Economy of JAPAN

(MACROECONOMICS PROJECT REPORT)

MBA PROGRAM(2010-12)
SECTION-J

Submitted to:
Prof. Jojo Mathew George

Submitted by: GROUP 9

S.No. Name Enrollment No. Seat No.
1. Varun Kohli 10BSPHH010861 46
2. Aayushi Kasliwal 10BSPHH010004 47
3. Nipun Sharma 10BSPHH010476 48
4. Khushboo Gumber 10BSPHH010917 49
5. Saurabh Trivedi 10BSPHH011076 69

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 Table of Contents

S.No. Topic Page

No.
1. Introduction 3
2. Sectoral Analyses 7
3. Economic Growth, Employment and Inflation 10
management
4. External sector (Currency management, NX, Net flow 15
of funds etc)
5. Prevailing economic policies 19
(Monetary/Fiscal/Trade/Currency)
6. CONCLUSION & OUTLOOK 24
7. References 27

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1.Introduction:

By Aayushi Kasliwal-10BSPHH010004 (Seat-47)

The economy of Japan is the third largest in the world after the US and the People‘s Republic
of China and ahead of Germany at 4th. For three decades from 1960, Japan experienced rapid
economic growth. With average growth rates of 10% in the 1960s, 5% in the 1970s, and 4%
in the 1980s, Japan was able to establish and maintain itself as the world's second largest
economy since 1968, until supplanted by the People's Republic of China in 2010. However,
in the second half of the 1980s, rising stock and real estate prices caused the Japanese
economy to overheat in what was later to be known as the Japanese Asset Price Bubble.
The economic bubble came to an abrupt end as the Tokyo Stock exchange crashed in 1990-
92 and real estate prices peaked in 1991. Growth in Japan throughout the 1990s at 1.5% was
slower than growth in other major developed economies, giving rise toThe Lost Decade.

The economic history of Japan is one of the most studied for its spectacular growth for three
periods. First was the foundation of Edo (in 1603) to whole inland economical developments.
Economic development during the Edo period included urbanization, increased shipping of
commodities, a significant expansion of domestic and, initially, foreign commerce, and a
diffusion of trade. The construction trades flourished, along with banking facilities and
merchant associations.

Second was the Meiji Restoration (in 1868) to be the first non European power. During this
period (1868–1912), leaders inaugurated a new Western-based education system for all
young people, sent thousands of students to the United States and Europe, and hired more
than 3,000 Westerners to teach modern science, mathematics, technology, and foreign
languages in Japan. The government also built railroads, improved roads, and inaugurated a
land reform program to prepare the country for further growth and development.

Third was the defeat of the World War II (in 1945) when the island nation rose to become
the world's second largest economy. Growth declined markedly in the late 1990s largely due
to the Bank of Japan's failure to cut interest rates quickly enough to counter after-effects of
over-investment during the late 1980‘s. Some economists believe that because the Bank of
Japan failed to cut rates quickly enough, Japan entered a liquidity trap. Therefore, to keep its
economy afloat, Japan ran massive budget deficits (added trillions in Yen to Japanese
financial system) to finance large public works programs. This implied lowering taxes and
increasing G, thus increasing AD.

Post World War II, Japan fought to regain the one-third of its industrial base it had lost in the
war. Japan‘s post war economy developed from the leftovers of an industrial infrastructure
that suffered widespread destruction during World War II. As a result Japan was considered a
less developed country with per capital consumption roughly one-fifth of the U.S. The
country saw its per capital GNP rise from 276 U.S. dollars in 1950 to nearly 25,000 U.S.
dollars in the late 1980‘s. There are several factors that have lead to this rebuilding and
explosion of the Japanese economy. These factors include Japan‘s widespread use of the
industrial policy, becoming one of the world‘s largest creditor nations, and penetrating
international markets in the car/electronic manufacturing industries.

The industrial policy has been consciously used by Japan for the sole purpose of stimulation
of economic growth. Japan became one of the world‘s largest and most important iron and

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steel exporters. These two core competencies factored into the growth of the manufacturing
industry. Japan is also the world‘s largest producers of machine tools, which are primarily
exported to the U.S. and South Korea. Japan‘s technological innovations have enabled the
country to regain a strong position in the development and construction of large-scale
machinery, automobiles and electronics.

In addition to having to deal with business trends such as deregulation and globalization, the
Japanese industry has also been affected by the aging of the Japanese society. Over 16% of
Japan‘s population is 65 or older. Within the next 15 years this figure is expected to be over
25%. This factor will increase the tax and social security burden that workers will have to
carry. At the same time it is likely that a decrease in personal savings will result in lowering
of overall capital accumulation. These labor shortages will become a limiting factor to the
future growth potential of Japan‘s economy.

The institutional approach Japan has taken highlights one of the key functions of any sort of
effective industrial policy. The key function is the gathering and dissemination of accurate
information. No matter how capable and powerful the bureaucracy, policy measures based on
incorrect information will not only fail to succeed in their intent, but are likely to have a
negative effect on growth. Japan has taken this theory and correctly identified the greatest
danger of the industrial policy and grown from a ―less developed‖ country to a ―developed‖
country in a matter of four decades.

On November 17, 2008, Japanese government officials announced that the economy was in a
recession. It was reported that Japan's economy contracted at an annual pace of 1.8% in the
third quarter of 2008. It is forecasted to have shrunk 0.8% through the fiscal year that ends
March 2009. In July 2009 unemployment reached a post-war high of 5.7 per cent, according
to the Japan Times. Although the economy has recovered in 2010, levels of public debt
remain high approaching 200% of GDP.

On March 17, 2010 the Bank of Japan moved to boost yen reserves for 3-month bank loans to
20 trillion yen, although economists see this as a move merely to please the Democratic Party
of Japan because, as no money is leaving the financial system, there will be no impact on
long term rates in either the ordinary market or the Foreign exchange market. As a result of
this the foreign press and the IMF believe Japan should be doing more to help its economy
recover.

