Economic Cooperation in the 1990s: European Common Market and Pacific-Asian Cooperation in a Changing Global Framework [1 ed.] 9783428475292, 9783428075294

Citation preview

Economic Cooperatioh in tbe 1990s

Schriften zu Regional- und Verkehrsproblemen in Industrie- und Entwicklungsländern Herausgegeben von J. Heinz Müller und Theodor Dams

Band 54

Economic Cooperation in the 1990s European Common Market and Pacific~Asian Cooperation in a Changing Global Framework

edited by Takashi Matsugi Alois Oberhauser

Duncker & Humblot · Berlin

Die Deutsche Bibliothek- CIP-Einheitsaufnahme Economic cooperation in the 1990s : European common market and Pacific-Asian cooperation in a changing global framework I ed. by Takashi Matsugi ; Alois Oberhauser. - Berlin : Duncker und Humblot, 1992 (Schriften zu Regional- und Verkehrsproblemen in Industrie- und Entwicklungsländern ; Bd. 54) ISBN 3-428-07529-3 NE: Matsugi, Takashi [Hrsg.]; GT

Alle Rechte vorbehalten © 1992 Duncker & Humblot GmbH, Berlin 41 Fotoprint: Wemer Hildebrand, Berlin 65 Printed in Gerrnany ISSN 0582-0170 ISBN 3-428-07529-3

Editors' Foreword The joint seminars held by the Faculties of Economics of the Nagoya and Freiburg Universities are already a tradition. Economic cooperation between Japan and the Federal Republic of Germany requires "staying power". Personal commitment on both sides, institutional validation by both Universities and mutual support of both technical and personal nature are required. The editors are pleased that this tradition of Japanese and German cooperation includes the publication in this series of the papers presented at seminar meetings. This publication contains the contributions made at the 12th Joint Seminar. The theme "Economic Cooperation in the 1990s: European common market and Pacific-Asian cooperation in a changing global framework" is of current significance. Europe wishes to acheive economic and political union by the turn of the century. The pacific area with its economic dynamism is seen as a challenge. It is of great importance to understand the development of both these - next to the USA gravitational centres. In the name of the Faculty of Economics the editors wish to thank the Ministry of Seiences and Arts for the financial support of the Freiburg meeting, as weil as the Rectorate of the Albert Ludwig University for its supportive interest over many years. A mention of thanks is also due to the Scientific Society of the Freiburg University for financing the printing of this publication. Freiburg, March 1992

J. Heinz Müller

Theodor Dams

Table of Contents

Takashi Matsugi

Impacts of the EC Single Market 1992 on the Japanese Economy, with Special Reference to Manufacturing/ Automobile Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9

Yoshinobu Sato

Japanese Direct Investment in the United States and Related Problems, with Special Reference to Automobile Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Soshichi Kinoshita/Jiro Nemoto

The Changing Pattern of International Specialization and Economic Interdependence among Asia-Pacific, the US and EC Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Wemer Pascha

On the Intricacies of Specialization and Interdependence - A Comment on S.Kinoshita's and J.Nemoto's Paper- ....... ... ... 41

Takashi Matsugi/Alexander Bernhard

On two Ways of Recycling Japanese Trade Surplus .............. .... 47

Hans-Hermann Francke

On Some Processual and Structural Problems of an European System of Centrat Banks .......... .. .......................... 61

Jun 'ichi Senda

Impacts of the EC Single Market 1992 on Japanese Banks and Securities Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

8

Table of Contents

Atsushi lida The Financial Accounting System in Japan- From an International Perspective - . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

Bernhard Kfllp Coordination Demand and Coordination Chances of a Stability Policy in the Common Market ............................... . 101 Yuko Arayama A Study on the Structure of the Labor Market: Empirical Study on a Socio-Economic Survey in Thailand ...................... 133 Rudolf KOgler The European Communities Single Market from a Swiss Viewpoint - Problems, Adjustments, Prospects - .. ............. ..... . 149

Impacts of the EC Single Market 1992 on the Japanese Economy, with Special Reference to Manufacturing/Automobile Industry Takashi Matsugi

