The Yen and The Competitiveness of Japanese Industries and Firms. March 4, 2008 (preliminary draft) Robert Dekle Department of Economics USC

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1 1 The Yen and The Compeveness of apanese Indusres and Frms March prelmnary draf Rober Dekle Deparmen of Economcs USC Kyoj Fukao Insue of Economc Research Hosubash Unversy Prepared for he ESRI Workshop March a he Cener on apanese Economy and Busness Columba Busness School.

2 2 I. Inroducon. In Sepember 1985 represenaves of he U.S. apan Germany he Uned Kngdom and France me a he Plaza Hoel n New York o engneer a deprecaon of he dollar o help elmnae he connung rade defcs of he U.S. As a consequence of hese polces by February 1986 he yen-dollar exchange rae approached 180 from abou 250 before he Plaza Accord. The yen connued o apprecae reachng 120 n early There was anoher spur of apprecaon n early 1995 wh he yen momenarly ouchng below 100. Subsequenly he yen weakened o as much as 130 alhough has been mosly n he range durng he las decade. Tha s he yen apprecaon has been que sudden afer he Plaza Accord; and ha over he las 20 plus years he yen has remaned a a rae essenally double ha before he Plaza. These rends n he apanese currency apply also n erms of he Nomnal Effecve Exchange Rae NEER alhough n erms of he Real Effecve Exchange Rae REER he yen apprecaon was more mued wh he REER oday fnally back a pre-plaza levels Fgure 1. The objecve of hs paper s o assess he mpac of hs dramac and susaned yen apprecaon from 1985 unl oday on apanese ndusres and frms. We wll examne how he hgh yen has lowered he compeveness of apanese ndusres by rasng he coss of apanese ndusres relave o U.S. ndusres. We wll compare n erms of a common currency--he average coss of apanese and U.S. ndusres. We wll show ha apanese average coss a he ndusry levels have

3 3 rsen subsanally beween Snce ha me he gap n average coss has narrowed largely owng o more rapd wage ncreases n he U.S. We also show ha n apanese ndusres n whch TFP growh has been robus he gap n apan-u.s. average coss has no wdened very much. Fnally we focus on examnng he deermnans of apanese TFP growh beween usng apanese frm level daa. We fnd ha larger frms and frms wh more foregn capal have hgher TFP growh raes. How apanese ndusres and frms responded o he rapd yen apprecaon s no only of hsorcal neres. Today here s anoher Asan gan runnng hgh curren accoun surpluses agans he Uned Saes wh ncreasngly srden calls n he U.S. for he Asan gan o floa and apprecae s currency. So far Chna has frmly ressed calls for a sharp remnb apprecaon; and one of he reasons ofen gven for hs ressance s he purpored damage he sharp yen apprecaon snce he lae 1980s has done o apanese ndusres and frms. The emphass of hs paper on apanese ndusres and frms may be puzzlng. Afer all as economss are we no mos concerned wh he effec of he yen apprecaon on apanese consumers? A yen apprecaon should lower he cos of mporables; and of mpor compeng goods hus lowerng he overall prce ndex resulng n hgher consumer welfare. The reasons why we focus on he supply sde on frms and ndusres and raher neglec he demand sde he consumers n hs paper s wofold. Frs a careful general equlbrum analyss of he exchange rae changes ha are requred o close global mbalances has already been done n Obsfeld and Rogoff 2005 Dekle Eaon and Korum 2008 and elsewhere. Also oher papers n hs 1 In relaed work orgenson and Nomura 2007 calculae usng dealed commody level prces he purchasng-power pary PPP exchange raes beween apan and he U.S. and found ha for many of he