In August 2010 the yen hit a 15 year high against the dollar in nominal terms. In real
exchange rate terms, however, the yen was still valued at less than its average since 1990.

The following graph shows the GDP Growth rate of Japan over the last 3 years:

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From the graph it can be seen that Japan's gross domestic product grew 0.9% in the July-
September period from the previous quarter, or at an annualized pace of 3.9%, up from a
revised +0.4%.

The expansion accelerated in the third quarter of 2010 as shoppers bought cars before
government subsidies expired, air conditioners to stay cool in a hot summer, and cigarettes
before a new tobacco tax kicked in. The result marked the fourth straight quarter of
expansion.

With the government currently focused on fiscal reconstruction, the chances of additional
fiscal spending are declining sharply. While government purchase incentives for electronic
goods, cars and other products has buoyed spending, the government is unlikely to extend or
expand those programs. Private consumer spending, which accounts for nearly 60% of
Japan's GDP, was flat in the April-June period, compared with a revised 0.5% growth in the
previous quarter. But with these incentives no longer in place, a slowdown already appears
underway as deflation and the persistently strong yen drag on growth.

Future of Japanese Economy

The Japanese economy has faced difficulties sustaining itself on a recovery track as the
effects of the government's fiscal stimulus measures have weakened, and the trend is
expected to continue in 2011. The key questions over the prospects for the country's
economy, which has remained stagnant for two decades, are whether businesses will restart
spending and consumers will keep their purse strings loose. Business investment, which has
been sluggish in Japan since the global financial turmoil in 2008, could make a notable
upturn in 2011 due mainly to tax reforms the government endorsed in December.

However, the major upheavals that Japan is facing today are not limited to economic
structural reforms and the renewing of the established systems. Rather, the greatest change
lies in the nation's ethics and aesthetics, which are the basis of everything, that is, the basis
for all choices and judgments. Since the Second World War, Japanese society has viewed
efficiency, equality, and safety as aspects of "justice." The concept that efficiency is "just" is

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common to all contemporary industrialized societies, and it has been recognized as such in
Japan ever since the Meiji era.

Although Japanese society is growing older faster than anywhere else in the world, plenty of
others are shuffling along behind it. Parts of Europe are ageing fast, and are unwilling to
adapt, as recent protests against rising retirement ages in France and Greece attest. Other
Confucian countries such as South Korea, China and Taiwan, have enjoyed a ―demographic
dividend‖—a rapidly expanding workforce and falling birth rate—similar to Japan‘s in the
1960s to 1980s. With fewer children and elderly to pay for, such countries could plough
savings back into economic expansion. As in Japan, relatively few women work after
becoming mothers and even fewer immigrants are let in. Such places will look to Japan for
how to cope with the economic and social consequences when their manpower starts to dry
up. At present, for instance, 62% of working women quit their jobs after having their first
child; less discrimination against them in the workplace would encourage them to go on
working. Retired people could be coaxed back to work, especially if they could claim their
pensions while working. More immigration could help Japan maintain an innovative streak
that it risks losing as its workers age.

The hardest task will be to raise Japan‘s productivity to offset the looming manpower
shortage. Deregulation would help, by making it easier to sell services (such as residential
care) to the elderly, by freeing up finance to allow them to make better use of their savings,
and by encouraging more competition in the domestic economy so that it can withstand the
inevitable shocks to external trade. Deregulation will also lead to the expansion of domestic
demand and an increase of imports and, as a result, will contribute to correcting the trade
imbalance. Though the effects of deregulation will be seen slowly over time, the important
thing is to build up efforts to dismantle regulations as far as possible, shifting responsibility
from the public to the private sector.

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2. SECTORAL ANALYSIS OF JAPANESE ECONOMY
By Varun Kohli- 10BSPHH010861 (Seat-46)

PRIMARY SECTOR

Only 12% of the land in Japan is arable, but the per hectare crop yield is one of the highest in
the world. This sector engages about 4% of the total labor force and is highly subsidized and
protected. Japan is self-sufficient in the production of rice. However, it heavily imports
wheat, corn, sorghum and soybeans, mainly from the US. It is the third largest importer of US
food products. Japan is also self-sufficient in producing apples, pears and oranges. Japan is
among the largest producers of fish in the world.

Agriculture, forestry, and fishing form the primary sector of industry of the Japanese
economy,
Together with the Japanese mining industry, but together they account for only 1.3% of gross
national product. Only 12% of Japan's land is suitable for cultivation, but the agricultural
economy is highly subsidized and protected. Agriculture, forestry, and fishing dominated
the Japanese economy until the 1940s, but thereafter declined into relative unimportance. In
the late 19th century (Meiji period), these sectors had accounted for more than 80 % of
employment. Employment in agriculture declined in the pre-war period, but the sector was
still the largest employer (about 50 % of the work force) by the end of World War II. It was
further declined to 23.5 % in 1965, 11.9 % in 1977, and to 7.2 % in 1988. The importance of
agriculture in the national economy later continued its rapid decline, with the share of net
agricultural production in GNP finally reduced between 1975 and 1989 from 4.1 to 3 % In
the late 1980s, 85.5 % of Japan's farmers were also engaged in occupations outside of
farming, and most of these part-time farmers earned most of their income from non farming
activities. Japan's economic boom that began in the 1950s left farmers far behind in both
income and agricultural technology. They were attracted to the government's food control

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policy under which high rice prices were guaranteed and farmers were encouraged to increase
the output of any crops of their own choice. Farmers became mass producers of rice, even
turning their own vegetable gardens into rice fields.

SECONDARY SECTOR
This sector employs about 28% of the total labor force of the country; manufacturing sector
of Japan is widely diversified. Although the manufacturing industry relies heavily on the
import of raw material and fuel, it comprises some of the most successful companies in the
world. The major manufacturing industries of Japan are automobiles, consumer electronics,
computers, optical fibers, optoelectronics, optical media, semiconductors, and iron and steel.
Economic growth is also dependent on petrochemicals, pharmaceuticals, bioindustry,
shipbuilding, aerospace, textiles and processed foods.