1. lntroduction The EC SingleMarketwill be formed at the beginning of 1993 and all efforts will continue until the end of 1992. There is great interest from J apanese companies and direct investments in EC member countries have increased remarkably in recent years. This is one of the economic adjustments to the enlargement of the EC market in the near future. The EC market integration is said to be motivated by the consciousness that the electronics industries in the EC have fallen behind Japan and the United States, as weil as by the fact that disarmament has been negotiated directly between the US and the USSR. The economic reason seems to be reflected in recent restrictive policies taken by some EC member countries against J apanese manufacturers, who then had to adjust and started local production in several European nations. Related arguments are made towards the so-called EC fortress, initiated by the United States who on its part is applying protectionist measures. Who will protect us from protectionism1? The common concem is how to maintain the world free trade system. In this paper we will consider the impacts of the EC single market 1992 on Japanese corporations, with the maintenance of the free trade system in mind.

1 See Blinder, Alan S. : Hard Heads, Soft Hearts - Tough-Minded Economics for a Just Society, Chapter 4. Addison-Wesley Publishing Company, Inc., 1987.

10

Takashi Matsugi

2. Economic meanings of the EC single market 1992 When the plan for the EC single market is completed at the end of 1992, the EC market populationwill have grown to 320 million. It is to expect that chances for sales promotion will increase and scale economies will be pursued, so that enterprises are keen to invest more and the market itself will be more competitive within the Community. The market integration gives rise to merits and demerits for those who are concemed in the Community2 • One of the merits is that the terms of trade will be more favorable to member countries, for volumes of trade are expected to increase within the EC market and decrease between the EC member countries and others outside the market, as a consequence of reduced duties. Another merit will come from hopefully realized scale economies. Operations will be rationalized and costs of production will be reduced under more competitive conditions resulting from the market enlargement. At the same time the expectation of increased profits will invite direct investments from abroad and these may contribute to more efficient resource allocation through competition. On the other band disadvantages will exist if the EC trade policy is inclined to be protective. lf import duties are not reduced and the market is not fully opened to foreign exporters, trade with countries outside the Community will decrease. The fear is that a vicious circle in world trade would be brought about. The EC agricultural common market is typical in the sense that the price for protective policies against foreign countries is paid in terms of subsidies to remove excess agricultural products. At present EC offleials deny the possibility of the so-called EC fortress. The fear expressed by the United States will remain an illusion, if EC foreign policies continue to be liberal in trade. But up to today some restrictive measures have been taken with respect to imports of high-technology related commodities, mostly from East Asian countries. Trade restrictions are exemplified in such cases as local content, product origin, dumping issues and the reciprocity. The policy stance as to

2 Economic Planning Agency: Economic Survey of Japan 1988-89, section 3-3-3 (in Japanese). Printing Bureau of Ministry of Finance, Tokyo, 1989.

Impacts EC Single Market on the Japanese Economy

11

international transactions is considerably different from country to country in the Community and it seems that Great Britain and France stand at extremes of the spectrum. It will not be an easy matter to reconcile the one with the other by the end of 1992. According to the market competitiveness EC manufacturing industries can be classified into three groups3 • The most internationally competitive industries include fashion, chemicals, pharmaceuticals, plant engineering and heavy machinery. They are strong in technology and product development and engaged in successful international businesses in the world as multinational companies. The second group comprises automobiles, home electric appliances and telecommunications equipment and services, which are as competitive as American and Japanese makers. As far as the position ofEuropean automobile industry in the world market is concerned, some models are more competitive and some are less so when compared with the US and J apanese products, so that trade frictions in the car market appear to be complicated matters of concern. The third group includes precision machinery (watches and cameras), shipbuilding, semiconductors and new electronic media. Such European products as timepieces and cameras were famous worldwide a couple of decades ago. Today they have been beaten together with shipbuilding. Semiconductor production and electronic media are typical high-tech industries, but European high-tech industries have got a late start, lagging a lot behind the US and Japanese production standards. But it is in the field of electronic products that the most profound economic frictions exist between EC and Japan. ludging by the debates on trade frictions in the past, an EC fortress could be firstly built for the third group of industries and then for the second group.

3 The Long-Terrn Credit Bank of Japan: EC Unification- Strategies of EC to Japan and Adjustments of Japanese Enterprises to Them- (in Japanese}, Monthly Report No. 250, June 1989, pp. 35-37.

