Global Recession and International Economy - Japan's challenge and approach

International trade has collapsed in the global recession that followed in the wake of the financial crisis, with particularly severe repercussions for Japan. The RIETI Policy Symposium, Global Recession and International Economy presents the results of research analyzing the conditions that Japan is facing at the company, industry, government, and international levels. It also takes both macroeconomic and microeconomic perspectives in proposing ways to resolve the issues that stand in the way of sustainable economic growth and trade development, while discussing future challenges and policies, and considering the direction of institutions and systems.

FUJITA Masahisa (President and Chief Research Officer, RIETI / Professor, Konan University / Adjunct Professor, Institute of Economic Research, Kyoto University)

• The subprime mortgage loan problem began to worsen from the summer of 2007, engulfed countries around the world, and subsequently led to a global economic crisis. The Research Institute of Economy, Trade and Industry (RIETI) has been conducting studies and discussions concerning the impact of the global financial and economic crises on the Japanese economy and the action that needs to be taken. It has been actively seeking to make an intellectual contribution by holding two policy symposiums in addition to the one today.
• The most serious question for Japanese companies and policymakers is why Japan, which was not the epicenter of the subprime problem, was among the most harshly affected countries in the industrialized world. One reason is that the Japanese economy has been heavily dependent on continuous growth in international trade linked to its ongoing integration into the international economy.
• Japan's economic growth has been driven by this expansion of international trade. For this reason, it needs to have a correct understanding of the crisis it is facing and play a new role in rebuilding a balanced, prosperous global economy. In particular, Japan needs to exercise real leadership to prevent the emergence of trade protection and to build a free and healthy international trade system.
• This symposium seeks to consider a number of questions, including new demands for international corporate behavior and international institutions in macroeconomic terms in the wake of the problems and challenges that companies, industries, governments, and the international economy are facing. It will also discuss the issues that confront companies, governments, and the international community, as well as the policies needed, institutional reforms, and the direction that must be taken to overcome this international economic shock.

ITO Koji (Senior Fellow, RIETI)

• The decline in international trade caused by the global recession has been greater and faster than the falls seen during the bursting of the IT bubble. Indeed, the downturn has been sharper than that experienced during the Great Depression.
• Consumer spending and capital investment in the European Union and the United States have been declining with particular speed since the fall of 2008. As a result, global imports have been falling rapidly.
• Looking at the contribution to imports of the European Union and the United States by item, the falls in consumer durable goods or capital goods such as general machinery, electric machinery, and transport equipment--all major exports for Japan--have been particularly noticeable.
• The proximate cause of the financial crisis was the U.S. housing bubble. However, the search for the ultimate factor reveals the ballooning investment capital on a global scale, driven by an increase in pension and investment funds linked to the aging of developed nations and a rise in the foreign reserves of high-growth emerging countries, which flowed into American housing through the U.S. financial system, particularly agency securities.

• Japan had relatively little exposure to the subprime problem and fewer troubled financial institutions compared with other developed countries, yet its economy was seriously affected.
• Although Japan experienced a recovery that was the longest in its postwar economic history from 2002 to 2007, the rebound in domestic demand, particularly consumption, was clearly weak compared with previous upturns, and the recovery relied on export growth. As a consequence, the collapse of exports since the autumn of last year had serious implications for the Japanese economy.
• In addition, exports, capital expenditure, and domestic production increasingly move in step, so the impact of a fall in external demand on the economy is exacerbated by a decline in capital expenditure, among other factors.
• If we break down the factors for the fall in exports since autumn 2008 into three components--volume, price, and foreign exchange--the decline in the volume basically has the greatest impact. Looking at export trends by destination market, shipments to the United States have been declining since the first half of 2008, while exports to all countries and regions have dropped since October 2008.
• Japan is not as export-dependent as either Germany or China, and yet the sharp decline in exports dealt a major blow to the Japanese economy. Two reasons for this can be identified. First, Japanese export growth encompassed not only direct shipments to Europe and the United States, but also triangular trade, meaning the export of intermediate goods to Asia, and then the shipment of export goods locally processed by production networks in Asia to Europe and the United States. As the final destinations of triangular trade are primarily Europe and the United States, shipments of intermediate goods to Asia fell sharply when exports to Europe and the United States dropped (for other countries in Asia, although exports to Europe and the United States fell, imports from Japan and elsewhere also declined). The second factor is the tendency for Japanese exports to have higher added value. Originally, Japan exported mostly machinery, such as electrical machinery and automobiles. Since the 1990s, however, the rise in added value has been consistent. The recent decline in exports was magnified by this added value.

