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September 24,1 982
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Japan'sTradeSurplus
The size of the Japanesetrade surplus with the
United States and the European Economic
Community (EEC)has seriously impaired
trade relations among the three major trading
partners. It has led to a growing debate over
the effects of trade imbalances on domestic
economies. Some policymakers in the U.S.
and the EEC have blamed their trade deficits
for widespread domestic recession and unemployment, while others believe that their
economic malaise is not a consequence of
foreign competition but a reflection of structural problems in Western economies.
Which side is correct in this debate? Lastyear,
the Japanese trade surplus with the EEC
reached $1 0.3 billion compared with $8.8
billion in 1980, and the U.S. bilateral trade
deficit with Japan registered $13.4 billion,
nearly double the 1 980 shortfall of $7 billion.
Projections by the international Organization
for Economic Co-operation and Development indicate this trend will continue
through 1 983.
The critics who blame Japan are calling for
voluntary restraints on Japaneseexports or
the imposition of import quotas in theircountries. Other analysts argue that the Western
economies would be better off emulating
Japan's performance by restoring the cost
competitiveness of their industries. They
stress that import or export quotas serve only
as short-term palliatives thattemporarily shelter inefficient industries from the rigors of
competition.
An examination of the economic factors
responsible for the large and growing trade
surplus can be a valuable aid to our understanding of this issue. It will also provide a
basis for analyzing the implications of future
economic policy in this area. Below, we
focus on Japan's export performance as a
means of highlighting what we consider the
most significant aspects of the situation.
Cost competitiveness
Commentators often note that because Japan
devotes a higher proportion of its output to
investment than any other major industrialized country, it has had a much higher growth
, in labor productivity. They claim these increases in output per manhour have improved the cost competitiveness of Japanese
products in world markets. For example, from
1 975 onward, labor productivity growth
averaged 7.6 percent in Japan, 3.2 percent in
the U.S., and 3.7 percent in the EEC.Furthermore, this higher labor productivity growth,
and its beneficial impact on competitiveness,
was not offset by higher nominal wage settlements by Japanese workers, unlike their
American and European counterparts. As a
result, labor costs per unit of manufacturing
output have remained virtually unchanged in
Japan since 1 975, while they have increased
at an average annual rate of 7.8 percent in the
U.S. and 11 .4 percent in the EEC.
Japan's successful containment of labor costs
wou Id seem to provide a cogent explanation
for its expanding trade surplus. But these
costs are measured in domestic currency
units. Adjusting for exchange rate changes
shows that Japan's cost competitiveness was
actually deteriorating through the third quarter of 1 978 (see chart). However, from that
point on, the yen exchange rate-far from
compensating for international differences in
unit labor costs-has depreciated sharply
against the
dollar. The drop in the yen's
exchange rate, most notably in the last four
quarters, has dramatically bolstered Japan's
competitive position in world markets.
u.s.
Exchangeratesand oil prices
The reversal of the upward trend in the yen
rate can, in part, be ascribed to a coincident
run-up in oil prices. Because oil represents 40
percent of the Japanese import bill, the sharp
rise in oil prices in the late 1970's greatly
enlarged Japan's import costs. As a result, the
yen exchange rate depreciated and improved
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Opi 11ions expressed in this nevvsletter do f1()t
necessarilv n-:'flect the vip\;vs oi the managemenl
of the Fecit'ral Reserve' Ballk of San Francisco,
or of the Board of Covernors of the Federal
Reserve Systern.
three percentage point decline in Japanese
short-term interest rates between December
1 980 and August 1982. The reduced yields
coupled with a liberalization of capital controls in December 1 980 increased the attractiveness of dollar denominated investments
to Japanese residents, prompting capital outflows and a weak yen. Thus, the evidence
implies that fiscal and monetary policies of
both countries are responsible for the depreciating yen and the
decline in u.s.
price competitiveness.
the price competitiveness of Japanese goods.
The depreciation thereby created the foreign
demand for a greater quantity of Japanese
exports. The increased exports found their
way into the u.s.and EECmarkets and thus
raised Japan's market share during the period
of widespread recession and unemployment.
On a trade-weighted basis, the yen depreciated 21.4 percent between the second half
of 1 978 and the first half of 1980. This drop,
resulting in part from oil price hikes, contributed to a 32.4 percent gain in Japanese cost
competitiveness in the same period as relative unit labor costs also moved in Japan's
favor. The improvement in Japan's cost
competitiveness led to a fall in the dollar
price of Japanese manufactured goods relative to foreign competitors of 13.6 percent
between 1 978 and 1 980. This improvement
in Japan's price competitiveness can largely
account for the 26.5 percent growth in export
volume between 1 979 and 1 981 . Because of
this exceptionally strong export volume
growth, the total trade account of Japan
moved from a deficit of $9.3 billion in the first
halfof 1 980to a surplus of $8.9 billion for the
year 1981 as a whole.
The confl ict between U.5. and Japan over
trade matters surfaced once before back in
1 977 -78. At that time, the u.s.advocated
that West Germany and Japan, two countries
with large trade and current account surpluses, should inject fiscal stimuli to expand
their economies. The resulting faster economic growth would produce a higher level
of imports, which, in turn, would reduce the
trade and current account surpluses. Because
the current account balance represents the
amount of private savings left over after
deducting the public sector deficit and private investment, a higher publ ic sector deficit
with unchanged private savings and investment would, by definition, produce a commensurate fall in the current account surplus.