12

Takashi Matsugi

3. Japanese direct investments in the European community Japanese companies have started to invest more in Europe since 1986 and direct investment increased from 1,930 million in 1985 to 3,469 million in 1986 and 6,576 million in 1987 in US dollars. By industry, finance and insurance share the largest and manufacturing talces second place on average. According to the figures for manufacturing in 1988, Japan's foreign direct investmentwas divided with 50% in the United States, with 25% in Asia and with 15% in Europe. This ranking has not changed for several years but the European market has become more significant since the program of the EC Single Market was published. Local production will be increased by foreign direct investment. Up to today J apanese overseas production ratio to the total ranged from 2 to 4 percent in the period 1979-87, whereas the ratio was in the range from 18 to 22 percent in the United States and in the range from 16 to 20 percent in West Germany. lf J apanese manufacturers follow the same process of internationalization as the United States, its overseas production ratio surely will go up further through future foreign direct investments. The main reasons why foreign direct investment is made by J apanese enterprise are different by region. For investment in EC member countries 75% of Japanese companies are interested in sales promotion in the local market and 40% of them are thinking of the necessity to adjust to trade regulations recently imposed by the European Community. Motivationsare nearly the same for the United States but percentages are different with 95% for sales promotion and 30% for adjustment to regulations. With regard to direct investment in Asian NIEs, the first reason is to utilize cheap Iabor (95%), the second is to promote sales in the local market (90%) and the third is to export local products to the third nations. The total number of Japanese organizations and establishments in Europe amounts to 2,257 of which 867 are branches of Japanese companies and 1,390 are joint ventures of Japanese and European companies. Of the joint ventures the greatest number by sector belongs to commerce, the second greatest to manufacturing and the third to finance and insurance. Finance and insurance in Europe dominates that in the United States in the absolute number and relative share. The percentage of manufacturing in Europe is smaller than that in the United

Impacts EC Single Market on the Japanese Economy

13

States (17. 7% to 21.9%). But the relative share of commerce in Europe is greater than in the USA. So the strategy of Japanese companies can be said to sell more and to produce less in Europe, compared with the strategy in USA. Trade frictions between EC and Japan may change this structure. The number of J apanese establishments in Europe shows another structure by country and city. West Germany and the United Kingdom are more favored as location than other countries. These two countries share 49.2% in the private sector. In the distribution of Japanese establishments by city, London functions as a center in Europe and Düsseldorf is occupied by the largest number on the continent. Establishments in three German cities of Düsseldorf, Harnburg and Frankfurt/M., when totaled, amount to 335 for the private sector, which is the same for London.

4. Reactions of Japanese manufacturing/automobile industries Trade restriction measures taken by the European Community manifest themselves in import quotas, anti-dumping and local content issues. They can be interpreted as consequences of trade imbalance between Japan and EC in recent years. Japanese industries involved in trade conflicts are automobiles, sewing machines, printers, VTR, micro wave ovens and semiconductors, to name the typical cases. Manufacturing enterprises in these sectors have been trying to react to recent EC policies and to solve trade conflicts. In the following some cases are tak:en to see the reality with reference to examples collected in Nagoya Region. 4.1. Office machines Anti-dumping issues broke out in the Community in 1985. The Brother Company in Nagoya, as a multiple mak:er of typing machines, word processor, copying machines, facsimile machines, sewing machines and micro wave ovens, was involved in the issues and declared to be guilty in January 1987 after investigation of dumping margins. Brother then had to abide by a 40% local content regulation in the EC market.

14

Takashi Matsugi

Brother Company bad experienced the similar issues in the United States before. The reaction was to start local production in the USA. It was prepared to take the same managerial strategy also in Europe and built a plant in the United Kingdom in 1985. The reasons for the location in UK are: (1) a marketing base has already been established in UK. (2) English is favored to train workers on the job and QC thinking. (3) The UK government eagerly invites direct investment from Japan. (4) A "big" nation is preferred from the viewpoint of security. Brother Company is satisfied with the selection of location, because Iabor costs are reasonable and well educated students are supplied by universities of Manchester and Liverpool. As for the local contents regulation complaints are expressed of high prices, low quality and delayed delivery of parts. The difficulty in parts supply was overcome by investing in parts production, either for itself or in cooperation with local suppliers. The remaining problern may be where to export the products made in the Taiwan plant from the view point of global management. Another dumping issue was raised in November 1986 against printers. Main European competitors are Olivetti, Phillips, Adler and Siemens. At that time, Japanese printer producers were unanimously the opinion that European makers bad made a mistake because they were not orientated to IBM convertible printers in the coming European market. The Japanese made it with success but the European did not. The result of this dumping issue was that local content regulations should be applied to printer makers. It is to be feared that this regulation will make products more costly and less reliable, with the consequence that only end users bear the burden. 4.2. Automobiles