• One global economic challenge is to diversify risk by avoiding a concentration of investment capital into the United States in order to prevent a similar crisis. Other industrialized nations need to increase their appeal to investors. And although emerging economies are currently suppliers of capital, they ought normally to have significant domestic demand for capital. They face a medium and long term need to improve their domestic investment environment and develop their own capital markets.
• With respect to protectionism, nothing extreme in terms of protectionist trade measures has been observed as yet, thanks to the presence of the WTO. It will be still important to prevent any possible protectionist tendencies within the framework of WTO rules.
• The Japanese economy has its own challenges. First, it must diversify export markets in response to the recession in the United States. It is particularly important to further penetrate markets in high-growth emerging markets such as China and India. Second, it is essential that industries in Japan create new products and services to deal with competitive pressures on export items, which are rising with the development of industries in emerging countries such as China. Third, Japan must consider the impact of globalization on its economic structure. Although the expansion of domestic demand is important, consumption and income barely moved, even during its most recent economic recovery, and it was difficult to increase employment because of the influx of cheap imports. The globalization of the economy is likely to continue. Given this, Japan needs to consider the transformation of its domestic industrial structure and the facilitation of movements of production factors between industries.

Q: You made a comparison with the Great Depression, but I wonder if the crisis this time is much broader than the Great Depression. Is there any signal that suggests that this current crisis is not a once-in-a-century phenomenon, but rather something that appears once in every few centuries?

Ito: The decline in trade in the first quarter of 2009 was steeper than it was during the Great Depression. However, figures have been improving slightly--or at least holding firm--since April. Still, it is difficult to conclude if a true recovery is underway or not. The policy approach, such as monitoring against protectionism, is important. At the time of the Great Depression, protectionist measures were used, such as gradually raising tariffs and dividing the world economy into blocs, allowing the contraction of trade to continue. If we make that kind of policy mistake this time, we may end up with a situation like the Great Depression.

KUROIWA Ikuo (Director-General, Development Studies Center, Institute of Developing Economies JETRO)

• We measured the impact of the decline in exports from Japan to the United States on Asian countries using the Asian International Input-Output Table for 2008, prepared by the Institute of Developing Economies (IDE). This analysis is able to quantitatively calculate not only the direct impact of the decline in exports from Japan to the United States, but also the impact on production of the triangular trade through Asian countries; that is, the repercussions (spatial linkage) through international industrial networks or production networks.
• Forecast real GDP growth for East Asia in 2009 suggests negative growth for every country except for China. The decline for export-dependent Singapore, Thailand, and Malaysia is especially significant.

• A comparison of trade structures in 2000 and 2007 indicates that China is rapidly expanding its presence in East Asia, and trade imbalances with the United States and Europe are increasing.
• Looking at the trade structure by dividing it into intermediate and final goods, the linkage between China and Japan/South Korea and between China and ASEAN is expanding on a larger scale than the linkage between Japan/South Korea and ASEAN in intermediate goods. With respect to consumption goods, trade between China and ASEAN, between ASEAN and Japan/South Korea, and from Japan/South Korea to China remains low, with exports from China to Japan/South Korea the only exception in East Asia. By contrast, exports of consumption goods to Europe, the United States, and the European Union are expanding, and China's share is overwhelming. One reason for this is that effective tariff rates on consumption goods are high in East Asia.

• In Japan, the fall in exports of transport equipment and electrical machinery has been noticeable. For transport equipment, the impact of triangular trade is relatively small. Possibly the primary reason for this is that the percentage of intermediate goods that move across borders is small, as transport equipment is a self-contained industry with high local content. In contrast, triangular trade has a substantial impact for electrical machinery. The reason for this seems to be that production networks are expanding rapidly, especially in East Asia, as the transportation cost of intermediate goods is low and therefore the accumulation effect is relatively small.
• The comparison of the shares of spatial linkage of production induced by exports from Asian countries to the United States in 2000 and 2008 shows that China has a relatively small share in both 2000 and 2008, while shares of Asian countries, including Japan, have been rising rapidly since 2000. A particularly common feature is that the impact of exports to the United States via China (triangular trade) is large.
• There is a very pronounced trade structure that benefits from the influence on production of exports from countries other than the original producing country to the United States through triangular trade. This is inextricably linked to the geographical expansion of production networks, like two sides of the same coin, as observed in electrical machinery.

Q: The impression from within the industry is that the density of production networks in the structure of the division of labor of automobiles may not be as low in comparison with electronics as your report emphasizes.

Kuroiwa: The automobile industry has a history of highly protectionist industry policies implemented in the ASEAN region. Auto parts have been directed by policies imposing local content regulations so that suppliers would be attracted to assemblers. At the same time, production networks are certainly expanding in such a way that production facilities in each country in the ASEAN region are specializing in certain parts and making them available within the region. However, the local content of automobiles tends to be high in comparison with electrical machinery, and I think that this is a result of being influenced by a large accumulation effect.

