Masaaki Shirakawa: Japan-US economic relations - what we can learn
from each other
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan Information
and Culture Center (JICC), Washington DC, 19 April 2012.
* * *
Introduction
It is my great honor to have this opportunity to speak at the Japan Information and Culture
Center (JICC) to celebrate the centenary of the city of Tokyo's gift of cherry trees to
Washington D.C. as an expression of friendship. Regrettably, I missed the chance to
appreciate the cherry blossoms on the banks of the Tidal Basin this year, but I can still find
consolation in viewing my favorite dogwoods instead. As you may know, dogwoods were
sent from the United States to the city of Tokyo as a gift in return, and we can still enjoy the
beautiful flowers of these original trees at Tokyo Metropolitan Engei High School (Chart 1).
The exchange of cherry and dogwood trees is just one small example of the deep ties that
exist between Japan and the United States. From my perspective as a central banker, the
economic relationship between our two countries is definitely the cornerstone of a
prosperous global economy. This relationship has had its ups and downs, as all inevitably
do. As we gradually emerge from the global financial crisis and renew our resolve in
maintaining and strengthening the global economic system - thereby ensuring prosperity for
all - I believe it is worthwhile to offer my observations on Japan's economy with special
emphasis on Japan-U.S. economic relations.
I. Some facts about Japan's economy
Before delving into the main subject, although you may already be familiar with facts about
the economic interdependence of the two nations, as well as the state of Japan's economy,
let me share some fundamental ones with you.
The economic interdependence of the two nations in recent years
First, I would like to highlight a few such facts specific to the economic interdependence of
the United States and Japan in recent years. In terms of GDP, the U.S. economy has the
largest and Japan's economy has the third largest within the global economy. The two
economies combined enjoy just over a 30 percent share of the global economy (Chart 2). A
glance at some economic data easily confirms that the two nations still have close ties and
are important partners (Chart 3). For example, looking at trade figures, the United States'
share of 15 percent marks it as the second largest destination for Japan's exports, after
China's 19 percent. Moreover, it appears that a large portion of the exports to China is
eventually sent on to the United States after going through the assembly process in China.
As a destination for U.S. exports, Japan has a share of 5 percent, which is the second
largest after China when excluding the NAFTA countries. As you can see by the example of
Apple's iPhone, for which Japanese manufacturers produce more than 30 percent of the
components, the industries of Japan and the United States are indeed closely connected
(Chart 4).
In terms of international investment, the share of the United States as a destination for
outstanding foreign direct investment from Japan is the largest, at 30 percent (Chart 5). The
share of the United States with respect to outstanding inward foreign direct investment to
Japan is also the largest, at 34 percent. From the other side of the picture, the share of
Japan in terms of outstanding inward direct investment to the United States is the second
largest, at 11 percent, after the U.K.'s 20 percent. Looking at securities investment, Japan's
U.S. Treasury holdings of 0.9 trillion U.S. dollars represent a share of 20 percent, second to
China's holdings of 1.2 trillion U.S. dollars, which give it a share of 26 percent.
Japan's economy after the bursting of a bubble
Second, I would like to highlight some facts about the current state of Japan's economy. With
regard to growth rates, to our regret, it is hard to claim that our performance has been
remarkable, and our experience has often been referred to in a negative context in recent
years as "a lost decade" (Chart 6). Having said this, although our GDP growth rates have
been on a declining trend, the average growth rate of GDP per capita in the past decade is
almost the same as the average for the G-7 countries. Moreover, it is surprisingly not well
known even among Japanese people that Japan recorded the highest growth rate among the
G-7 countries in terms of GDP per working-age population - that is, the population aged
between 15 and 64 years. Needless to say, Japan has confronted a number of difficult
challenges, just like other countries. In fact, there has been a series of problems in the past
quarter century, including the forming and bursting of a bubble, the subsequent financial
crisis, mild deflation, the aging of and decline in the population, and the Great East Japan
Earthquake. At the same time, other advanced countries have also ultimately experienced at
least some of the same problems as Japan, and this can be seen in developments since the
mid-2000s. One clear difference between Japan and other advanced countries is the fact
that Japan was the first to experience such problems and, in the absence of a textbook that
might address them, had to tackle them through its own efforts. In this sense, Japan suffered
from these difficulties in the unique position as a forerunner. Such experiences provided
some lessons that helped us recently in dealing with the global financial crisis, as evidenced
by the relative soundness of Japanese financial institutions.