4 4 projec for example by Phlp Lane and Maurce Obsfeld have more macroeconomc general equlbrum reamens of apanese nernaonal macroeconomcs. By focusng on apanese ndusres and frms we are fllng an mporan recen gap n he leraure. 2 The second reason s ha as noed by Banerjee and Duflo 2005 may be napproprae o smply aggregae ndusres and frms n counres characerzed by sgnfcan exernales and mpedmens o he mobly of labor. There s a vew n developmen economcs ha emphaszes he exporables secor as an engne of growh and developmen Rodrk Suppose ha producvy ake-offs orgnae n he exporables secor; and spll over no oher ndusres. Then counres may prefer o manan a deprecaed exchange rae o promoe he exporables secor and o enhance such spllovers. In such counres an apprecaon of he exchange rae ha equally punshes lowers he profs of he exporables secor bu benefs rases he profs of of say he ules secor wll hur he overall economy. Wh only macroeconomc daa we wll no be able o analyze how an exchange rae apprecaon may have specfcally hur some hgh exernales ndusres n he exporables secor. II. The Smple Framework. Le C C be he average cos funcons n a common currency say he dollar U for ndusry n he radeables secor n apan and n he U.S. respecvely. A rse n he yen relave o he dollar wll have wo effecs on say C. Frs holdng yen coss he same dollar coss wll rse one-for-one. Second ypcally yen coss wll fall somewha snce some npus are mpored. However snce no all npus are mpored a rse n 42 ndusres examned he acual yen-dollar exchange rae was much hgher han he PPP exchange raes. 2 McKnnon and Ohno 1997 have exensvely analyzed he yen apprecaon epsodes of he lae 1980s and early 1990s. They prmarly examne aggregae and ndusry-level rends from a paral equlbrum

5 5 value of he yen wll almos always rase C as we show for several ndusres n he nex Secon. Applyng a smple wo-good apanese- goods U.S.-goods model of consumer choce e.g. Bodnar Dumas and Marson 1998 Dekle 2005 we ge he followng expresson for he prce-cos markup for apanese goods n radeables ndusry : P 1 = C [ ρ 1 λ] where P s he dollar prce of apanese goods and ρ s a uly parameer measurng he subsuably beween apanese and U.S. goods. λ s he marke share of apanese goods and s equal o: λ = 1. ρ C 1 CU We can see from he above expressons ha when he average cos of apanese goods ncreases he marke share of apanese goods declnes. Ths s because as a apanese frm s cos rse he frm wll have o rase dollar prces; and he rse n relave prces wll cause consumers o shf her demand o U.S. goods. The degree o whch hs happens depends on he elascy of subsuon or ρ. The hgher hs elascy he more he rse n he cos of apanese goods wll shf demand o U.S. goods. The prce-cos margn wll decrease when here s an ncrease n apanese relave average coss. A fall n he marke share nduced by hs ncrease n apanese coss wll rase he nverse prce elascy of demand P/ X / P/ X = ρ 1 λ 1. Thus wh a hgher nverse prce elascy for he same decrease n demand for apanese goods perspecve. The auhors do no formally examne he mpac of he yen apprecaon on U.S. and apanese cos funcons nor do hey examne frm level daa as we do here.

6 6 prces of apanese goods wll rse by less. Ths wll decrease he gap beween apanese prces and coss; and lower apanese un profs. When here s a decrease n he prce-cos margn here s a declne n he amoun of profs per un of good sold un profs ha a apanese frm earns. In addon he rse n dollar prces wll lower he quany of apanese goods sold. Thus wh boh un profs and he oal number of uns sold fallng apanese profs n dollars wll declne. We wll show below ha he relave average coss of apanese frms wll end o rse when he yen apprecaes relave o he U.S. dollar. Ths wll occur when here s no large offseng decrease n he cos of npus no apanese producon; or a rse n apanese frm producvy TFP. The nex Secon shows ha a he ndusry level he rapd yen apprecaon snce 1985 was generally no offse by npu cos reducons or producvy ncreases. III. The Changng Relave Average Coss of apanese Indusres versus U.S. Indusres snce In hs Secon we wll analyze how he compeveness or U.S.-apan relave average coss have changed over me. We measure changes n he compeveness of apanese ndusres by esmang he changes n her average cos of producon n comparson wh he changes n he average cos of producon of U.S. ndusres. The change n average coss can be decomposed no he change n capal coss he change n wages he change n he cos of npu maerals and fnally he change n oal facor producvy.