Thus, Japan could cut its projected surpluses
on current account by increasing its fiscal
deficit through higher public spending or
lower taxes.
Fiscaland monetary policies
More recently, the yen exchange rate has
continued to decline against the dollar despite the fall in energy prices. This apparent
paradox has been attributed by many
observers to the different mix of monetary
and fiscal policies instituted in the two countries. Japaneseofficials believe Washington's
economic policy involving big budget defi. cits and monetary restraint has produced
abnormally high real interest rates that have
dramatically bolstered the dollar's value in
the foreign exchange markets. They therefore
feel that the dollar's strong performance
against the yen is due entirely to U.S. macroeconomic policy.
In 1 977 and 1978, Japan's economic
environment was receptive to this course of
action. The yen exchange rate was appreciating markedly, creating slack economic
conditions. A stimulatory fiscal policy would
have posed no policy dilemma for Japan on
domestic grounds; it would have complemented the appreciating exchange rate in
bringing about a lower current account
surplus.
Japanese macroeconomic policy, however,
has not been blameless in the depreciation of
the yen. The Japanesegovernment's monetary and fiscal policy mix brought about a
The present economic environment in Japan
is not too dissimilar. While the yen exchange
rate has been depreciating against the dollar,
economic activity has stagnated, in part
2
because of a slowdown in export volume
growth due to voluntary restraints on shipments to Western Europe. Because real economic activity in Japan is slowing, there is
room for fiscal stimulus. The government,
however, is adverse to do so because of
already large fiscal deficits which have averaged between 4 and 5 percent of G N P in the
1978-1981 period, considerably higher than
those of the U.S. In fact, Japan's medium term
strategy calls for reducing the growth of
public spendingto bringthe budget back into
balance by fiscal 1 984/85.
What to do?
Further compounding the trade imbalance
problem are the high and possibly growing
budget deficits projected 'for the U.S. in the
foreseeable future. A move toward fiscal
restraint would improve the u.s. trade picture, but the fiscal policies presently adopted
by the u.s. and Japan, are likely to exacerbate the current account problems of the two
countries and further the trend towards
protectionism.
More recently, the different mix of monetary
and fiscal policies implemented in the two
countries has added to the trade imbalance.
The move towards fiscal expansion in the
u.s. and fiscal restraint in Japan has exacerbated the trade and current account imbalances between the two countries. And it is
this misalignmentoffiscal actions, rather than
a long-run decline in U.s. labor productivity,
that has contributed to Japan's expanding
trade surplus.
Contrary to popu lar opi n ion, Japan's expanding trade surplus against the U.s. is not a
product of lower labor cost increases and
related productivity gains of Japanese
workers. Until the runup in oil prices, movements of the yen rate more than compensated
for any cost advantage when Japan's labor
costs were rising more slowly than those of
the u.s. It was the fall in the yen's value,
resulting, in part, from oil price hikes, that
contributed greatly to the expansion of
Japan's bilateral trade surplus with the U.S.
KennethBernauerand David Parsley
COST CO MPETI TIVENESS
1975==100
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labor Costs· · ·
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1977
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Japans Unit
labor Costs*
or.
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1979
*Measuredin yen
**U.S.centsperyen
***U.s. unit laborcostsrelativeto Japan(measured
in dollars)
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BAN KING DATA-TWELFTH FEDERALRESERVE
DISTRICT
(Dollar amounts.in millions)
SelectedAssetsandLiabilities
LargeCommercialBanks
Loans (gross,"adjusted)and investments*
Loans (gross,adjusted)- total#
Commercial and industrial
Real estate
Loansto individuals
Securitiesloans
U.s. Treasurysecurities*
Other securities*
Demand deposits - total#
Demand deposits - adjusted
Savingsdeposits - total
Time deposits - total#
Individuals, part. & corp.
(Largenegotiable CD's)
WeeklyAverages
of Daily Figures
Member BankResentePosition
ExcessReserves(+ )/Deficiency (- )
Borrowings
Net free reserves(+ )/Net borrowed(-)
Amount
Outstanding
9/8/82
161,362
141,462
45,124
57,454
23,509
2,379
6,466
13,434
41,775
27,983
31,648
99,176
89,379
37,099
Weekended
9/8/82
149
14
135
Change
from
9/1/82
-
-
-
-
Changefrom
year ago
Dollar
Percent
62
79
225
13
54
47
132
115
83
464
427
83
111
164
-
-
Weekended
9/1/82
606
6
600
9,309
10,419
5,644
3,189
485
1,015
708
1,818
2,246
1,849
1,516
13,126
11,537
2,172
-
6.1
8.0
14.3
5.9
2.1
74.4
12.3
11.9
5.1
6.2
5.0
15.3
14.8
6.2
Comparable
year-agoperiod
-
118
331
213
* Excludestrading account securities.
'# Includes items not shown separately.
Editorialcommentsmaybeaddressed
to theeditoror to theauthor....
copiesof thisandotherfederal
Reservepublicationscanbeobtainedby callingor writing the PublicInfohnationSection,FederalResente
Bankof SanFrancisco,P.O.Box7702,SanFrancisco94120.Phone(415)544-2184.
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@FedFRASER