Fragile Export-Led Recovery: 2003-07

Fortunately, since 2002, the world economy has been sufficiently buoyant to attract Japanese exports and stimulate investment in export-related activities. In 2003, Japan's economy began recovering: real GDP has been increasing about 2.3% per year. Table 3 [ PDF 123KB | 1 page ] shows GDP's various components from 2002 to 2006 in undeflated nominal terms -which, because of mild ongoing deflation, tends to understate real growth rates. Overall nominal GDP grew from 2002 to 2006 by just 3.33%.

Figure 16 [ PDF 89.5KB | 1 page ] summarizes the relative contributions to overall GDP growth over these four years as proportion of Japanese GDP in 2002. What is remarkable is the lack of growth in private consumption. Despite being a "normal" 57% of GDP, consumption was just 30% of the overall GDP growth from 2002 to 2006. Moreover, private residential investment was virtually stationary. In contrast, corporate investment (which is normally just 17% of GDP) contributed an astonishing 100% of the increment in Japan's overall GDP. To square the accounts, government spending was the big negative -falling 1.14 percentage points or 34% of the incremental growth in GDP. And Table 3 shows that the bulk of this fall in government spending was in public sector investment.

Exports also made a substantial contribution to Japan's modest recovery. But the standard presentation of the GDP accounts (the bars to left of the first vertical broken line in Figure 16) shows growth in Japan's net exports to be slightly negative. However, this masks the huge increase in gross exports from Japan after 2002 when the price of oil and related petroleum products began to increase substantially -and Japan is completely dependent on oil imports. Without any significant change in the quantity of oil imported, the yen cost of oil imports rose almost 150% through 2006 (Table 3). Thus, Japan had to export more in real terms just to pay for the more expensive oil.

But the problem is more general than just oil. The prices of many important basic inputs- iron ore, copper, various minor metals, agricultural raw materials, as well as mineral fuels- sharply increased after 2002. Thus, without any increase in Japan's net trade surplus, manufactured exports had to expand dramatically -if only to offset the adverse change in Japan's terms of trade. Figure 16 and Table 3 show gross exports of manufactured goods expanding by even more than GDP from 2002 through 2006.

The large increases in Japan's domestic corporate investment can now be better understood. Although both consumption and public expenditures have languished since 2002, increased investment was induced by, and supported, expanding manufactured exports. Reinforcing this effect, the depreciation in Japan's real exchange rate against both the euro and the dollar, and against other Asian currencies with exchange rates more closely tied to the dollar, makes investment in Japan look relatively inexpensive (McKinnon, 2005, chapter 2). In particular, Japanese multinational firms, which normally engage in outward foreign direct investment (FDI), may instead be investing more at home -mainly in export activities.

This result is neatly portrayed in Chart 1 [ PDF 103.2KB | 1 page ] taken from the Wall Street Journal article "Japan Inc. comes back home", by Yuka Haysashi. Since 2002, it shows a virtual doubling of new factory construction within Japan while factory construction in Japanese companies (and their affiliates) overseas has declined. "Japanese companies registered to build 1,782 factories in Japan last year, up from 844 four years ago, and the highest number in 14 years according to government figures. Meanwhile, they are building fewer plants abroad-182 in the year ended March 31, down from 434 four years earlier, according to a government survey of 19,000 companies" (Hayashi, page 14).

While it is all well and good to analyze the decline in the real exchange rate of the yen against the dollar and the euro as presented earlier in the paper, Hayashi's article also compared the changes in hourly nominal compensation costs for manufacturing workers from 1995 to 2005 across the broader spectrum of countries shown in Chart 2 [ PDF 87.7KB | 1 page ]. Notably, "the average dollar denominated wage for a Japanese manufacturing worker was $21.76 in 2005, down 7.3% from a decade earlier according to the U.S. Bureau of Labor Statistics. During the same period, the average wage in the U.S soared 38% to $23.65, while the German average climbed 9.6% to $33". Chart 2 also shows wages in other East Asian countries rising faster than in Japan. Korean wages rose a remarkable 86% while a guesstimate for the PRC is 211%. However, the PRC's absolute wage level of $1.33 is still so low relative to Japan's that this high percentage increase is less meaningful.

The data on which Hayashi drew from the U.S. Bureau of Labor Statistics provides another striking perspective on the relative stagnation of money wages in Japan, falling 7.3% from 1995 to 2005, compared to its neighbors (Chart 2). Figure 4 shows the official Japanese CPI fell about 2.3% over a comparable period-implying that Japanese real take home wages have been falling about 0.5% per year. But this weakness in Japanese wage setting, including the surprising quiescence of trade unions, could be partly a statistical illusion.

In a recent intriguing paper by Christian Broda and David Weinstein (2007), they show that Japan's official CPI could well be overestimating Japan's inflation, i.e., underestimating the rate of deflation, by 0.8 percent year. Japan's statistical bureau still uses an old fashioned fixed-weight Laspeyres price index rather than the more modern cost-of-living index (COLI) used by the United States. The Japanese method fails to take substitution effects into account when relative prices in the consumer basket change, and does not allow sufficiently for improved product quality from technical progress.

In a complex statistical exercise, Broda and Weinstein re-calculate Japan's CPI inflation rate using the American COLI methodology. Their result is shown in Figure 17 [ PDF 152.1KB | 1 page ]. From 1998 to 2006, the COLI methodology shows Japan's CPI falling by 8%, whereas the official (Laspeyres) methodology shows a fall of just 3%. Referring back to Chart 2 showing the 7.3% fall in money wages, the COLI methodology is consistent with approximately stable real wages-whereas the official CPI shows them in decline. Real wage stability, rather than persistent decline, is easier to accept intuitively.

True enough. But the COLI methodology shows that Japan's deflationary hangover is worse than the official statistics show-and remains very puzzling indeed.

Download this Discussion Paper [ PDF 428.3KB| 33 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.