One-fourth of Japan's GDP is heavily dependent on imported raw materials and fuels.
Internationally, Japan is best known for its automotive and electronics industries, as the home
of big manufacturers such as Toyota, Honda, Nissan, Mitsubishi, Mazda, Sony, Matsushita,
Toshiba, Nikon, Suzuki and Hitachi. Japan also holds a large market share in high-technology
industries such as semiconductors, industrial chemicals, machine tools, and (in recent years)
aerospace. Construction has long been one of Japan's largest industries, with the help of
multi-billion-dollar government contracts in the civil sector. Robotics constitutes a key long-
term economic strength.

The nation's industrial activities (including, manufacturing, and power, gas, and water
utilities) contributed 50.7% of total domestic industrial production in 2005, up from 45.8
percent in 1975. This steady performance of the industrial sector over the period was a result
of the growth of high-technology industries. During this period, some of the older heavy
industries, such as steel and shipbuilding, either declined or simply held stable.

The fields in which Japan enjoys relatively high technological development include
semiconductor manufacturing, optical fibers, optoelectronics, optical media, facsimile and
copy machines, industrial robots, and fermentation processes.

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TERTIARY SECTOR
This sector is the backbone of the country‘s economy, employing 68% of the labor force as of
2009. However, the growth was impacted by the 2008 recession. To boost the sector the
Japanese government announced a stimulus package of ¥7.2 trillion in 2009. Some of the
major service industries in Japan are banking, insurance, telecommunications, transportation,
real estate and retailing.
Japan's economic growth in the 1960s and 1970s was based on the rapid expansion of heavy
manufacturing in such areas as automobiles, steel, shipbuilding, chemicals, and electronics.
The secondary sector (manufacturing, construction, and mining) expanded to 35.6 percent of
the work force by 1970. By the late 1970s, however, the Japanese economy began to move
away from heavy manufacturing toward a more service-oriented (tertiary sector) base. During
the 1980s, jobs in wholesaling, retailing finance and insurance, real estate, transportation,
communications, and government grew rapidly, while secondary-sector employment
remained stable. The tertiary sector grew from 47 percent of the work force in 1970 to 59.2
percent in 1990 and was expected to grow to 62 percent by 2000.
The real estate and retailing are the other most important component of service sector.

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3. Economic Growth, Employment and Inflation management In
JAPAN:
By Saurabh Trivedi-10BSPHH011076 (Seat-69)

Real GDP Growth

14%
12%
10%
8% S t a ble gr owt h per iod No gr owt h per iod
6%
4%
High gr owt h per iod
2%
0%
-2%
-4%
1953

1956

1959

1962

1965

1968

1971

1974

1977
1980

1983

1986

1989

1992

1995

1998

2001

2004
Yen floats 2nd Oil Shock

1st Oil Shock Bubble collapses

I) Post-War Growth (1951-1970): After the end of the Second World War, Japan
embarked on a journey of rapid industrialization with the support of its financial
institutions, which became the drivers of its growth. Japan introduced the concept of
'just-in-time inventory' and other concepts, which have become the pillars of various
corporations around the world. This is the period in which the Japan had the highest
growth rate till today after the WW-II. After the war, the Japan got relieved from the military-
dominated government which helped it devoting all its resources to reconstruct its lost and
well known industrial capacity. In this period, Japan‘s GDP was growing at a rate of more
than 9%.The main sources of growth were manufacturing and mining, construction and the
infrastructure. 42% of the employment of Japan was in these sectors whereas only 25% of the
labor force remained in the agriculture. Between 1956-60, Japan became the world‘s largest
ship manufacturer and world‘s top steel producer and it surpassed the U.K., Italy, Germany
and France.
Japan‘s highly acclaimed postwar education system contributed strongly to modernizing the
whole process. Japan‘s high literacy growth rate and well-advanced education acted as the
main source for its technologically advanced economy.

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In the mid 1960s, a major step was taken by the Japan. It opened some of its industries to
international competition. This helped the manufacturing and mining sector to grow at 17%
per year between1965-70.
In this era Japan entered into the virtuous cycle featuring demand expansion-production
expansion-increase in income-consumption expansion-further income expansion-increase
in savings-investment growth and an expansion of production capacity.

ii) Stable Growth Period (1970-1990): In 1970, Japan integrated its

manufacturing and service sector to streamline its operation due to which its growth rate
evened out to 8%.By 1970s; Japan has the third largest economy in the world. The main
elements of this achievement were its initial focus on certain areas of industry: electronics,
automobile, shipbuilding; focus on export and later on consumer goods for domestic market.
Due to the Oil Crisis of 1973, Japan faced its first postwar decline in its growth in this period
together with high price inflation. By 1973, a rapid increase in the money supply led to
extensive speculation in the real estate and domestic commodity market. Japan was already
suffering from the double digit inflation rate due to the oil crisis. Japan faced large fluctuation
in the rate of inflation in this era. Inflation peaked at around 25% in 1974.The consequent
recession lowered the GDP growth rate from 10% level to an average of 3.7% in the period of
1974-79.The second oil crisis in 1979 forced the Japan to a fundamental shift in its industry
structure from emphasis on heavy industry(highly oil-dependent) to VLSI semiconductor
industry. Government also responded with the Keynesian stimulus which included massive
deficit spending funded by bond issues. Due to these changes, 1979 Oil Crisis had little
impact on Japan economy and it start growing at a pace of 5.5% in 1980s.These structural
changes were not being able to check the slowing of growth rate but helped Japan to face the
crisis in a more comprehensive manner than by the other countries.