7 7 We begn by explanng our mehodology and basc assumpons. Suppose ha here exss a well behaved consan reurns o scale producon funcon for a represenave frm n ndusry of counry of he followng form: T X K L F Y = 1 where Y denoes he real gross oupu of hs frm a me L s he labor npu K he capal servce npu X he npu of nermedae goods and T he echnology level. The average cos of producon of hs frm C z s expressed by Y X q K r L w C = 2 where w denoes he nomnal wage rae measured n counry s currency for workers n ndusry of counry a me r represens he capal servce prce and q he nermedae npu prce. We assume ha each frm s a prce aker n all facor markes. We also assume ha facor prces and he echnology level T are connuous funcons of me. By dfferenang equaon 2 over me and usng cos mnmzaon condons we oban ˆ ˆ ˆ ˆ ˆ A q s r s w s C X K L = 3 where he crcumflex accens denoe he growh rae of varables. s L s K and s X denoe he cos share of each producon facor:

8 8 X q K r L w X q s X q K r L w K r s X q K r L w L w s L L L = = = A denoes he oal facor producvy TFP level of ndusry n counry a me. The TFP growh rae can be defned by ˆ Y d dt T F A = Usng growh accounng we can esmae he TFP growh rae. Equaon 2 shows ha we can explan he relave compeveness whch we measure by he gap n he average cos of producon of he wo counres n each ndusry by he gap n facor prces beween he wo counres and he gap beween her TFP levels. In order o apply equaon 2 o dscree me-seres daa we use a Tornqvs-ype approxmaon of hs equaon: 1 ln ln 1 ln ln ln ln ln ln ln ln = A A q q s s r r s s w w s s C C X X K K L L 4 We use year 1980 as he benchmark year and se C 1980=100.

9 9 We can measure he ner-emporal changes n he compeveness of ndusry n counry n comparson wh ha of ndusry n counry U by he changes n he rao of he average cos of producon n he wo counres measured n he same currency: ec / C U* where e denoes he nomnal exchange rae ndex beween he currences of he wo counres he value of counry s currency n erms of counry U s currency. We use year 1980 as he benchmark year and se e1980=100. Nex we explan our daa. Daa on he followng facor npus and on he TFP growh rae were obaned from he EU KLEMS Daabase March 2007 verson. w L : nomnal labor compensaon n ndusry n counry ; w : labor compensaon dvded by he qualy adjused labor npu ndex 1995=100 of ndusry n counry ; q X : nomnal nermedae npu cos of ndusry n counry ; q : nermedae npu cos dvded by he real nermedae npu ndex 1995=100 of ndusry n counry ; and lna lna 1: TFP growh rae of ndusry n counry. We esmaed he servce prce of capal as follows: r =gross fxed capal formaon prce ndex all asses 1995=100 neres rae deprecaon rae capal gans We obaned he gross fxed capal formaon prce ndces from he EU KLEMS Daabase. We calculaed he capal gan erms from hese ndces. For neres raes we use he yeld of newly-ssued 10-year governmen bonds for apan and he marke yeld on 10-year US Treasury secures for he US. Deprecaon raes were obaned from he apan Indusral Producvy IP Daabase for apan and from he BEA webse for he