KAWASE Tsuyoshi (Faculty Fellow, RIETI / Professor, Faculty of Law, Sophia University)

• The current global recession has led to the introduction of trade-distorting measures by a number of countries for the purpose of employment security and capturing domestic demand. In contrast to the days of the Great Depression, however, major countries have already adopted a clear stance of rejecting protectionism at the G20 Washington Summit in November 2008, a reflection of international governance centering on the WTO.
• In response to requests by the international community such as the G20, the WTO has initiated an attempt to summarize the protectionist movements of each country and publish a quarterly report.

• A hike in tariffs and surcharges is generally nothing more than raising the effective tax rate within the scope of duty concessions. As for non-tariff barriers, import restrictions and import permits with uncertain legal foundations have been introduced, as have export restrictions designed to retain access to resources. Restrictions through specifications and standards for steel and IT products and restrictions for health and quarantine purposes such as the response to the swine flu are also highly visible.
• With respect to the preferential treatment of domestic products, favorable treatment in public procurement is clearly evident. Particularly in the United States, despite the promise of non-discriminatory government procurement under the Government Procurement Agreement (GPA), the "Buy American" provision of the American Reconstruction and Reinvestment Act (ARRA) stipulates the prior use of domestic products in public construction programs. Even in areas other than the public sector, there are certain measures in purchase assistance for eco-cars that are suspected of constituting preferential treatment for domestic products that do not comply with national policy.
• Support measures for domestic financial institutions are not regulated as subsidies, given that no provision for this is made in the current General Agreement on Trade in Services (GATS). However, they could become a violation of national policy, depending on the commitment of governments to liberalizing financial services.
• In trade remedies, approximately 60% of investigations of anti-dumping duties initiated in the last year were concentrated on the second half after the financial crisis, and the WTO anticipated the initiation of 400 investigations by the end of 2009. With respect to safeguards, although the initiation of investigations increased dramatically in the first half of 2009 compared with recent years, it will be difficult to identify either the causal relationship or any increase in imports under recession. As for countervailing duties, there is no noteworthy trend, but vigilant surveillance will be necessary over the next few years in relation to industrial revitalization and stimulus packages.
• Although economic stimulus measures currently taken are comprehensive packages such as the Act on Special Measures for Industrial Revitalization and the Policy Package to Address Economic Crisis in Japan and the ARRA in the United States, there are some programs that could be subject to rules under the Agreement on Subsidies and Countervailing Measures ("SCM Agreement") if benefits are conferred to recipients. In the automobile industry, given the significant injection of public funds in a number of countries, including the bailout of the Big 3 in the United States, the countervailing duties and the SCM Agreement will apply.
• As for export support programs, while the expansion of trade finance provided by multi-banks, individual regions and member nations is welcome in the wake of the decline in the trade capacity of developing nations, such measures could constitute an export subsidy. Other than these, the refund of internal taxes on exports and the resumption of export subsidies on agriculture have also been reported.

• It is true that at this point WTO members are oriented to restrictive and distorted trade policies. However, WTO monitoring and surveillance have been successful in curbing any inclination toward extreme protectionism, and the international community has recognized this. It is also important to ensure that rules are followed, by using effective dispute settlement procedures as well as surveillance.
• As many of the current protectionist measures lie just within the "play" of the WTO rules, every country still recognizes the agreements as normative restrictions. It would be premature to discuss the limitations of the WTO because of the current circumstances and the struggles of the Doha Round.
• The first challenge going forward is to address the size of the Secretariat of the WTO, which is very small and has only limited surveillance resources. Second, as every country takes protectionist measures in some areas such as automobiles and steel, there is concern that they may agree to avoid using the dispute settlement procedures. Third, the Doha Round is essential for the expansion of international trade, especially to lower the tariffs and liberalize the trade of developing countries and major emerging non-WTO members such as Russia.

Q: In some cases, surveillance of trade restriction measures is undertaken by several international organizations other than the WTO, including the World Bank, the OECD, and the UNCTAD, and a question of which is the most suitable organization may arise. What do you think?

Kawase: Although the World Bank and the UNCTAD have surveillance sections, I think that the overall role of proactively monitoring national trade policies should be taken by the WTO, particularly the Trade Policy Review Mechanism (TPRM). However, as there are limits to its resources, the WTO will need to collect information in cooperation with other relevant organizations.

Q: It seems realistic to think that developing nations will inevitably protect their domestic markets with strictly protectionist policies. What position should we take on this?

Kawase: Although the reality is as you described, the WTO rules are set up to respond flexibly to critical situations. For example, an exceptional application of rules to protect the balance of payments and more relaxed rules for subsidies are permitted for developing nations. The rules are also able to respond to a sharp increase in imports by initiating safeguards. Therefore, my understanding is that the WTO gives developing nations sufficient advantage within the framework of its rules. I know, at the same time, that some developing nations complain that the WTO as it stands is not really beneficial to them. The extent to which the WTO can evolve to appeal to developing nations will be vital in the present Round.