 The Bubble Economy (1980-90): After the 1985 Plaza Accord, the Yen‘s
value rose sharply reaching 120 Yen to the U.S. Dollar in 1988-three times its value
in 1971.This consequent increase in the price of Japanese exported goods reduced
their competitiveness in the overseas market, but the efficient financial measure taken
by the government contributed to growth in domestic demand. Land and Asset prices
were rising drastically in the late 1980s.The higher land prices led to higher stock
prices which led to equity finance boom. During this period, land prices got doubled
and Nikkei Stock market rose by 180%.In May 1989, the Government tightened its
monetary policies to suppress the rise in the value of assets. However, higher interest
rate led the downward spiral of the stock prices. By the end of 1990, the Nikkei Stock
market fell by 38% wiping out 300 trillion Yen in value and land prices dropped
sharply from their speculative peak. This push into the recession is known as the
―bursting‖ of the ―bubble economy‖.
iii) The post bubble recession continued through the second half of the 1990s and into the
new millennium. In 1992, the real GNP growth slowed to 1.7%. Even the automobile and
electronics industries that had experienced tremendous growth in the previous 2 to 3 decades
entered the recessionary period in 1992.The domestic market of Japan shrank at the same
time that Japan‘s share of the USA‘s market declined. Its electronics export was facing a stiff
competition from the Taiwan, Korea and USA semiconductor products. Until 1990, Japan
was on track to become the number 1 economy of the world. The bubble happens and the
bubble bursts but unfortunately for Japan the decline never ended. Between1990-2004, the
average real GDP growth averaged around 1.2%.It almost stopped growing. One of the
possible reasons for this was over dependence on domestic consumption in 1980-90

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which did not increase from more than 2% after 1989.In this period, Japan faced four
possible identifiable recessions. In hindsight, the Bank of Japan continued too long with its
tight monetary policy and did not shift aggressively enough to quantitative easing after 1993,
when its policy changed. Regulatory authorities were unwilling to close insolvent financial
institutions, permit the bankruptcy in the corporate sector and instead adopted the policy of
denial and avoidance. It was quite simply a classic stagflation which is still going on. This,
we also know as the ―lost decade‖ in Japan.
Some temporary improvements were seen in the economy in 1995 and 1996, partly due to the
fall in the value of Yen and additional demand generated by the recovery efforts for the
January 1995 Great Hanshin-Awaji Earthquake. In 1997, however, a rise in the consumption
tax rate, a reduction in the government investment activities and the bankruptcies of the
major financial institutions quickly worsened the recession. Due to the further tightening of
the lending by the banks and financial institutions (due to huge volume of bad debts
aggravated by still falling land prices) forced the companies to reduce their investments in
plants and equipment. This, combined with falling exports due to the Asian Financial Crisis,
resulted in the lower profit in all its sectors. Employment salaries and wages also fell which
further dragged the consumer spending down and in 1998 Japan faced the negative economic
growth.
Real GDP during the 1990s stagnated. It rose only from 428,827 billion yen in 1990 to
469,485 billion yen by the end of 2000.Growth has been negative since 1998.The
unemployment rate increased from 2.1% in 1991 to 4.8% in 2000. As far as world‘s standards
are considered, it is not a very high increase in unemployment but in Japan‘s context it is
quite significant as this never crossed the mark of 2.8% in the entire history of Japan‘s
economy.

Japan’s Deflation:
Inflation in Japan was already low in the late 1980s, but it continued to fell further and
became negative in 1994.Many economist says that this deflation is derived from:
 Accumulated bad loans.
 Huge amount of import of highly cheap Chinese goods.
 Diminishing growth potential of Japanese economy.
 Demand shortage.

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  Japan has an ageing population (23% of people are above 65 years) that is not
growing and will soon start a long decline.
 Insolvent Companies and Banks.
There was absolutely no growth in the nominal size of Japan‘s economy because of deflation
during Japan‘s lost 20 years. It was only Japan which experienced no growth in this period.
Real estate‘s prices were falling even when the other countries were seeing a surge in this
sector. This made Japan‘s stagnation even worse.
A decline in the wages despite of the outstanding productivity was the most significant
characteristics of Japan‘s prolonged period of stagnation. In Japan‘s case, rising productivity
allowed the companies to reduce its investment in labor, which caused unemployment to rise.
Consumption shrank and the wages fell as the supply of the worker available increased.
Deflationary pressure grew as a result. This is precisely what happened in Japan. Otherwise
increase in the productivity lead to wage hike, increase in demands and ultimately this
process creates more jobs.
Japan‘s deflation was harmful to the finance industry and the service sector mainly. It did the
most damage in these 2 sectors. Only the Japan‘s manufacturing sector was able to increase
income consistently by raising productivity. But due to the yen‘s appreciation manufacturers
were unable to translate the higher earning into the higher salaries for their employees. This is
how falling wages shrank domestic demand and produced a negative cycle in Japan.

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After 2002, Japan economy entered a period of slow but steady growth that continued
through the middle of this decade. After a long period of more than 10 years, the negative
after-effects of ‗bubble economy burst‘ finally appeared to have been largely tackled. The
non-performing or bad debts ratio of major banks got lowered from 8% in 2002 to 2% in
2006 and this has contributed to regain the lost confidence for the banks. The bank came back
on track of lending and acts properly as financial intermediaries. Reflecting business
recovery, the Nikkei Stock rose strongly between 2003 to 2006.However this expansion got
severely hit by the 2008 financial shock which originated with US subprime mortgage crisis.
Japan‘s export, which has been the engine of growth in this period of expansion, again got
dramatically plunged. This again showed the vulnerability Japan‘s reliance on its export
demand which become very low due to the crisis of 2008. (See Figure)

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4. JAPAN- EXTERNAL SECTOR:
By Khushboo Gumber- 10BSPHH010917 (Seat-49)
The economy of Japan is the third largest, after United States of America and China and is
ahead of Germany. The country‘s stands at 23rd position when compared on the basis of
GDP.
After World War II, there were factors that led and helped Japan to become a technologically
advanced economy. The success of Japan basically is because of two things:

Close Interlocking of the holders like Manufacturers, suppliers and Distributors

known as keiretsu,
The guarantee of lifetime employment for a substantial portion of the urban labor
force

Though now these features are losing importance because of global competition and domestic
demographic change.

