Regional President Speech

Economic Forces Shaping U.S.-Japan Trade: A Longer-Term Perspective Thomas M. Hoenig President Federal Reserve Bank of Kansas City Presented to Midwest U.S.-Japan Association Wichita, Kansas September 10, 2001 It is a distinct pleasure to be asked to speak at the 2001 Midwest U.S.- Japan Association conference. The theme of tills year’s conference, "Creating a Global Advantage in the Information Age," is both timely and important. Indeed, the revolution in information and conununications technologies has been a key factor in the globalization of the world economy and expansion in world trade and rising incomes in recent years. My task this morning is to help set the stage for the discussion over the next two days by looking at some of the fundamental economic forces that have shaped U.S.- Japan trade in recent decades and by highlighting key factors that are likely to be influential in the future. My remarks will focus on three topics. First, I will briefly look back at how relative economic performance in the U.S. and Japan has influenced their trade relations in past years. Next, I will take a more detailed look at what economic forecasters are saying about the near-term outlook for the U.S. and Japanese economies and the implications that this may have for U.S.- Japan trade. Finally, I will highlight key elements in the economic environment that may influence the evolution of world trade over the next several decades. Economic Perfonnance and U.S.- Japan Trade Relations As the world’s two largest economies, the United States and Japan have played key roles in the growth in world trade and rising standards of living over the past half-century. But, as important as they have been to the world economy, they have been equally or more important to each other. Indeed, Japan is our third largest trading partner, accounting for about 11 percent of U.S. trade. Moreover, each country is the other’s largest source of foreign direct investment. With such strong economic interdependence, it should be no surprise that trade issues have, at times, played a prominent role in U.S- Japan policy debates. And, as you know, trade relations have not always been smooth. Japan’s large and persistent trade surplus with the U.S. and the yen/dollar exchange rate have been a frequent source of economic and political friction over the past three decades. What I also find particularly interesting about U.S.-Japan trade issues over this period is how they have been influenced by the relative economic performance of the two countries. During most of the postwar period, Japan’s rate of growth far exceeded that of the U.S. For example, from 1960 to 1990, real GDP growth averaged more than 6 percent in Japan compared with about 3.5 percent in the U.S. Indeed, by the late 1970s and early 1980s, the Japanese economy and the Japanese business model were the envy of the world. Much of the growth of the Japanese economy during tills period was driven by exports to the U.S. and other industrialized countries. The rising tide of Japanese exports increased trade frictions, and many of the trade disputes during this period centered on the issue of the flow of Japanese products to U.S. markets. The more recent events of the past decade have now changed matters in important ways. Following the collapse of the Japanese asset price bubble in the late 1980s and early 1990s, the Japanese economy has struggled, and since 1990, GDP growth has averaged only about 1.5 percent, hi contrast, after slow growth in the early 1990s, from 1994-2000 the U.S. economy has shown its strongest performance hi the postwar period. As relative economic performance has changed, so has the focus of trade relations. In fact, we have seen a noticeable reversal in emphasis. Over the past decade, instead of the dominant focus being on the flow of Japanese products into U.S. markets, U.S.- Japan trade issues have shifted toward the openness of the Japanese economy and its need for more U.S. product and direct investment into the more sluggish Japanese economy. Going forward, relative economic performance is likely to continue to play a critical role in future U.S.- Japan trade relations. Indeed, a key question, it seems to me, is whether the next several years will be more like the 1990s or more like the early postwar period. To address this question, let me turn next to a more detailed look at the near-term outlook for the U.S. and Japanese economies. Economic Outlook for the U.S. and Japan I will start by stating the obvious. Both the U.S. and Japan are currently experiencing a significant slowdown in economic activity. After several years of exceptional performance, the U.S. economy has now seen four quarters of growth less than 2 percent, with the most recent quarter showing the weakest performance since the 1990-1991 recession. Japan, after a rebound in activity last year, appears to be slipping back into recession. And, with the slowing in the world’s two largest economies, prospects for world economic activity are less optimistic as well. U.S. economic outlook The consensus of U.S. economic forecasters, however, is that the U.S. slowdown is nearing an end. Many forecasters see a rebound hi U.S. economic activity by the end of this year and a return to trend growth next year. The combination of considerable easing of monetary policy by the Federal Reserve and the federal tax rebates is likely to lead to continued strength hi consumer spending and housing over the coming months. In addition, an end to business inventory liquidation should help