The Future of the Current Account Balance
Japanese current account balance is undergoing structural changes. The trade account surplus has turned deficit in 2011. Because of the trade deficit, current account surplus, which we have seen almost consistently for the past 50 years, has also become smaller (please see the Table). This month’s column will discuss the future of the Japanese current account and its implications.
Historical background of the current account surplus
Japanese current account started to record sustained surplus in the latter half of 1960s. It reflected the improved competitiveness of Japanese goods, and the consequent increase of the trade account surplus. It was more than enough to offset the deficit in the services account. As the net foreign assets accumulated, the surplus was also reinforced by the growing surplus in the incomes account. Surplus in the incomes account had grown to exceed the surplus in the trade and services account in the 2000s.
Standard scenario for the future of the current account balance
The recent decline in trade surplus is a result of a number of factors: First, the appreciation of the yen that has taken place since late 2000s has discouraged exports from, and encouraged imports into, Japan. Second, the appreciation of the yen also stimulated shift of production sites abroad which also replaced exports from Japan. Third, imports grew as a result of the appreciation of the yen and the increased imports of final products from production sites abroad. In addition, as a result of the shutdowns of nuclear power plants, imports of LNG and other fuels also increased.
As far as these factors remain, the basic scenario is for the current account to show a smaller surplus, and eventually turn into deficit in the medium-term. Projection of current account deficit is also a conclusion reached naturally from the fall in household savings rate that is brought about by the aging of the population. Emergence of current account deficit is a shared characteristic of many medium-term forecasts (including that of the JCER).
Current account deficit may seem inevitable. However, current account balance turning into deficit has some important implications. First, it will increase the role of foreign savings in the market, and may change the environment which, until now, allowed long-term interest rate to stay low. Second, it means that the nation is starting to run-down net foreign assets that have been accumulated in the past. The future of such a nation seems gloomy (although there is an important exception of the USA).
Alternative scenarios for the future of the current account balance
What awaits the future of the Japanese current account balance? Is the current account balance deficit inevitable? Aren’t there any other possibilities?
In trying to answer the question, a number of alternative scenarios can be listed (the following is based on my presentation at a seminar hosted by the Brookings Institution earlier this year (http://www.brookings.edu/events/2013/02/20-japan-economy). They are the scenarios that may allow Japan to maintain current account surplus in the medium-term. The scenarios are as follows:
Scenario A: Correction of the past overshooting of yen takes place. Stronger exports and weaker imports will make trade account to return to surplus.
Scenario B: Enhancement of product innovation improves the competitiveness of Japanese exports. It will reverse the trend in the trade account balance from deficit to surplus.
Scenario C: Enhancement of product innovation can also take place in services sector, thereby improving the competitiveness of the services sector and increasing service exports (one promising area is export of technology service). Surplus in trade and services account will be recovered.
Scenario D: Further increase in factor income receipts from abroad, which will more than offset the deficit in the trade and services account.
Scenario E: Expansion of output capacity of high-value added sectors by receiving more foreign workers. Being able to respond to demand for Japanese high-value added products, it will help in improving the trade account.
Necessary conditions for the scenarios to realize
Which of the alternative scenarios is going to realize, if any, depends on whether necessary conditions for the scenarios are met or not.
Scenario A can be said as being realized in the short-term since last December under Abenomics. While the recent trend in the exchange rate helps to correct the overshooting of the yen, sustained current account surplus and deflation will continue to provide upward pressure on yen. Moreover, emerging and developing economies will continue to challenge the competitiveness of our products.
For the scenarios B, and C to realize requires overhauling and renewal of Japanese national innovation system, which was once regarded as the best practice, but which became outdated as it failed to match the changes in the underlying condition (in terms of changes in demographics, severity of competitive environment, and the speed of technological innovation).
If the scenario D is to have impact on the domestic economy, income receipts from abroad (large portion being direct investment income) need to stimulate household spending. Households may respond to increase in direct investment income if they hold shares of the firms directly or indirectly (through mutual funds). At present, however, Japanese households holds majority of their financial assets in bank deposits and only a small portion in shares.
Consensus on whether to receive foreign workers in the area other than the skilled and the talented is not reached. Even if the consensus is reached so as to receive more unskilled foreign workers, the opportunity of realizing scenario E may be missed if Japan fails to make efforts to become an attractive destination for those workers by becoming more acceptable and by preparing necessary infrastructure.
Discussion above shows that the realization of alternative scenarios can be achieved only if the economic policies are successful in addressing the respective challenges. If any of the alternative scenarios is going to be pursued, there is no time to waste but to identify the necessary polices and include them in the growth strategy package.
Issues from a wider perspective
The reality of the alternative scenarios can also be discussed from a wider perspective. In particular, two points are worth mentioning in this context.
First, Japan can be considered to be following typical development stages of the balance of payment à la Crowther (1957): Japan is currently in an immature creditor-lender stage (surplus in trade and services account and deficit in capital account), and is destined to move on to a mature creditor-lender stage (deficit in trade and services account and deficit in capital account), and eventually to a creditor-borrower stage (deficit in current account and surplus in capital account). If that is the case, realization of any of the alternative scenarios implies that the developing stage of the BOP is going to be reversed; i.e. back from mature creditor-lender stage to immature creditor-lender. How this could be explained is a topic for future research.
Second, current account deficit is considered to be inevitable due to the fall in household saving rate that accompanies aging of the population. If the current account surplus is going to be persistence irrespective of the aging, the surplus has to be explained by offsetting changes in net lending and net borrowing of other sectors. Whether the changes are realistic, and, if so, what are the conditions for them to be realistic are important issue that remain to be considered.
These points imply that maintaining current account surplus in Japan is not only an important policy issue, but also an interesting theoretical one.