Global Imbalances Poised to Further Expand on Japan's Capital Import
Developed countries are becoming capital importers as their saving ratios fall sharply

Faculty Fellow, RIETI

Contrary to the "standard pattern" of capital flows from developed to developing countries, capital exports from over-saving developing countries in East Asia and elsewhere to developed countries are expanding. Falling household savings ratios in developed countries are adding impetus to this new trend and there is a possibility that Japan will become a capital importer five years from now.

Two "standard patterns" no longer prevail

The development of financial markets on a global scale, along with trade, serves as a major driving force for globalization. Well-developed financial markets contribute to the economy in two ways: enabling the transfer of capital from low-return countries to high-return countries and from entities with capital surplus to those with capital shortage.

With respect to the first flow, international capital movements, Economic Theory expects that the situation would fall into the standard pattern of capital exports from developed to developing countries, given the fact that the rates of return on capital will be higher for developing countries with low capital accumulation than for developed countries with high capital accumulation. Indeed, England was the leading country and a major capital exporter in the 19th century, as has been the United States since World War I. Meanwhile, with the second flow, migration of surplus funds, the pattern predicted by Economic Theory in which household savings enable corporate investments was established in the 20th century as the separation of ownership and control was becoming a norm among developed countries.

Surprisingly, however, neither of these two standard patterns still prevails. In regard to the first pattern, a reverse phenomenon has occurred subsequent to the 1997 Asian currency crisis and today developed countries are importing capital from developing countries (see table). The table shows that a major cause of the reversal is that after the crisis Asian countries, which used to be capital importers, began to export capital. This, too, is a product of the crisis.

Table: Global Current Account Balances (billion dollars)

The currency crisis, which in nature resembled bank runs, was triggered because some East Asian countries did not have sufficient dollar reserves while their dollar-denominated short-term debt obligations were rapidly building up amid active investments. Having gone through this experience, the governments of these countries increased foreign reserves and companies became more cautious in making investments, thereby creating a situation where savings exceed investment, and bringing the current account balance into surplus.

Over-saving globally

In April 2005, Ben Bernanke, then governor of the Federal Reserve Board, said that a "global saving glut" triggered by the catastrophe in East Asia is the major cause of the ongoing problem of global imbalance. Underlying this argument is the fact that real interest rates in the world are declining; the rates would have been driven up by excessive demand for funds in the U.S., the largest capital importer in the world, if it were the major cause of the problem.

So then why has the U.S., alone among developed countries, come to stand out in the scale of current account deficits? This is because the U.S. embarked on expansionary fiscal and monetary policies in response to signs of recession. "Savings" refers to the portion of income that is not used or spent. If such withheld spending is not compensated for by expenditures on "investment," the lack of spending relative to the size of income may trigger a recession. Therefore, the global saving glut, along with the falling real interest rates, poses a threat of recession and, in this regard, the U.S. expansionary policies should be credited for preventing the onset of a global recession.

However, monetary easing policies recently adopted by the U.S. and other developed countries also have their negative side; a tendency to induce a speculative bubble. More specifically, these easing policies stimulate the economy - lower interest rates stimulate housing investment, which would lead to a seemingly speculative rise in housing prices, whereby households, encouraged by rising asset prices, would increase their consumption. In developed countries where housing prices are rising, the current account balance is deteriorating. This is in sharp contrast with Japan and Germany where housing prices are continuing to fall and the current account balance is improving.

Next, with respect to the second standard pattern, household savings enabling corporate investment, a major change has been observed in developed countries. While household savings ratios fell substantially, excess savings - a gap between savings and investment - at companies expanded. In particular, the household savings ratio in the U.S. fell to near zero, which is inextricably linked to the expanded consumption resulting from economic stimulus measures. On the other hand, excess savings at companies are most conspicuous in Japan.

It should be noted, however, that this is recognizable as a trend for all companies, including financial institutions, only from 1998 when deflation set in. Figures of business corporations, non-financial companies, are more closely linked with the macroeconomic performance of the economy, turning into a saving surplus only in the recessionary phases. This is probably because business corporations, when in recession, tend to prioritize the reduction of the existing debt burden and curb investment. Non-financial companies posted 53 trillion yen in excess investment in 1990, the peak of bubble, and 11 trillion yen in 1997. After this, however, things changed with savings exceeding investment by 20 trillion yen in 1998 and 10 trillion yen in 2003. As far as financial institutions are concerned, savings have been consistently exceeding investment since 1992, that is, since the bursting of the bubble. The amount of excess savings peaked at 18 trillion yen in 2002 and came down to 15 trillion yen in 2003.