boost growth in the second half of this year, and lower energy prices may help boost discretionary income and consumer confidence. At the same time, there remains significant headwinds that may slow near-term progress. Business fixed investment spending is likely to be held back over the next few quarters by weak cash flow and by an existing capital goods overhang, and exports could be under pressure from both the continuing strength of the dollar and from the slowing world economy. There are also other potential risks to the outlook. Consumer spending could be vulnerable to the continuing weakness hi equity markets and increased unemployment. And, with the recent lowering of estimates of the budget surplus, it may be difficult to engineer additional fiscal stimulus should the recovery falter. Still, while there are clear risks to the U.S. outlook, I remain optimistic that we will see signs of a pickup in activity in coining months, and I hold the view that the U.S. economy will be back on track next year. Economic outlook for Japan The outlook for the Japanese economy, in contrast, is clearly more pessimistic. Last year, stronger private investment spending and increased exports led some to believe that the Japanese economy might finally be on the road to recovery after a decade of sub par performance. In the first half of this year, however, investment spending has collapsed, and export growth has weakened with the slowing in the U.S. and world economies. As a consequence, most forecasters have marked down estimates for growth in Japan both this year and next year. Generally, forecasters see a decline in Japanese real GDP this year and little or no growth next year. At the heart of the problem in Japan is a banking system that has become dysfunctional because of large amounts of nonperfonning loans left over from the collapse of the asset price bubble in the late 1980s. In these circumstances and with nominal interest rates near zero, the Bank of Japan is limited in its ability to stimulate economic activity. Moreover, after several years of fiscal stimulus in the form of public works expenditures that have created a large public debt, Japan now appears to have a more limited scope for additional fiscal policy actions. Realistically, a sustained economic recovery in Japan will depend heavily on revival of domestic business and consumer confidence, a truly functional financial system, and resumption in export growth through expanded world economic activity. Implications for U.S-Japan trade issues These forecasts suggest that the U.S. economy is likely to perform relatively better than the Japanese economy over the next few years. If so, there are several implications for U.S.-Japan trade. But first I should note that we are likely to see some further reduction in the U.S.-Japan hade deficit in the near term as weakness in the U.S. economy leads to reduced U.S. imports. Once activity strengthens in the U.S., imports from Japan should pick up, leading to a larger hade deficit. And. as the U.S. economy improves, the increased U.S. demand for Japanese exports and greater demand for U.S. direct investment in Japan should make an important contribution to the recovery of Japan’s economy. Second, although the yen/dollar exchange rate will certainly influence the evolution of U.S.-Japan trade, its behavior will continue to be difficult to forecast, and I will not attempt to do so here, today. A final implication of these forecasts is that continuing economic weakness hi Japan is likely to create renewed pressure for structural reform of the Japanese economy. In the short run, these reforms will likely be costly and, perhaps, lead to further weakness in economic activity. Over the longer run, however, the result is likely to be a Japanese economy that is more competitive, both domestically and internationally, and more open to U.S. and world products and direct investment. Longer-Term Influences on U.S.-Japan Trade Let me conclude tins morning by touching briefly on three developments in the global economy that are likely to help shape world trade hr corning years. The first of these developments is the ongoing revolution in information and communications technology. Despite the recent shakeout hi high-tech investment in the U.S. and the plunge in tech stocks, I am confident that the IT revolution will continue in the U.S. and will spread to other countries. Indeed, countries that participate in the IT revolution are likely to experience increased productivity and faster economic growth, which will spur world trade. Japan is one country that will surely benefit. Although Japan is a world leader hi the production of IT equipment, its usage has fallen behind the U.S. and some European countries. There are several reasons, including such impediments as the slow pace of telecom deregulation, labor market practices, and the lack of venture capital financing. Consequently, productivity in Japan has lagged that of the U.S. and other countries in recent years. As the Japanese economy is restructured and the financial system repaired, the stage will be set for IT to make an important contribution to growth and productivity in Japan. Another avenue by which the IT revolution will affect world trade is through its impact on the size and competitiveness of markets around the world. Information technology expands interactions between producers and consumers and between producers and suppliers. The result is greater competition that drives down prices and promotes cost efficiency while expanding potential markets both