The long-term developments in Japan's economy
Third, I would like to take a look at how Japan's economy has developed over a longer time
span (Chart 7). Japan opened its doors to the world 160 years ago when a U.S. fleet led by
Commodore Perry, who held an official letter from President Fillmore, anchored off the coast
near the capital city. After experiencing rapid economic development, Japan became the first
industrial nation among non-Western countries. Japan's real GDP and GDP per capita back
in 1870 - for which relevant statistics are available - were 26 percent and 30 percent,
respectively, of the relative figures for the United States (Chart 8). The ratios had not
changed much by the time the cherry trees were sent to Washington D.C. as a gift of
friendship 100 years ago. They gradually rose thereafter, but the ratio in terms of GDP per
capita was still a mere 44 percent at the peak before World War II. The war caused
disruptive economic damage, but Japan, after making strenuous efforts toward
reconstruction, entered a period of rapid and high economic growth. The country's high
growth period started in the mid-1950s and ended in the early 1970s. The average annual
growth rate in this 15-year period was high, at 9.7 percent (Chart 9).
There have been various discussions about the factors that enabled Japan's high growth
after the war, but given the time constraint, I would like to highlight just three of them. The
first factor is favorable demographics. Japan benefited from the so-called "population bonus"
that occurred when the total population increased together with the ratio of the working-age
population. The second factor is the adoption of a market economy as a development model.
Although there were other countries with growth potential, emerging economies including
China only started to adopt a market economy model from the 1990s. In such a situation,
Japan benefited from the free trade system that was led by the United States after World
War II. The third factor is that the Japanese firms and society developed a unique business
model that placed importance on long-term relationships, and this model had excellent
compatibility with the relatively stable global economic conditions during the period of the
Cold War.
Even after the high growth period, Japan continued to enjoy a relatively high rate of
economic growth compared to other advanced countries. As a result, the economic gap
between the United States and Japan narrowed and, at the height of the Japanese bubble
economy around 1990, the ratio of Japanese real GDP to U.S. real GDP exceeded
40 percent while the ratio in terms of real GDP per capita exceeded 80 percent (Chart 8).
Against the background of the narrowing gap, the two nations experienced rising economic
frictions, especially on the trade front, including over textiles in the 1970s and over autos and
semiconductors in the 1980s. In such an environment, Japan initiated so-called
"selfrestraint" with regard to exports. Over the past half century, the U.S. dollar registered its
highest level in nominal terms in 1985. I should note that there is a universal phenomenon
that trade frictions take place following the appreciation of currencies (Chart 10).
II. The prospects for the U.S. economy: implications from Japan's experience
There is a reason why I have spent a relatively long time on explaining some facts about
Japan's economy. This is because, judging from frequently asked questions from my
American friends, I believe that such historical facts might be of some help in considering the
prospects for the U.S. economy. One such frequently asked question is related to the policy
conduct for the time being - that is, will the United States suffer the Japanese experience of
"a lost decade"? The second question is based on a longer-run perspective - namely, how
long can China continue to enjoy its current period of high economic growth? This question is
seemingly intended to draw implications from Japan's past experience with regard to the
current state of the Chinese economy, which has great importance for the U.S. economy.
Will the United States suffer the Japanese experience of "A Lost Decade"?
Let me start with the first question. Before the global financial crisis, a prevailing view among
economists in the United States was that, even if a bubble existed and burst, the economy
could avoid a big downturn similar to that experienced by Japan if aggressive
macroeconomic policies were pursued promptly. Since 2009 - probably in reflection of this
view - we have witnessed repeated episodes of rising optimism triggered by some signs of
economic recovery, which are then followed by the resurgence of pessimism.
Let's look at some data. During the six years since 2006, when housing prices started to drop
in the United States, the average real GDP growth rate was low, at 0.9 percent, and real
GDP stayed at a level equivalent to 103 percent of the level seen in 2006 before the decline
in real estate prices. In the case of the large bubble experienced by Japan in the latter half of
the 1980s, the average growth rate for the six years following the record peak year of real
estate prices was 2.1 percent and GDP stayed at a level equivalent to 107 percent of that
seen in 1990. As is evident from these figures, the negative legacy of the bursting of the
bubble is enormous, both in the United States and Japan. A similarity is also observed in
terms of real estate price developments in the two countries (Chart 11). Once a bubble
bursts, economic entities that have expanded expenditures and debts need to go through a
process of reducing debt to a normal level. During that process, downward pressure from
balance-sheet repair continues to weigh on economic activity.
At the same time, there are many important differences between the two economies.