10 10 U.S. To measure capal servce npus we used he real capal sock n 1995 prces from he EU KLEMS Daabase. For he yen-dollar exchange raes we used he annual average nerbank marke exchange rae from Nkke NEEDS. If he apprecaon of apan s real exchange rae Fgure 1 had been accompaned by superor producvy growh n comparson wh oher counres hen he apprecaon of he Yen unl he md-1990s would no have reduced he nernaonal compeveness of apan s manufacurng secor. However n many manufacurng ndusres he TFP growh acheved was no suffcen o cancel ou he effecs of he Yen apprecaon. In parcular from he 1990s apan s TFP sagnaed and apan s manufacurng ndusres los n compeveness. Fgure 2 compares he TFP growh of manufacurng ndusres n apan and n he U.S. In he perod gross-oupu base TFP growh raes n mos manufacurng ndusres n apan were hgher han hose n he U.S. However durng TFP growh n almos all manufacurng ndusres became very low n apan wh he excepon of he elecrcal and opcal equpmen ndusres and U.S. TFP growh n mos manufacurng ndusres exceeded apan s. Fgure 3 Panel A shows how average producon coss have changed over me n apan and n he U.S. n he elecrcal and opcal equpmen ndusry. Producon coss wll fall when here s a declne n wages capal coss maerals coss or a rse n TFP. In dollar erms apanese producon coss wll rse when he yen apprecaes. Fgure 3 shows ha holdng he yen consan apanese producon coss n he elecrcal and opcal equpmen ndusry have rended along wh U.S. producon coss. However n erms of dollars apanese producon coss n hs ndusry surged afer he yen

11 11 apprecaon n 1985 reachng a peak a abou Thereafer apanese producon coss n erms of dollars sared o declne gradually approachng U.S. levels by To see he role of wage rae and producvy changes on apan-u.s. relave average producon coss Fgure 3 Panel B shows ha relave o apanese wages U.S. wages have surged especally snce 1995 conrbung o he convergence of apan-u.s. average coss. apanese TFP growh raes have generally been lower han U.S. TFP growh raes excep for he perod afer 2002 n he elecrcal and opcal equpmen ndusry. Fgures and 7 depc smlar daa for he rubber and plascs he exles apparel leaher and foowear he ranspor equpmen and chemcals and chemcal producs ndusres respecvely. 3 Generally he paerns observed n hese ndusres are smlar o he paern observed n he elecrcal and opcal equpmen ndusry. Frs he yen apprecaon sharply deeroraed he compeveness of apanese ndusres sarng n However he rapd ncrease n U.S. wage raes has parally offse he drop n apanese compeveness. The declne n capal cos and nermedae npu prces n apan unrepored o conserve space also conrbued o offseng he effec of he yen apprecaon. Second apan s compeveness relave o he U.S. reached boom n Ths resul s conssen wh he fac ha apan s real effecve exchange rae REER was mos apprecaed n 1995 along wh he yen-dollar rae and he nomnal effecve 3 We creaed smlar fgures for oher manufacurng ndusres general machnery; basc and fabrcaed meals; oher non-meallc mnerals; coke refned peroleum and nuclear fuel; food beverages and obacco; wood and of wood producs; pulp paper prnng and publshng; and manufacurng no elsewhere classfed and recyclng. However o conserve space we om hese fgures.

12 12 exchange rae Fgure 1. Afer ha he yen gradually deprecaed n REER erms and by 2006 he real effecve exchange rae approached he level of he level of Thrd n ndusres where apan s TFP growh was on a par wh or hgher han ha of he U.S. before 1990 such as ranspor equpmen chemcals and chemcal producs general machnery and pulp paper prnng and publshng he apan-u.s. average cos gap n dollars dd no become very large even n 1995 and becomes neglgble by On he oher hand n ndusres where apan s TFP growh was much smaller han ha of he U.S. such as elecrcal and opcal equpmen rubber and plascs exles apparel leaher and foowear basc meals and fabrcaed meal and food beverages and obacco he apan-us gap n he average cos of producon measured n dollars became very large n 1995 and even now remans szable. Thus appears ha n order o undersand he rends n relave compeveness across counres s mporan o undersand dfferences n TFP growh raes across counres. In he nex Secon we wll examne he deermnans of apanese TFP usng apanese frm level daa. IV. A Frm Level Analyss of apanese Average Coss and Producvy. In order o quanfy and o deermne he sgnfcance of he relaonshp beween average coss producvy he real exchange rae GDP and oher varables here we run regressons wh apanese frm level daa. The apanese frm level daa are a merged sample beween he Developmen Bank of apan Corporae Daabase whch ncludes frm level ncome and balance shee varables; and a cusom daase consruced by Kyoj Fukao whch ncludes frm level facor shares and oal facor producvy Fukao Inu Kabe and Lu The merged daase s of all he frms lsed on he varous Sock exchanges of apan. The daa are annual and run from

