Weak Yen and Services Trade
Vice Chairman & Vice President, RIETI
Yen is depreciating again
Over the past two years, the Japanese yen has been on a weakening trend. In terms of the nominal effective exchange rate that takes into account the euro and some other non-U.S. currencies, the yen peaked in July 2012 and then lost 25% of its value by the end of 2013. In 2014, the yen remained relatively stable for months. However, prompted by the U.S. Federal Reserve's announcement on October 29, 2014 of its exit from the third round of quantitative easing (QE3) and the Bank of Japan's decision to expand its monetary easing, the yen has started depreciating again and sharply.
In the meantime, against the backdrop of increasing fossil fuel imports following the March 2011 Great East Japan Earthquake, trade deficits have become chronic. Yet, despite such a significant weakening of the yen, Japan's export volume has not been boosted as much as would have been hoped for. The failure to produce the J-curve effect has been causing serious concerns particularly in the light of Japan's continuing trade deficits, which seem to have become the norm because of a sharp increase in fossil fuel imports following the March 2011 earthquake. Indeed, despite the fact that the yen's effective exchange rate depreciated by more than 25%, Japan's export performance in terms of volume has been disappointing with recent monthly figures fluctuating between positive and negative year-on-year growth. Some people attribute this to a decline in the competitiveness of the Japanese manufacturing industry. However, such arguments about the relationship between the currency exchange rate and export volume are often based on misconceived notions.
Is the loss of competitiveness a true cause?
One reason why Japan's export volume has been failing to gain momentum amid a weaker yen is the weak growth in global income (Nakajima, 2014) (Note 1). Another reason is that Japanese companies have not reduced foreign currency-denominated export prices in response to a weaker yen, thus resulting in no export-boosting effects. This reflects the fact that Japanese exporting companies have enhanced their price competitiveness over the years.
A while ago when the yen was rising sharply, we heard a lot of arguments advocating the mistaken belief that Japanese companies were unable to increase their export prices despite higher costs denominated in foreign currencies because that would further weaken their price competitiveness. This time around, the focus of debate is on why a weaker yen has not led to price cuts. In other words, the prices of Japanese exports have become insensitive to changes in exchange rates in recent years. Economists describe this phenomenon as having low pass-through of exchange rate changes into export prices.
Though this is just a textbook-level discussion, the change in the optimal (or profit-maximizing) price resulting from foreign exchange fluctuations and hence a shift in the supply curve (based on the foreign currency-denominated price) is smaller for a company if it exports products that are unique and differentiated, and thus are less subject to competitive market pressure than would be under perfect competition, i.e., where the company faces competition from other companies selling identical products. A comparison of the pass-through of exchange rate changes under perfect competition and that under monopoly can be illustrated as shown in Figure 1 (Note 2). We can see that the impact of a weaker yen is smaller under a monopoly than under perfect competition in terms of both price declines and volume increases. I will not go into details, but, as a general rule, cases of duopoly and oligopoly fall somewhere between the cases of perfect competition and monopoly. It is well known that prices of goods and services supplied by monopolies in their domestic markets are inelastic in both upward and downward directions, and a similar phenomenon is occurring in export markets.
Against the backdrop of the development of manufacturing industries in South Korea, China, and Southeast Asian countries, and having undergone drastic changes in the yen's value repeatedly, Japanese manufacturers have pursued the strategy of moving the production of commodity goods—those with little differentiation and that are easily exposed to competition—to overseas destinations while retaining the production of highly-differentiated, market-dominating goods in Japan. As a result of such strategic shift toward high value-added manufacturing, the pass-through of exchange rates into export prices has dropped significantly whereby a weaker yen has only led to a marginal increase in export volume, or that is probably the standard interpretation. Under this situation, leading manufacturers with the ability to control prices are posting strong earnings as a weaker yen pushes up the yen-denominated amount of their revenue.
Increasing the number of tourists from abroad
Does this mean that a weaker yen has no export-boosting effect? The effect on manufacturers' exports is as discussed above. However, we are already seeing the impact of the recent depreciation of the yen on Japan's trade in services, particularly in the balance of payments in travel services. The number of inbound travelers has increased with the weakening of the yen, and Japan's travel receipts—spending by international visitors within Japan on travel-related expenses such as lodging, food, and purchases of souvenirs—have been increasing steadily (Note 3). Plotted in Figure 2 are Japan's international travel receipts and payments in relation to the yen's exchange rate. The horizontal axis represents the yen's real effective exchange rate (natural logarithm) while the vertical axis measures the amount of travel receipts and payments (natural logarithm of amounts in 100 million yen). We can see that foreign nationals' travel expenditures in Japan and Japanese nationals' travel expenditures aboard are very sensitive to changes in the yen's exchange rate. Simple calculations show that the exchange rate elasticity of trade receipts in value is approximately -3.0 and that of trade payments is approximately 1.0 (Note 4).
Travel receipts shown in Figure 2 are denominated in yen. Thus, an increase in the amount of Japan's international trade receipts generally means an increase in the volume of Japan's exports in travel services, provided that there have been no significant changes in domestic prices of lodging, souvenirs, and so forth (almost all denominated in yen). Meanwhile, for Japanese people going on overseas trips, a weaker yen means greater yen amounts for the same quantity of services (priced in the local currency) with the amount of yen-denominated payments increasing by the same percentage as that of decrease in the yen's value. Based on the values plotted in Figure 2, the exchange rate elasticity of Japan's services imports in volume is estimated to be approximately 2.0. In other words, a weaker yen has led to a decrease in the number of Japanese tourists traveling overseas with some of the demand for outbound tourism substituted by the demand for domestic tourism.
Needless to say, trade in travel accounts for only a small portion of Japan's overall trade in goods and services with travel receipts and payments in 2013 amounting to about 1.5 trillion yen and 2.1 trillion yen, respectively. However, amid fierce competition among tourist destinations across the world, a weaker yen has undoubtedly been benefiting the Japanese tourism industry in volume. For instance, the Yanesen area in Tokyo—which happens to be my neighborhood and collectively refers to the three old-fashioned downtown districts of Yanaka, Nezu, and Sendagi—is becoming ever more popular among tourists from abroad. Also, when I visited the Nyuto hot spring resort in Tohoku over a long weekend this fall, I saw many tourists from various countries around the world staying and taking a dip in an outdoor hot spring in this secluded area.
As Japan has a strong image as a major trading country driven by the manufacturing industry, its trade in services tends to be overlooked. In reality, however, Japan's service sector nationwide has been enjoying the benefits of a weaker yen in the form of increased volume. In discussing a weaker yen's effects on service industries, the negative impact caused by increased costs tends to be overemphasized. In reality, however, effects of changes in the currency exchange rates vary across industries, companies, and regions.
- ^ Nakajima, Atsushi (2014), "Japan is Outperforming Many Others in Exports: Trade balance remains in deficit but the weaker yen is having a significant impact," (English translated version from the RIETI website. The Japanese original was posted on the WEDGE Infinity website on July 30, 2014)
- ^ The figure is based on the assumption that the slope of the demand curve is uniform for all goods. It should be noted that the slope varies across goods in reality.
- ^ Travel expenses such as airfares are classified as transportation payments, not travel payments.
- ^ The estimation period is from January 1996 through August 2014. The effective exchange rate elasticity of overall trade in services is approximately -1.9.
November 11, 2014
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