The first difference is that the scale of the bubbles, which determines the significance of
damage, appears to be smaller in the case of the United States. Looking at the size of capital
gains arising from real estate and financial assets during the bubble period, this was larger in
Japan, at 4.6 times nominal GDP compared to 3.1 times in the United States (Chart 12). The
same conclusion can be drawn when we compare the size of capital losses. As the scale of
this bubble was relatively small, the burden associated with balance-sheet repair should be
smaller in the United States.
The second difference is with regard to the speed of dealing with non-performing assets,
which, importantly, reflects differences in the two economies' financing structures (Chart 13).
The problem in the United States started with an increase in subprime mortgage loans to
households, which were financed by banks directly and indirectly in financial markets using
securitized products. In this way, relying on market financing tools, banks faced pressure
from market participants who recognized valuation losses, and the authorities had no choice
but to inject capital into banks at an early stage using public funds. On the other hand, in the
case of Japan, the funding of non-performing assets was mainly carried out by banks, which
did not rely so much on capital markets. This funding structure failed to exert strong pressure
on concerned parties to deal with non-performing assets promptly.
The third difference is the relatively small burden shouldered by domestic investors. In the
case of the United States, capital losses - that is, the costs associated with balance-sheet
repair - were imposed not only on domestic investors but also shared by investors abroad to
a significant extent. This corresponds to the fact that investors abroad increased their
exposure to the complicated securitized products that originated from subprime loans
(Chart 14). On the other hand, in Japan, an increase in debt was mainly reflective of
borrowing from domestic financial institutions, which basically shouldered the burden of
subsequent balance-sheet repair.
The fourth difference is with regard to demographics. Japan faced a rapid aging of the
population and its working-age population started to decline after reaching its peak in 1995
(Chart 15). On the other hand, although its pace of increase has been on a declining trend,
the U.S. working-age population is still growing, at 0.8 percent. At the same time, however,
we need to pay attention to the fact that the pace of increase in the number of net immigrants
has been diminishing, reflecting a recent decline in U.S. growth rates.
The fifth difference is in terms of the flexibility of the economy. The U.S. economy has more
flexibility, as witnessed by vigorous entrepreneurship, efficient and smooth functioning of
labor and capital markets, and the country's leading role in research and development.
Nevertheless, we should bear in mind that the entry rate and labor mobility have remained at
low levels after the bursting of a bubble.
The sixth difference is with respect to the global economic environment surrounding the two
nations. Balance-sheet repair in Japan was completed in the early 2000s, supported by
global economic upturns such as strong growth in the United States and in emerging
economies. However, global economic conditions are not favorable this time around. Japan's
bubble was a domestic one, whereas the recent financial crisis was a global credit bubble. In
the current conjuncture, the European debt problem is exerting an impact on the global
economy, including the U.S. economy. As is evident from the fact that European financial
institutions increased their exposure to U.S. financial products, the U.S. housing bubble and
excess debts in Europe are not independent from each other. Thus, the balance-sheet repair
in the United States might take some more time.
It is sometimes pointed out that one of the differences between the two bubbles is the sector
in which excess debt accumulated: the corporate sector in the case of Japan and the
household sector in the case of the United States. What matters in shaping the impact of
balance-sheet repair on economic activity, however, is whether such an adjustment is taking
place in a sector driving economic recovery. In this sense, there is no significant difference
between the two cases because, while economic recovery in the past has been led by the
corporate sector in Japan, it has been driven by the household sector in the United States.
An overall assessment of the differences seemingly indicates that the balance-sheet repair in
the United States will likely end earlier than in the case of Japan, and I do hope that is the
case. In the end, I think that the most important factor determining economic developments
following the bursting of a bubble is the economy's capacity to develop a new growth model
that best suits a changing economic environment. In the case of Japan, its stagnant
economic performance largely owed to its failure to adjust to economic globalization
associated with the collapse of planned economies, especially the breaking up of the Soviet
Union, as well as to the IT revolution, both of which took place almost at the same time that
Japan's bubble burst. In the current conjuncture, the most significant changes taking place
on a global scale are the swift rise of emerging economies and the rapid aging of the
population. Respective corollaries to these changes are a rise in international commodity
prices and a deterioration in the fiscal balance. While Japan has had a tough time trying to
develop a new growth model in response to these changes, we do have some strengths in
this regard. First, Japan is located in Asia, the engine of global economic growth. Second, it
has a high level of technological prowess, which is necessary when adjusting to a rise in
energy prices. Third, as they have faced the problem of an aging population ahead of the
rest of the world, Japanese firms have been making serious efforts and progress toward
developing new business models that focus on markets for the elderly. As the governor of
Japan's central bank, I do sincerely hope that a new growth model for Japan will be
developed that takes advantage of these strengths.
