure cannot resolve the basic economic issues
dividing the two countries. Such a viewpoint,
however, does not consider the broader implications of the Report.
While the Report's recommendations are not
likely to be implemented soon, they reflect a
growing awareness that impatience with Japan's
large and continuing external surplus threatens
the world trading system from which Japan has
benefited so greatly. They also reflect the realization that timely changes in economic policies
are needed to defuse protectionist sentiment
among Japan's trading partners. Thus, the adoption of measures addressing the international
concerns that prompted the Maekawa Report
should prove to be in Japan's own self-interest.
However, achieving a more balanced world
trading environment will be difficult unless
Japan's major trading partners (particularly the
U.s.) take steps to reduce their own domestic
spending.
Thomas F. Cargill and Ramon Moreno
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.S. Treasury and Agency Securities 2
Other Securities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances 4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+ l{Deficiency (-l
Borrowings
Net free reserves (+ l{Net borrowed( - l
Amount
Outstanding
Change
from
6/4/86
201,317
182,782
52,438
66,603
39,222
5,633
10,736
7,799
207,511
54,283
36,387
16,713
136,515
5/28/86
-
-
Change from 6/5/85
Dollar
Percent?
112
456
207
86
92
3
325
19
4,259
3,240
2,787
983
37
46,794
253
35,848
21,671
- 326
-1,260
-
-
9,616
9,545
249
3,340
4,984
254
748
819
8,593
6,017
5,482
2,620
43
5.0
5.5
0.4
5.2
14.5
4.7
- 6.5
11.7
4.3
12.4
17.7
18.5
0.0
2,799
6.3
2,469
873
- 6.4
- 3.8
-
Period ended
Period ended
6/2/86
5/19/86
127
18
109
28
41
13
1 Includes loss reserves, unearned income, excludes interbank loans
2
Excludes trading account securities
u.s.
3 Excludes
government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
S Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change
@FedFRASER