Significance of the Deterioration in Japan's Balance of Payments
Senior Executive Fellow
Fujitsu Research Institute
On 12 May, Japan's Ministry of Finance announced that the FY2013 current account balance had slumped heavily on the last fiscal year from 4.2 trillion yen to 0.8 trillion yen, marking the third consecutive year that the surplus has shrunk. The rapid decline is due to the trade balance, a key component of the current account balance, slipping into the red as of FY2011 and subsequently continuing to plummet. The trade balance represents the amount remaining when imports are subtracted from exports, so a deficit means that imports outweighed exports, signifying a rapid loss of strength in Japan's export industries, the backbone of the economy. Moreover, this deficit is growing rapidly with no sign of stopping. Economists and economic policy pundits are concerned that this might have various negative impacts on the Japanese economy ahead.
Does a current account deficit await in Japan's near future?
However, it would be a mistake to judge based simply on the trade balance. Exports are not the only way of earning money from offshore. Other sources include shipping, finance, and tourism and other service exports, as well as investing offshore and earning interest and dividends. All these things in total make up the current account balance. The current account balance is a better guide to overall economic performance than the trade balance. The chart below looks at trends in Japan's current account balance. When this is in surplus, the amount earned from abroad by Japan as a whole is greater than the amount paid out, and the difference between the two means an increase in the assets and bonds held against other countries. If the declining trend to date continues and Japan's current account balance goes into deficit this fiscal year, it would be Japan's first current account deficit since FY1980, and would likely impact on the entire economy, including not only the exchange market but also stock prices and interest rates. Economists are very familiar with the international balance of payments development stage theory. As a country industrializes, its trade surplus expands, but eventually the companies from that country shift offshore to countries with cheap labor costs and strong growth prospects, pushing the trade balance into deficit. However, because after a while investment profits from offshore grow greater than the trade deficit, the current account balance can be kept in surplus. Again though, as manufacturing hollows out, at a certain point the current account slides into deficit and the economy faces issues such as loss of employment and currency devaluation. The UK, the US and many other developed countries have experienced that process, so it would hardly be surprising if Japan joined their ranks.
Trade deficit not caused solely by nuclear power plant shutdown
The major earthquake and tsunami of 11 March 2011 impacted directly on Japan's trade balance. All nuclear power generation, which accounts for 29 percent of Japan's power production, was halted and switched instead to thermal power generation, causing imports of natural gas and fuel oil to soar. A further cause for concern has been the spike in imports of manufactured products like the flat-panel televisions, smart phones and other consumer electronics where Japan has traditionally enjoyed overwhelming competitiveness. Most of these imports are from China, Korea and other Asian countries, and in many cases they comprise reverse imports of products manufactured by Japanese companies in Asia. Yen appreciation between 2008 and 2012 encouraged many Japanese firms to transfer their production bases to Asia. Once they have made that shift, companies are not going to bring their plants home again simply because the yen is now weaker.
Weaker yen fails to have the expected effect
What has surprised economists is that yen depreciation has not to date shown any sign of boosting exports. The yen has dropped almost 30 percent in value from 80 to the US dollar in fall 2012 down to 102, hugely improving the profitability of export firms. However, on a quantitative basis, exports are actually down on a year ago-and in the absence of greater volume, employment and investment will not increase, nor will the economy grow. Export volume has held low because rather than dropping their prices and boosting volume, exporters have instead chosen to expand their profit.
The composition of export products has also changed. The export core has shifted from consumer-oriented final goods like cars and home electronics to core components and raw materials for the assembly plants of Japanese firms which have moved offshore. This inter-company trade is affected not by price but by final product demand, or in other words, economic conditions in the host market. This is why exports to the currently economically robust US are growing while exports to Asia and Europe remain flat.
Call for wage hike again next year
Turning to imports into Japan, around 80 percent of these comprise products like resources, energy and cereals, the prices of which are dollar-denominated. If the yen loses 30 percent of its value, the value of imports in yen terms rises 30 percent. The weak yen was a major cause of FY2013 imports growing by a solid 17 percent. Higher import prices will impact a wide range of commodities and services, ultimately pushing up the consumer price index. This might be great for the Bank of Japan, which is keen to break the economy out of deflation, but the people of Japan would suffer. In March, many corporate majors engaged in negotiations with trade unions on wages from April on. These negotiations resulted in agreement to raise wages, including an across-the-board pay rise, for the first time in 17 years, with a 1-2 percent difference in the size of the hike. In the case of small and medium enterprises, it is unclear whether wages will rise at all. Prices, on the other hand, were up 2.7 percent as at April thanks in part to the consumption tax hike. This means that wages are effectively shrinking. Even those members of the public who have the sense that Abenomics might improve their lives are likely to realize in the latter half of this year that this in fact hasn't been the case. Next year, Prime Minister Abe will probably have to call on companies again to raise wages.
Southern Europe revisited?
At the end of this year, the Prime Minister will once again confront the difficult decision as to whether he should hike the consumption tax up further to 10 percent. By that stage, Japan's current account deficit may well have become a permanent fixture. In other words, the budget deficit may be too large to cover with domestic savings, and Japan may have to borrow from overseas. Confidence in Japanese government bonds could be lost, with interest rates shooting up. The yen would weaken still further and push import prices even higher, putting a strain on household budgets. The administration would be unable to avoid the politically unpopular steps of raising taxes and cutting spending. Japan could wind up much like Greece, Italy and Spain.
To avoid such a situation, Japan will need to foster new industries with international competitiveness, as well as increasing the efficiency of supply of medical and nursing care services and bridling the budget deficit. Regulatory reform in the electricity, agriculture, medical and nursing care sectors will make a direct contribution to these goals. This is just what Abe's "third arrow" is supposed to achieve, but given stiff resistance to reform, that arrow appears unlikely to be able to fly far at this stage. Japan's sluggish stock prices could well reflect investors' premonition to that effect. Abenomics seems likely to reach a difficult turning point in the latter half of this year.
(original article : Japanese)