The prospects for the Chinese economy in light of Japan's experience of high growth
Now I would like to move on to the question of the sustainability of high growth in China.1
Economic history tells us that a convergence of the sizes of two economies is likely to cause
some sort of friction. A typical example is the aforementioned economic friction between the
United States and Japan that reached its height in the latter half of the 1980s. As I referred to
a short while ago, the average annual growth rate in Japan during the 15-year period of high
growth that started in the mid-1950s was 9.7 percent. China's high growth started in the early
1990s, and its average growth rate over the last twenty years is 10.2 percent, almost the
same as Japan's growth rate (Chart 16). What is different is the time span of the high growth
period, which has been longer in the case of China. However, no country can maintain high
growth forever. Therefore, looking at a slightly longer time horizon, a meaningful question is
not whether China's high growth will continue but whether China can make a smooth
transition from a high growth phase to a stable growth phase. This is a challenging task, and
I have often been asked by Chinese friends to provide advice in light of Japan's experience. I
always note the following three points.
First, do not fall into a mode of complacency. When high growth continues, especially
coupled with low inflation, such favorable economic performance tends to engender
overconfidence. Although the formation of bubbles involves a complex mechanism, one
crucial factor is excessive risk-taking caused by complacency and overconfidence.
Second, be prepared for demographic changes. The inverse dependency ratio, which
represents workers per non-working population, appears to have a positive correlation with
real estate market development (Chart 17). This implies that attention should be paid to
demographics as a factor contributing to the formation of financial bubbles.
Third, pay attention to changes in financial institutions' behavior following financial
liberalization. Although active lending by financial institutions has been the direct cause of
the formation of bubbles in advanced economies, these institutions' lending attitudes became
aggressive as a result of fierce competition and an associated decline in profitability triggered
by financial liberalization. While financial liberalization itself is necessary, it should be
pursued under a combination of appropriate regulations and supervision.
I understand that these three pieces of advice do not directly answer the question from my
American friends, which is "How long can China continue to enjoy its current period of high
economic growth?" I hope that China will successfully make a smooth transition from a high
growth phase to a stable growth phase, which will arrive at some point in the future.
III. The current state of and prospects for Japan's economy
Lastly, I would like to talk about the prospects for Japan's economy after summarizing its
current state.
Reconstruction after the Great East Japan Earthquake
As for the current state of Japan's economy, this cannot be described without referring to the
effects of the tragic event known as the Great East Japan Earthquake, which occurred on
March 11 last year. The economy significantly suffered from the multiple shocks of the
earthquake, tsunami, and nuclear power plant accidents.2 During this time of hardship, we
received much support and encouragement from the government and people of the United
States. Soon after the quake, the United States Armed Forces' Operation Tomodachi, or
"Friends" in English, provided assistance to Sendai Airport and restored its functionality
about a month after the disaster (Chart 18). People in Japan really appreciate such support
from the United States, from the bottom of their hearts. Looking back at all those efforts over
the past year or so to overcome the difficulties caused by the disaster, I would like to make
the following four observations.
First, I am very impressed by Japanese firms' competitiveness at worksites. Although the
earthquake caused serious damage to factories and business facilities, as well as disruptions
in supply chains, such problems were overcome much earlier than initially anticipated thanks
to the efforts and new creative ideas of concerned parties.
Second, there are differences among areas in terms of the pace of reconstruction. Those
areas that suffered serious damage have not yet entered the full-scale reconstruction phase,
although they have started to resume some economic activities. In the rest of the disaster
areas, however, there are some signs of steady recovery in economic activity, including an
increase in reconstruction-related capital investment and a recovery in private consumption,
which had plummeted soon after the tragic event.
Third, there are new initiatives motivated by experiences accumulated since the earthquake
disaster. Firms have been reviewing their approach to risk management as well as relevant
business operations, for example, by reexamining business continuity plans and
reestablishing supply chains. With lingering uncertainty about the supply of electricity, firms
have pursued various technological innovations and established new business models under
the slogans of "creating energy", "saving energy", and "storing energy". Such positive
initiatives are expected to create new demand and consequently raise Japan's growth
potential in the medium to long term.
Fourth, financial system stability was maintained. Despite the tremendous shock caused by
the earthquake, we have managed to maintain the working of the financial system and
secure the smooth operation of payment and settlement systems. The Bank of Japan
Financial Network System, or BOJ-NET, which plays a core role in the payment and
settlement of funds and Japanese government securities, has maintained stable operations
after the quake without any disruptions. The Bank's Fukushima branch, which is located
about 40 miles from the Fukushima Daiichi Nuclear Power Plant, also continued with
business as usual. Despite the shocks arising from the European debt problem, financial
markets have also remained stable, except for a brief period soon after the quake. As can be
judged from the level of risk spreads in funding markets, financial markets in Japan have
been the most stable among those in advanced countries.