In 1997, the year in which the currency crisis hit Asian countries, Japan also saw an economic downturn. Therefore, both phenomena - East Asia becoming a net capital exporter and Japanese companies shifting from excess investment to excess savings - are a reflection of their streamlining efforts. In other words, the ongoing "abnormality" in the pattern of international balance of payments is partially attributable to short-term factors. However, it must be noted there are also two long-term factors at work. One is the so-called China factor. China has been substantially expanding investment in recent years. Still, its savings continue to exceed investment, adding to the global saving glut trend. The other factor is falling household saving ratio in developed countries amid the increasingly aging population.

Corporate savings hold the key to setting the direction for Japan's current account balance

Much attention is being focused on Japan where the postwar baby boomers, those born in 1947-1949, will reach their retirement age in 2007-2009. Because retirees live on their savings, Japan's household savings ratio is expected to fall sharply in the coming years.

The government's white paper on economic and fiscal policy for fiscal 2005 predicts that Japan's household savings ratio measured against the GDP will be about 2.5% (3% if measured against disposable income) in 2010. Meanwhile, outstanding government debts currently stand at 170% of the GDP. Assuming a 2% interest rate, this means that Japan would be required to make a yearly interest payment in an amount equal to 3.4% of the GDP, which alone exceeds the projected amount of household savings.

Will Japan need to rely on foreign capital for servicing its debts in five years from now? The key lies in corporate savings. The general rule is that when in a good economy, non-financial companies boost investment and thus their investment exceeds savings. But this must happen within five years as the Japanese economy is bound to dwindle otherwise. Hopefully, by around that time, Japanese financial institutions will be putting an end to the problem of nonperforming loans and beginning to reduce their savings. If Japan, currently the world's largest capital exporter, becomes a net capital importer, real interest rates would rise sharply and investments would go down on a global scale. Should this become a reality, Japanese companies might choose to save more than they invest, resulting in a further increase in excess savings. This, however, would not eliminate concern about the possibility that Japan five years from now will need to seek the help of foreign capital in servicing deficit-covering bonds. If Japan falls into such a situation, the world would enter into an abnormal state where the leading economies are dependent on capital imports from East Asian and oil producing countries.

If Japan is to become a net capital importer while holding a huge amount of fiscal deficits, it needs to prop up the domestic financial market in preparation for that eventuality. Such, I believe, must be the thinking of the Prime Minister Junichiro Koizumi's administration. The privatization of the state-run postal services, which was the focal point of the recent House of Representatives election, must be one of the steps toward that end. The enactment of the postal privatization law, under which full privatization is to be realized only after 12 years, will not improve the Japanese economy any time soon. Yet the transparency of funds management within the yucho postal savings system, the world's largest financial institution in terms of assets, is directly linked to the transparency of Japan's financial market. In addition, gains on the sale of postal businesses will help repay the government's debts. As such, the postal reform is sure to serve as a strong notice to the market.

In the election for the House of Representatives, Koizumi fielded Takafumi Horie, an entrepreneur who had attempted a hostile takeover of Fuji Television Network, Inc., to run in a constituency in Hiroshima Prefecture against Shizuka Kamei, a big name lawmaker who defected from Koizumi's Liberal Democratic Party in opposition to postal privatization. The move was apparently meant to be a message to the market signaling the government's "endorsement" of a hostile takeover, another strong notice to the market. Through this election, Koizumi earned credit as "fairly market-friendly reformer" from the magazine The Economist, and Japanese share prices reacted favorably to the landslide victory of his LDP. As such, things have turned out exactly how the Koizumi government had hoped for. However, given the prospect that Japan will soon face a rapid fall in savings ratios while holding mounting government debts, this is nothing but a tiny first step in a crusade to tackle a daunting task ahead.

>> Original text in Japanese

* Translated by RIETI.

October 18, 2005 Nihon Keizai Shimbun

December 28, 2005