Quantifying the Nature of the Structural Change

How these changes in Japan's trade and industrial structures may have affected the response of the Japanese economy to global demand shocks can be analyzed by a vector autoregression (VAR) technique. VAR is a standard statistical procedure to investigate how shocks are transmitted from one entity to another. Using this statistical technique, we examined the impact of a shock that originates within Japan (a Japan shock), within emerging Asia (an emerging Asia shock), and in the rest of the world (a global shock), in order to see how changes in Japan's economic structure over the past decade or so affected the responsiveness of its GDP to supply or demand shocks originating abroad.⁶

For convenience, we used the Asian financial crisis of 1997–1998 to divide the sample. We then used two measures of the responsiveness of Japanese GDP to global and Asian shocks. The first measure is the response to a one-standard deviation shock to the global and regional outputs. The second measure is the extent to which the total variance is explained by the variance of respective shocks. In order to quantify the nature of the structural change that may have taken place in Japan over the past decade, we compared these measures obtained from the pre-crisis and post-crisis samples. It should be noted, however, that VAR only helps uncover temporal statistical relationships among several variables but gives no indication of how and why they affect each other.

Consider the following moving average (MA) representation of the VAR model, which consists of three equations representing global, Japanese, and emerging Asian outputs:

where Xt is real GDP in the US and Europe (henceforth referred to as “global”), Yt real GDP in Japan, and Zt real GDP in emerging Asia, all expressed as indices in order to remove the influence of nominal exchange rate changes; u, v and w are, respectively, a shock to global GDP (a global shock), a shock to Japanese GDP (a Japan shock), and a shock to emerging Asia's GDP (an emerging Asia shock). We are particularly interested in examining the pattern of response of Japanese GDP (Y) to the past global and emerging Asia shocks, before and after the Asian financial crisis of 1997-1998.

The simplified setup of equations (1)–(3) is dictated by the small number of observations, especially when the data are divided into the pre-Asian crisis and the post-Asian crisis period. Even with this simple setup, various data limitations have restricted the coverage of countries as well as the choice of sample.⁷ The results reported below are based on the assumptions that in the long run global GDP affects both Japanese and emerging Asian GDPs; Japanese GDP affects only emerging Asian GDP; and emerging Asian GDP affects neither. In the short run, all the GDPs affect each other. We have verified, however, that the substantive results are robust to the choice of ordering. Lag length is determined by the Akaike Information Criterion (AIC). The pre-crisis period refers to Q1:1988–Q4:1996, while the post-crisis period covers Q1:1999–Q4:2006.

Figure 10 [ PDF 41.5KB | 1 page ] shows the responses of Japanese GDP to a one-standard deviation shock to global, Japan, and emerging Asia GDP. Before the Asian financial crisis of 1997, Japanese GDP did not respond significantly to a global shock (in each graph, the red dotted lines indicate a confidence interval). In the post- crisis period, however, Japan's output became significantly responsive to a global shock, while the response to its own shock declined significantly. There was little change in the responsiveness to an emerging Asia shock across the two samples.

Next, Figure 11 [ PDF 34.6KB | 1 page ] indicates the variance of Japanese GDP that can be explained by a global shock, a Japan shock, and an emerging Asia shock. Before the Asian financial crisis of 1997-1998, virtually 100% of the variance of Japanese GDP was explained by a Japan shock alone. Global and emerging Asia shocks had no role. In the post-crisis period, however, the portion explainable by a global shock increased significantly (to about 40% after a few quarters), with little change observed for the emerging Asia shock. Consistent with the impulse response analysis reported above, global GDP shocks tend to have a much more significant impact on Japanese GDP in recent years. As a result, the variance of Japanese GDP can be explained almost equally by Japan and global shocks.

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