The prospects for Japan's economy
Now I would like to move on to the current state of Japan's economy and its prospects.
After experiencing a sharp rebound from a plunge caused by the earthquake toward summer
last year, economic activity has been more or less flat, reflecting downward forces deriving
from the effects of a slowdown in overseas economies and the appreciation of the yen. More
recently, there have been some signs of a pick-up. The Bank of Japan believes that the
economy will gradually emerge from the current phase of flat growth and return to a
moderate recovery path as the pace of recovery in overseas economies picks up, led by
emerging and commodity-exporting economies, and as reconstruction-related demand after
the earthquake disaster gradually strengthens. The plausibility of such an outlook depends
on the following two factors.
The first factor is global economic developments. In this regard, the good news is that the
stagnant European economy has recently stopped deteriorating amid receding tail risks
arising from the European debt problem. Although some more time is needed to complete
balance-sheet repair, U.S. economic conditions have also been gradually improving, mainly
in the areas of consumption and employment. Business conditions in emerging economies
are also gaining support from somewhat more stable inflation rates in the recent period,
which increases real purchasing power and creates more room for monetary easing.
The second factor is reconstruction-related demand. The portion of the government budget
earmarked for reconstruction amounts to about 19 trillion yen. This represents about
4 percent of Japan's nominal GDP and 60 percent of the combined nominal GDP of the three
disaster-stricken prefectures. This sizable budget will be disbursed over the next five years.
Labor market conditions in the disaster areas have already tightened, especially in
construction-related sectors. The implementation of the budget is expected to become
fullfledged in the coming period, and this will further contribute to raising domestic demand.
At this juncture, let me explain the Bank of Japan's conduct of monetary policy. For the time
being, the Bank will aim to achieve the goal of 1 percent inflation in terms of the year-on-year
rate of increase in the CPI and continue to pursue powerful monetary easing until the goal is
in sight, mainly through a virtually zero interest rate policy and the purchase of financial
assets (Chart 19). Monetary policy measures currently pursued by central banks in advanced
economies, including the U.S. Federal Reserve and us, are called "unconventional monetary
policy measures". Looking at the type of assets purchased and the gigantic scale of
purchases, they are indeed "unconventional". However, the transmission mechanism of such
unconventional measures is not unconventional but actually quite conventional. As Chairman
Bernanke notes, the large-scale purchase of financial assets aims at lowering long-term
interest rates. In terms of assessing monetary policy in Japan in light of such an aim, the
financial conditions in Japan are extremely accommodative (Chart 20). For example, the
interest rate for corporate bonds with a maturity of 5 years is 0.5 percent in Japan and
1.4 percent in the United States. The mortgage loan rate is 2.2 percent in Japan and
3.9 percent in the United States. Long-term interest rates applied for firms and households in
Japan have been as low as those in the United States in real terms, based on real interest
rates derived from long-run inflation expectations, on which economists place importance.
One of the most significant challenges for Japan is to stem a declining trend in the potential
growth rate. Although several factors contribute to a drop in this rate, a significant one is
responses to a change in demographics - namely, an aging of the population that has been
progressing at a pace unprecedented in advanced countries. Although the aging of the
population lowers the potential growth rate through various channels, what is causing a
profound impact on the economy is not the aging itself but a delay in responding to such a
demographic change. This delay is one of the major causes of a deterioration in the fiscal
balance in Japan, which is coming into the spotlight these days. Uncertainty regarding future
fiscal burden has also led to restrained spending by the working generations. In any case, a
gradual decline in the potential growth rate has been significantly contributing to mild
deflation by bringing down expected future income and restraining expenditures. In addition
to powerful monetary easing pursued by the Bank of Japan, in order to overcome deflation, it
is crucial to make strenuous efforts to strengthen the growth potential of Japan's economy.
IV. Concluding words
As I have almost used up my time, let me conclude my remarks. Japan-U.S. relations are
quite often described as one of the most important relationships in the world. That
importance, I believe, is not measured just in terms of the amount of trade between the two
countries or their overlapping interests in the sphere of national security. The fact that both
can learn a lot from each other is also a valuable asset that forms the cornerstone of the
relationship. This is especially true with respect to stewardship of the economy, as it is not
possible to conduct controlled experiments as regards economic policy. Of course, as I have
noted today on current developments, while the best lessons we might learn from each other
remain uncertain, our insights will be much, much better.
Thank you very much for your attention.
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