Imports
1. The industrial sector of the economy is dependent on import of the raw materials and
fuels.

2. Japan though self-sufficient in rice, imports about 60% of its food on a caloric basis.
Economic Growth

3. World‘s largest fishing fleet‘s accounts for 15% of the total global catch are being
maintained by Japan. From 1960-80‘s there has been spectacular real economic growth.
But the story was not same in 1990‘s; this was due to inefficient investment and the asset
price bubble.
Exports- leading to recession
4. It was in 2008 that the economy entered into recession even though the financial sector
was not that much affected with the sub-prime mortgages, it was the down slopping
business investment and the demand for Japan exports globally that pushed the economy
further into recession.
Trade Deficits

5. In early 1960‘s the economy incurred an annual trade deficits ranging from US$400
million to US$1.6 billion. However it changed during 1965-1969. The economy was
known as the surplus trading economy.

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Trade surplus
6. The rise in surplus during early 1970‘s led United States to devalue the Dollar and
revalued Japan‘s yen- this gave an end to bretton wood system of fixed exchange rates.
The rise in surplus was due to increasing exports and low imports.
Imports and Exports

7. Export Growth and stagnant imports of Japan helped the economy in the times of rising
petroleum prices in the period of 1970‘s to 1980‘s

Currency Management:

The value of the currency is determined by the foreign exchange markets keeping in mind the
demand and supply.

1. The demand of Yen- Depends on desire of the foreigner‘s interest in investing

in Japan.
2. The supply of Yen- Dependent on the wish of Yen holders.

By 1971 the currency got undervalued due to which the cost of exports in the foreign markets
was very low and the imports from those markets costed the economy too much. The
undervaluation was clearly noticed in the current account balance as well.

Even though the in 1973 the nations allowed their currencies to float, The Japanese
government still continues to interfere in the foreign –exchange marketing because of the
growing concern that the rise in the value of currency would lessen the growth of exports by
making the economy‘s products less competitive and leading to a damage in industrial base
as well.

There was a drastic change in the value of currency during oil shocks:

Before the oil prices impact, the market caused an increase in the currency value i.e.
¥271 per US$1 in 1973.
Increase in the cost of oil caused the value to depreciate i.e. ¥290 to ¥300(1974-
1976). But the trade surplus got Yen back to ¥21(1978).
The second oil shock reversed the whole situation with the value of currency dropping
to ¥227 by 1980.

In 1980s, the currency failed to rise in value even though current account surpluses returned
and grew quickly. The increase in the current account surplus generated stronger demand for
yen in foreign-exchange markets, but was an offset by other factors. Difference in interest
rates, with United States interest rates much higher than those in Japan, and the continuing

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moves to deregulate the international flow of capital, led to a large net outflow of capital
from Japan.

This capital flow increased the supply of yen in foreign-exchange markets, as Japanese
investors changed their yen for other currencies (mainly dollars) to invest overseas. This kept
the yen weak relative to the dollar and fostered the rapid rise in the Japanese trade surplus
that took place in the 1980s.

In 1985 the value of Yen increased, which made exports of Japan less cheaper and imports
got more competitive to price. The currency appreciated in 1985 but the effects on the current
account balance was seen till 1987.

External Economic Summary

Gross
External
Debt

Foreign
Exports Direct
Investment

Imports

The Imports of the economy accounts to $490.6billion (2009), with major import Partners as
below:

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 Importing…
China
USA
Saudi Arabia
Australia
South Korea

The Exports of the Economy was $516.3 billion (2009)

Exporting Partners (2009)

China
USA
South Korea

It can be inferred that the Net exports of the Economy are positive which is good in most
cases.
FOREIGN DIRECT INVESTMENT: The FDI of the economy is $205.4 billion
GROSS EXTERNAL DEBT: The gross external debt is 204.5 trillion yen.

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5.I)monetary policy:
By Nipun Sharma- 10BSPHH010476 (Seat-48)

In response to the economic recession, the Bank of Japan took various steps to ensure
stability in the market ; for ex (a)lowering the policy rate in two parts from 0.5 percent to 0.1
percent in October and December 2008, and providing enough liquidity to the markets,
including unlimited U.S. dollar funding.(b) In addition to this, the Bank adopted exceptional
measures such as outright purchases of CP and corporate bonds to support a recovery in the
functioning of market. (c)Also, through its special funds-supplying operations to facilitate
corporate financing, the Bank provided an unlimited amount of funds at a fixed rate of 0.1
percent against corporate debt submitted as collateral. By the help of the above mentioned
efforts, the Bank helped firms deal with difficulties in funding through markets and also
encouraged interest rates to decrease.
After achieving the intended objective of restoring the proper functioning of markets, the
Bank decided to terminate purchases of CP and bonds by the end of December 2009. In the
meantime, it decided to extend special funds-supplying operations to facilitate corporate
financing until the end of March 2010, and thereafter to continue providing liquidity through
monetary policies.
At the Monetary Policy Meeting held on 1st Dec. 2009, the BOJ decided to introduce a new
operation to provide funds of 10 trillion yen approximately, for a period of three months at a
fixed rate of interest of 0.1 percent. This decision was made so as to come out of economic
turmoil from the financial side against the background of increased risk that international
financial developments and foreign exchange market instability since the latter half of
November 2009, such as the debt crisis in Dubai, might adversely affect economic activity
by impacting business and household sentiment.
The Bank‘s basic attempt by using monetary policy at present is to provide support to the
Japanese economy in order to overcome deflation and return to a sustainable growth path
with stability in the price level.
It is important for the BOJ to maintain this basic monetary policy. At the same time, the Bank
should not have any already decided outlook regarding the future use of monetary policy, but
should take measures that would be most appropriate on each occasion in response to
changing economic and financial conditions.