domestically and internationally. Clearly, the globalization of markets made possible by information technology has great potential to expand world trade. At the same time, however, because the economic fortunes of countries are increasingly linked, countries could be more vulnerable to economic forces originating beyond their immediate borders. For example, the Asian financial crisis in 1997-1998 spread through Asia and extended to other parts of the world because of the increased interconnections among financial markets. Fortunately, the economic effects of this crisis were mitigated by the strength of the U.S. economy and the strong U.S. demand for imports, which helped many other countries recover quickly horn the crisis. Similarly, the simultaneous weakness in the economies of the U.S., Japan, and Europe is a contributing factor to the slowing that we are currently seeing in economic activity in developing countries in Asia and Latin America. The second long-term development that is likely to affect world hade is the pending demographic revolution. Over the next fifty to one hundred years, demographers expect unprecedented population changes. The rate of growth in the world population has been slowing for several decades, and many demographers expect population to stabilize by the end of this century. Population is expected to actually decline in most industrialized economies over the next fifty years while continuing to increase rapidly in some developing countries. In addition, there will be a significant aging of the population in most industrialized countries during this period. These demographic trends have important implications for world trade and economic growth. In industrialized countries, population aging implies significant changes in the demand for consumer products. For example, health care expenditures will rise significantly as a percent of GDP. In this environment, the senior citizen rather than the teenager will drive consumer expenditures. Of course, the opposite will be true in those developing counties experiencing the most rapid population growth. These demographic trends also have important implications for labor markets and the location of business production around the world. In the absence of increased immigration or expanded labor force participation, many industrialized counties will experience a shrinking labor force. Businesses will have to respond by boosting productivity or moving production to areas of the world with adequate labor supply. Of the industrialized countries, Japan is most likely to be affected by these changes. Currently, for example, the Japanese population is expected to decline beginning in 2007 and the labor force in Japan is expected to decline by 0.5 percent per year through the year 2025. During this period, there will be a significant aging of the population in Japan as well. I emphasize these demographic issues because I believe that they have not received the attention they deserve. Most of the emphasis on demographics recently has focused on the implications of an aging population for Social Security. If these demographic trends materialize, however, the implications for the growth in world hade and trade patterns are likely to be enormous. Let me end with a few comments on the importance of multilateral trade negotiations to trade and economic development. While bilateral hade relations and negotiations will continue to be important in the future, I strongly believe that continuing multilateral hade liberalization is essential if we are to continue to achieve rising levels of world trade and higher global living standards. In many respects, however, tills task is likely to be more difficult in the future than in the past. In part, this reflects the fact that we have successfully dealt with many of the easier hade issues. Many remaining issues, such as agriculture and intellectual property rights, are more politically or conceptually complex. However, globalization itself is changing the nature of hade issues. In a more global environment, specific trade issues directly or indirectly affect a broader range of players. This makes bilateral negotiations less efficient but, at the same time, makes multilateral consensus more difficult to achieve. Thus, in my opinion, the long-term outlook for world trade depends importantly on whether a new WTO round can be initiated in the WTO ministerial meetings scheduled this fall in Qatar. I hope that you, as leaders in the U.S. business community, will lend your support to this important effort. Concluding Comments hi closing, I would echo some of the optimism expressed by participants at a recent conference on the "Information Economy" sponsored by the Federal Reserve Bank of Kansas City. In many respects, the rapid advances in information and telecommunications technology that we have see hi recent years are likely to be only the harbinger of further changes in the years ahead. While these changes will provide exciting opportunities, they will also pose significant challenges. Conferences such as this can play an important part in helping us to understand and adapt to a changing global economic environment.

Thomas M. Hoenig (2001, September 9). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20010910_thomas_m_hoenig

@misc{wtfs_regional_speeche_20010910_thomas_m_hoenig,
  author = {Thomas M. Hoenig},
  title = {Regional President Speech},
  year = {2001},
  month = {Sep},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20010910_thomas_m_hoenig},
  note = {Retrieved via When the Fed Speaks corpus}
}