13 13 Even whn raher narrow ndusry caegores such as moor vehcles here are sgnfcan varaons among frms n he paern of oal average coss and oal facor producvy. Fgures 8 and 9 depc he behavor of oal average coss and TFP for Nssan and Toyoa Moors. Whle Toyoa s TFP ncreased sharply beween 1987 and 2000 Nssan s was fla unl abou 1998 a whch pon sharply acceleraed unl Of course Toyoa s known as a hghly successful global frm hroughou hs perod; whle Nssan sruggled unl Carlos Gosn ook over as CEO n he lae 1990s. Table 1 shows he relaonshp beween log oal average coss a he frm level he log real exchange rae and he log GDP level for varous frm caegores. From our sample we drop agrculure coal mnng meal and nonmeallc mnng ol and gas exracon and publc servces. We classfy frms no he nonraded and raded manufacurng caegores; and n urn classfy he raded caegory no hose frms producng dfferenaed and non-dfferenaed goods. The dfferenaed goods caegory ncludes apparel prnng and publshng non-elecrcal machnery elecrcal machnery moor vehcles ransporaon equpmen and nsrumens. Below we depc resuls from fxed effecs panel daa regressons. All sandard errors are robus. When here s an apprecaon of he log real exchange rae npu coss wll declne snce some npus are mpored. Ths declne n npu coss wll end o lower log oal average coss. From Table 1 we see ha for all specfcaons a rse n he log real exchange rae lowers log oal average coss. For he moor vehcles ndusry for example a one percen apprecaon of he real exchange rae lowers oal average coss by abou 50 percen. Toal average coss are very srongly pro-cyclcal.

14 14 Table 2 depcs he relaonshp beween log oal facor producvy a he frm level he log real exchange rae and he log GDP level. When here s an apprecaon of he real exchange rae for he radeables ndusres a leas prce-cos margns and profably are squeezed. In order o lower coss he frm may aemp o ncrease s oal facor producvy. In addon wh a real exchange rae apprecaon he frm wll be able o mpor hgher qualy mpors a a lower prce. If mpored npu prces end o underesmae qualy hen TFP should rse. However we see ha n all frm caegores an apprecaon of he log real exchange rae s assocaed wh a declne n log oal facor producvy. Only n he moor vehcles ndusry do we see even an nsgnfcan effec. Thus here s no evdence ha a company wh producvy squeezed wll end o rase s producvy. In Table 3 we examne wha frm level characerscs are assocaed wh mprovng oal facor producvy. The frm level characerscs we examne are log oal asses he log rao of ne lqudy o sales and he foregn-ownershp share. In all specfcaons a rse n log oal asses rases TFP. Tha s large frms end o have hgher producvy. The rao of ne lqudy o sales lowers TFP on average for he sample and for frms producng non-radeables. For frms producng radeable goods; and for he moor vehcles ndusry a rse n he ne lqudy-sales rao ncreases log TFP. Fnally for all frms an ncrease n he foregn ownershp share rases log TFP. V. Concluson. We have shown ha he subsanal apprecaon of he yen snce 1985 has resuled n a sgnfcan rse n he rao of apanese average coss o U.S. average coss. apanese ndusres ha managed o connue o ncrease her TFP n he 1980s and

15 s have seen he smalles eroson n her compeveness. Usng frm level daa we show ha compared o oher frms large frms and frms wh foregn ownershp have managed o ncrease her TFP.