Measures to Pull Japan out of Economic Disarray

The current position of the Japanese economy is considered to be of modest debt deflation,
in which prices continue to fall as companies and banks - suffering under the weight of
excessive debts and NPLs(non performing loans), respectively - are forced to sell their assets
at .Thus, while deflation is one of the major cause of the further increase in NPLs, the
continuation of the NPL problem is also a cause of deflation. Reducing banks' Non-
performing loans is a vital policy for severing the mechanism of debt deflation (or the vicious
cycle of the continuation of deflation and an increase in NPLs), and this is the policy agenda
that must be given high priority if Japan is to be pulled out of its ongoing economic disarray.

As a step to facilitate corporate restructuring, it is inevitable to ease restrictions on banks' tax-

free disposal of NPLs, which are overly stringent and have been encouraging creditor banks
to force small and medium-size corporate borrowers into bankruptcy. Monetary policy to

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counter deflation: In response to the turmoil in economic and financial conditions, the Bank
took various steps to ensure market stability; for example, lowering the policy rate in two
stages from 0.5 percent to 0.1 percent in October and December 2008, and providing enough
liquidity to the markets, including unlimited U.S. dollar funding. Furthermore, the BOJ
adopted exceptional step such as outright purchases of Commercial Papers and corporate
bonds to support the desired recovery in market function. Also, through its special funds-
supplying operations to ease the corporate financing, the BOJ provided an unlimited amount
of funds to counterparties at a fixed rate of 0.1 percent against corporate debt submitted as
collateral. In this way, the BOJ tried to help firms to deal with difficulties in funding through
markets and also encouraged interest rates to decrease.

ii)Japan's Fiscal Policy

$154.55 billion stimulus plan has been declared by Japan‘s Liberal Democratic Party. The
plan includes measures to

(a)create jobs,(b) revive the real estate market,

(c) And ease corporate costs, largely via new fiscal policy.

The fiscal easing, or tax cuts, will help create new employment opportunities the emergency
small-business loan plan follows on similar measures taken last year in previous stimulus
packages. It seeks to protect weak, small companies from losses financial institutions have
suffered. Their lack of availability of credit is a major impairment for domestic firms that
need this cash flow for daily operations.

It is true that Japan has fiscal shortfalls, but it is almost certain that the government will
certainly hike VAT once the country is out of its economic troubles. Surely this will help pay
back tax losses which are incurred now and in the previous stimulus package.

The new package is expected to generate an increase of 2% in GDP and 1.4 to two million
jobs. This new stimulus package is Japan‘s 4th in less than eight months, but such a policy is
needed badly since Japan depends a lot on exports and the exports are falling.

Despite of the fact that Japan posted a trade surplus in February, both domestic and foreign
demand collapsed in March. Major auto and electronics manufacturers have cut down on
production, sending shockwaves through the domestic market. Due to this, residents stop
spending, as fears of job losses loom. Which in the long run can be a chronic problem for the
country?

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iii)Trade policy :

Since Japan depends a lot on its exports. So all its trade policies are designed to promote
exports.

(i) Export-promoting tax system

(a) Special deduction of export income:

In Japan exporters are allowed to subtract certain percentage of export income from
their total income, which gives producers a perk to export, because the same value of sales in
the foreign market brought more after-tax income than the value of sales in the domestic
market. However, this program constituted a violation of the GATT provision and was
abolished in 1963.

(b) Import tariff refund

When the Japanese producers import raw materials and intermediate goods to
produce export goods, import tariffs paid on the input are refunded to producers at the time of
export.

(ii) Export-promoting financing

(a) Pre-shipment export bill discount:
When producer A in Japan exports goods to import to B in, say, the United States, the
transaction is usually settled in the form that importer B issues a payment bill (similar to a
check) to producer A in Japan. Producer A brings the bill to a foreign exchange bank in Japan
to receive money for his already exported goods. Normally, the cash transaction is made
after producer A completed the shipment of the exported goods. However, in order to
encourage exports, the Bank of Japan rediscounted the bills at very low interest rate before
actual shipment is made.
(b) Japan Export-Import Bank
In 1951, the Japan Export-Import Bank was established to provide medium and long-
term loans to shipbuilders and producers of plants (or mini-factories) whose major markets
were those in foreign countries.

Export Contest
In order to encourage export, the Japanese government set up ‗export contest‘ among
firms to combine the benefits of competition and cooperation. But for competition to be
successful reward s are necessary. In Japan, preferential access to credit and foreign exchange
are very attractive rewards. The government officials who have designed and supervised the
contests were generally competent and impartial.

Import Policy

(1) Customs Clearance Procedures

The average time taken in customs clearance from import declaration to import
permission in Japan has been shortened by reform of customs clearance procedures,
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 expanded introduction of computerized system and other measures. The Government
of Japan has introduced "Simplified Declaration Procedures" in March, 2001 which
allows certain cargoes to be released prior to lodging of a declaration for customs duty
payment, by separating import declaration and duty payment declaration.

(2) Agricultural and Food Products

Tariff levels of each country were determined by the Uruguay Round Agreement and
the Japanese Government has been properly implementing the agreement. WTO
Members have maintained certain tariffs, as per the WTO Agreement.

(3) Leather

Japan introduced tariff-quota system for leather and leather shoes in 1986, as per the
GATT rules. The Government of Japan has steadily implemented significant reduction
of the tariff rates which was committed in UR. In addition to this, quota is allocated to
importers automatically calculated following calculations that are done according to a
publically specified formula.

(4)Wood Products and Housing

Japanese Agricultural Standard (JAS) for wood products is a voluntary system for
maintaining quality standard for wooden products that are distributed domestically
which treats domestic products and import products equally.

Ministry of Land, Infrastructure and Transport and Japan Craft Inspection Organization
held an expert level meeting March and December last year with the National Marine
Manufacturers Association in order to promote mutual understanding. The meeting
based on technical knowledge of experts, was friendly and constructive, and the
Government of Japan intends to continue to hold such meetings. In the meeting, there
was no indication of a claim neither that Japan‘s standard was non- transparent nor that
the standard was a trade barrier.

Summary(Trade Policy):
Japan‘s shift to free trade agreements shows a shift in conventional wisdom. In particular
Japan realized the earlier policy could not reduce the growth of regionalism elsewhere and
could not resolve the costs of non-participation. To date Japan has approached the issue
bilaterally, leading to certain agreements with Malaysia and the Philippines and agreements
with Mexico and Singapore. Negotiations continue with countries like Thailand, Indonesia
and Korea. Agreements do not seem to be a ‗testing ground‘ for wider liberalization, reflected
in the accommodation of agricultural protection especially rice. Developed APEC members
have been excluded, Japan‘s strategy has an Asian focus and aside from Singapore, all the
countries are developing countries. If Japan‘s program with ASEAN countries is successful,
then perhaps the Japanese conventional wisdom is filtered primarily through the lens of a
redefinition of Japan‘s ‗Asia Strategy‘ rather than ‗complementing‘ the WTO. Such a
redefinition of Japan‘s approach to regional integration to fit within the post-war
GATT/WTO model may offer greater flexibility in negotiating with other countries.
However, accommodating Japanese Trade Policy and ‗Economic Partnership Agreements‘
Japan‘s new conventional step alongside the aspirations of ASEAN and China still remains a
major challenge.

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iv)Japan’s Currency Policy:

The recent bold currency intervention made by the Japan has triggered global suspicion and
unease. However, only a few people have a clear idea of what Japan has done and what kind
of backlash will be felt.

After Japan‘s intervention in the yen exchange rate by selling of billions of dollars, that
quickly drew world‘s attention, Japan decided to come back to its zero interest rate policy
(ZIRP) at the beginning of October. Its economic complications do not only lie in the long-
term money supply. Japan‘s intervention to slow the upward movement of the yen has raised
eyebrows in the United States and brought claims that Japan is manipulating its exchange rate
in order to gain unfair advantage in world trade. In the past, Japan has intervened (bought
dollars and sold yen) in high quantities to counter the yen‘s appreciation, but since March
2004, the Japanese government has not intervened significantly. The huge purchasing of
dollars has resulted in an accumulation of official foreign exchange reserves to $893 billion
(June 2007) by Japan which is the highest as per Japanese standards. The intervention seems
to have had little lasting effect. It mainly has slowed the rise in value of the yen rather than
reverse its direction of change. For the last few years, the yen has been continuously
depreciating and is now at a 20-year low. Private company estimates of the misalignment of
the yen range from an overvaluation of 1.8% to an under-evaluation of 29%. The median
value of these estimates is that the yen is about 15% undervalued. The problem with currency
intervention to maintain a positive balance of trade is that about half of the increase in the
value of a foreign currency gets depicted in prices of imports into the United States. Periods
of heaviest intervention also coincided with slower (not faster) economic growth rates for
Japan. Major policy options for government include (1) let the market adjust ; (2) clarify the
definition of currency manipulation; (3) require negotiations and reports; (4)require the
President to certify which countries are manipulating their currencies and take remedial
action if the manipulation is not halted.

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CONCLUSION:
From our analysis we see that Japan has gradually moved from agriculture to manufacturing
to service sector like every other developed nation. It did not jump any phase like India( India
had a transition from agriculture to services) so there is not much of a problem. The
movement through manufacturing sector is important because it leads to increase in output,
generates high employment thereby increase the income and purchasing power of people.

Deflation and policies: Deflation is caused by a shift in the AD and AS curve, particularly by
a fall in the aggregate demand i.e., there is a fall in how much the whole country is willing to
buy, at the prevailing price level. As the price of goods is falling, consumers have an
advantage in delaying purchases and consumption until prices fall a little more, which in turn
results in a fall in the overall economic activity. Since this leaves productive capacity not
fully utilized, investment also falls, leading to further reductions in aggregate demand. This is
called the ―deflationary spiral‖. The solution to falling demand is stimulus, either from the
Bank of Japan, by expanding the money supply, or by expansionary fiscal policy to increase
demand, and to borrow at interest rates which are below those available to private entities.

The government takes the following steps in this regard:

First, extend the maturity of debt to at least 15 years from the today‘s average of 5.2 years.
(Whoever was responsible for allowing Japanese debt to be so short term when the
government can borrow at incredibly low long-term interest rates seems utterly incompetent.)
That would bring average Japanese maturities above the far more sensible UK level of 13
years.

Second, hire a central bank governor who knows how to create inflation – an Argentine,
Zimbabwean for example. It is almost certain that any moderately determined central banker
could do this, if he wanted to do so, by direct purchase of public and private sector assets on a
sufficiently large scale. The government should prod this along by giving the Bank of Japan
an inflation target of 3 per cent, after maturities have been extended, while informing the
policy committee that all its members will be sacked, ignominiously, if they fail to hit the
target within two years.

Third, let us suppose inflation indeed goes to 3 per cent. That should raise the interest rate on
JGBs to 5 per cent. Other things equal, the market value of the outstanding net government
debt would fall by 40 per cent. So now the Japanese government buys back the outstanding
debt at its new market price, reducing the face value by 40 per cent of GDP. In the new
inflationary environment, the Japanese find the real value of their huge holdings of cash
falling sharply. So they buy real assets and consumer goods, instead, and, at last, the
economy expands vigorously.

Fourth, now the government raises taxes and cuts spending, moving into a small primary
surplus. Assume that the government only needs to borrow to roll over its debt and the debt
ratio stabilizes. How big a primary surplus is needed depends only on the relation between
the real rate of interest and the rate of growth of the economy.

~ 24 ~
So there we have it. By extending maturities of debt, moving from deflation to modest
inflation, Japan eliminates almost half of its outstanding debt, relative to GDP, and
normalizes the economy, in the process.