16 16 References. Banerjee A. and E. Duflo 2005 Growh Theory Through he Lens of Developmen Economcs Handbook of Economc Growh Volume 1 Par A pg Bodnar G. Dumas B. and R. Marson 1998 Pass-Through and Exposure Workng Paper he Wharon School. Dekle R Exchange Rae Exposure and Foregn Marke Compeon: Evdence from apanese Frms ournal of Busness 78 1 pp Dekle R. Eaon. and S. Korum 2008 Global Rebalancng wh Gravy: Measurng he Burden of Adjusmen manuscrp Chcago NYU and USC. Fukao K. Inu T. Kubo S. and D. Lu An Inernaonal Comparson of TFP Levels of apanese Korean and Chnese Lsed Frms manuscrp Hosubash Unversy. orgenson D. and K. Nomura 2007 The Indusry Orgns of apanese Economc Growh manuscrp Harvard Unversy McKnnon R. and K. Ohno 1997 Dollar and he Yen Cambrdge: MIT Press. Obsfeld M. and K. Rogoff 2005 Global Curren Accoun Imbalances and Exchange Rae Adjusmens Brookngs Papers on Economc Acvy Rodrk D Indusral Developmen: Sylzed Facs and Polces mmeographed Kennedy School of Governmen.

17 17

18 Fgure 1: Exchange Raes Nomnal Effecve Real Effecve Nomnal Dollar-Yen :100

19 Fgure 2 TFG Growh on a Gross Oupu Bass by Secor and by Perod: apan-us Comparson 4.0% 3.0% Panel A % 1.0% apan: US: % -1.0% -2.0% 6.0% 5.0% 4.0% 3.0% Elecrcal and Opcal Chemcals and Chemcal General Machnery Coke Refned Peroleum and Oher Non- Meallc Wood Wood Producs and Manufacurng nec; Recyclng Texles Apparel Rubber and Plascs Transpor Equpmen Basc and Fabrcaed Pulp Paper Prnng and Food Beverages Panel B apan: US: % 1.0% 0.0% -1.0% -2.0% -3.0% Elecrcal and Opcal Transpor Equpmen Oher Non- Meallc Rubber and Plascs Manufacurng nec; Recyclng Chemcals and Chemcal General Machnery Basc and Fabrcaed Texles Apparel Wood Wood Producs and Food Beverages Pulp Paper Prnng and Coke Refned Peroleum and -4.0% Source: EU KLEMS Daabase March 2007

20 Fgure 3 Elecrcal and Opcal Equpmen Average Cos apan Average Cos Exchange Rae apan Average Cos US Panel A. Average Coss Wage Rae apan Wage Rae US TFP apan TFP US Panel B. Wage Raes and TFP

21 Fgure 4 Rubber and Plascs Average Cos apan Average Cos Exchange Rae apan Average Cos US Wage Rae apan Wage Rae US TFP apan TFP US

22 Fgure 5 Texles Apparel Leaher and Foowear Average Cos apan Average Cos Exchange Rae apan Average Cos US Wage Rae apan Wage Rae US TFP apan TFP US

23 Fgure 6 Transpor Equpmen Average Cos apan Average Cos Exchange Rae apan Average Cos US Wage Rae apan Wage Rae US TFP apan TFP US

24 Fgure 7 Chemcals and Chemcal Producs Average Cos apan Average Cos Exchange Rae apan Average Cos US Wage Rae apan Wage Rae US TFP apan TFP US

25 Fgure 8

26 Fgure 9

27 Table 1 Dependen Varable: "Average Toal Coss" All Non-radeables Tradeables Tradeables Tradables Moor Dfferenaed Non-dfferenaed Vehcles RExchR Log GDP: R-squared: Frms: Years: Feb

28 Table 2 Dependen Varable: "Toal Facor Producvy" All Non-radeables Tradeables Tradeables Tradables Moor Dfferenaed Non-dfferenaed Vehcles RExchR Log GDP: R-squared: Frms: Years: Feb

29 Table 3 Dependen Varable: "Toal Facor Producvy" All Non-radeables Tradeables Tradeables Tradables Moor Dfferenaed Non-dfferenaed Vehcles RExchR: Log GDP: ToAsses 1.50E E E E E E NeLqud/ Sales: ForShare% R-squared: Frms: Years: Feb