Bank of Japan has tried zero-interest rate policy from 2001-2006 to counter the deflation and
the stagnant economic growth. In 2006, the Japan‘s economy started to show some signs of
improvement as rate started to increase to 0.5% but that was not significant enough and in
late 2008, it again started to cut the rates due to the serious damages done by global economic
crisis.

Monetary Policies like quantitative easing are not helping the economy to get out of this
downward spiral. Despite of the ample liquidity, banks are struggling to encourage the credit
growth. This is obviously the typical situation of ―Liquidity Trap‖ where the monetary policy
loses its effectiveness significantly.

As mentioned above, Japan has tried lots of measures to curb this deflation but the “Falling
Wages” which is more particular in case of Japan is something which is making all these
policies ineffective. People lose their purchasing power when wages fall. Companies respond
to this by cutting the prices to maintain sales volume which leads to the further wage cuts and
the productivity also start falling subsequently because of the diminishing demand. In this
way, Japanese economy has got trapped into the vicious cycle. The main reasons for the
falling wages in Japan are company-based unions, its employment culture and an
increase in the cheap non-regular workers which is unique to Japan. So, it becomes clear
that maintaining a gentle rise in the wages is very necessary in Japan to overcome this
long-term deflation in Japan. Wages did not improve during the time of recovery from 2002-
2007 and the advantage of improving productivity were mostly nullified by the companies
profits. Hence, it is very necessary to increase the purchasing power of the workers in
Japan to combat the deflation and it also requires the bridge the gap between the wages
of regular and non-regular workers.

One of the other major problem that Japan is facing is it high dependency on exports
which it makes competitive by depreciating its currency. The fact that the country faces
deflation has led the policy makers to frame policies whereby they can export huge
quantities of good(since internal demand is low). But with international trade
agreements this is no more a feasible option. Also the fact that the US is not allowing it
to depreciate its currency is making life difficult for them. To add to its problems china
has been constantly dumping goods.

Japan faced a lot of problems during the economic turmoil due to the high amount of
business it has with the US. Thus Japan would do good to adopt conservative
policies(not to forget the Japan bubble burst of the 80’s from which till today it has not
fully recovered) like India so that there is not too much of a fall during recessionary
conditions.

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Problems Faced by Japan Due To International Trade Policies:
The WTO Ministerial Conference at Cancun was a failure for Japan for the following
reasons: (1) the increased technical complexity and disruptive domestic economic effects of
the issues being negotiated; (2) the shift in relative bargaining power among the negotiating
participants in favor of the developing countries; (3) the proliferation of bilateral and regional
free trade agreements in contrast to multilateral agreements, and (4) the increased emphasis
on achieving ―fairness‖ rather than reciprocity in trade liberalization.

Japan has a problem similar to that of the US i.e. it has huge amounts of public debt. But
most part of the debt is internal to the economy (in the case of US it is external debt, thus a
huge matter of concern). Meaning to say that the government of Japan has borrowed huge
amounts of funds from the Japanese people. In both Japan and the west the problem is of
unmanageable public debt. According to estimates by all the country needs to do is generate,
say, expectations of 3 per cent inflation and the public debt problem should not prevail. But
the longer time taken, the bigger the ultimate adjustment will need to be.

Outlook:
In the interim assessment report released after the Monetary Policy Meeting held on January
25 and 26, 2010, the median of the Policy Board members‘ forecasts for year-on-year real
GDP growth was minus 2.5 % for fiscal 2009, 1.3 % for fiscal 2010, and 2.1 % for fiscal
2011, indicating that the Japanese economy was developing basically in line with the Bank of
Japan‘s outlook which was released in October 2009. This shows that Japanese economy is
improving gradually, reflecting the improvement in the overseas economies.

However, the recovery in overseas economies is likely to be moderate because it takes a

considerable amount of time to overcome the various distortions accumulated in the global
economy, mainly in industrialized countries. Hence, it will take some time for the Japanese
economy accordingly to achieve a full-fledged recovery. Due to the sluggishness in the
economies of industrialized countries, it is indispensible for Japanese firms to reach out to
consumers in emerging economies, which have a rapidly expanding middle class.

There are both upside and downside risk factors which must be taken into account in
considering the outlook for the Japanese economy. The first one consists of a possible
upward movement in the economic growth of emerging economies and commodity-exporting
countries resulting from accommodative financial environments and economic stimulus
measures in various countries. The other one relates to the possible implications of balance-
sheet adjustments in the United States and European countries, as well as Japanese firms‘
medium- to long-term expectations of future economic.

~ 26 ~
REFERENCES:

DORNBUSCH FISCHER STARTZ- Macroeconomics 9e

www.wikipedia.com
http://www.economist.com/
www.boj.or.jp
www.nytimes.com/2010/03/18/business/global/18yen.html
www.mises.org/journals/qjae/pdf/qjae8_1_2.pdf - United States
Various Reports on Japan Economy
http://www.oppapers.com,
http://www.mongabay.com,
http://www.experiencefestival.com,
http://www.jstor.org,
http://www.economywatch.com,
http://www.markit.com,
http://countrystudies.us,
http://www.google.co.in\
http://wpweb2.tepper.cmu.edu/faculty/mccallum/JapanMonPol2.pdf
http://en.wikipedia.org/wiki/Monetary_and_fiscal_policy_of_Japan
http://www.boj.or.jp/en/theme/seisaku/kettei/index.htm
http://www.boj.or.jp/en/type/release/adhoc10/k101105.pdf
http://www.boj.or.jp/en/type/release/adhoc10/k101028.pdf
http://www.boj.or.jp/en/type/release/adhoc10/k100126.pdf
http://www.boj.or.jp/en/type/release/adhoc10/k100317.pdf
http://www.boj.or.jp/en/type/release/adhoc10/un1003d.pdf
http://www.boj.or.jp/en/type/release/adhoc10/k100407.pdf
http://ideas.repec.org/p/hst/hstdps/d05-99.html
http://ideas.repec.org/p/hst/hstdps/d05-99.html

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