The major issues facing the Japanese automobile industry in 1989 will be4 : (1) the acceleration of local production in North America by eight Japanese car makers, along with its impact on the US auto market and on the domestic auto parts industry which will have to produce less; 4 The Japan Economic Journal: Japan Economic Almanac 1989. The Japan Economic Journal, lnc., Tokyo 1989, p. 129.

Impacts EC Single Market on the Iapanese Economy

15

(2) the establishment of production bases in the European Community in readiness for the unification of the EC in 1992, like Toyota Motor Corp.'s proposed passenger car factory in England; and (3) the introduction of the consumption tax in Japan beginning April 1 and its effect on domestic auto sales. As long as the domestic consumption is booming, the so-called "hollowing out" problern may not be realistic, but it will be sure to appear under the present circumstances of world trade. The EC, the USA and Japan today are competing with each other in the European car market in which the situation is different from country to country. German car makers are strong in technology and quality and have good sales in Japan since the Yen evaluation, because the price of German cars is regarded as reasonable for the time being. The UK welcomes the local production of automobiles and Toyota has a plan to operate a plant in England after Nissan and Honda. Japanese direct investments now contributes much to the growth of British economy by creating jobs and exporting goods. France and ltaly seem to berather restrictive to foreign trade and, judging from recent events, raise issues concerning dumping and local contents against Japan. However it should be noted that the restrictive policies could have induced J apanese enterprises to invest in Europe and bring new technologies in the field of autornative parts and semiconductors through a chain effect. The "Big Three" areready to compete and survive in the European car market. It is reported, for example, that US car makers are planning to increase their local production and expand sales in Europe. Recently General Motors has started to try a six day week at its Belgian plant and Ford Motors is thinking of introducing a continuous 24 hour production system at its main European plants. They aim to get ahead of Japanese car makers who will start operations in the UK before long. As for the strategies on the part of Japanese makers, Nissan is planning to install 80 robotics in the body welding process with a view to cost reduction. It started local production in the UK in 1986 but the scale of production has been too small to use such a number of robotics. Annual production of 70,000 cars at present will be increased to 200,000 cars in 1992, so that the introduction of automated equipment will be more suitable on a larger scale. On the other band, the joint venture of Mitsubishi with Chrysler in the USA is going to export sporty cars to Europein 1990, which is the first case of a Japanese car

16

Takashi Matsugi

maker making direct exports from the USA to Europe. It is probable that Honda will follow Mitsubishi on the same line. New regulations are expected to ensue from the European Community. European car makers are reacting to the strategies mentioned above. Fiat is planning to build a large plant in England to produce 300,000 passenger cars a year, while Peugeot is said to invest US$ 1,400 million in France for the purpose of competing with US cars by newly supplying the 605 series. European analysts see the possibility that protective policy measures will be taken by governments to support European car makers in their survival strategies. A further point to be considered is how to achieve a local content of 40% at present required by France for cars originating from the UK. Japanese car makers are not satisfied with European auto parts' suppliers because frequently the price is high, the quality is low and the delivery is delayed, as is the case with business machines. American car makers produce most of their parts in their own divisions. General Motors proeures nearly 70% of total parts by itself. This is not the case for Japanese car makers, who produce around 30% ofparts themselves. In the local production in Europe, parts plants will be set up for engine and electrical parts. The rest have tobe supplied by local producers or by Japanese companies who are affiliated to "parent" car makers and which will follow "parents" to invest in Europe and start the local production of auto parts. In the former case, both technology and management transfer should be necessary for satisfactory parts supply conceming price, quality and delivery. Research and development also should be carried out in cooperation with local parts suppliers. It is reported that a French auto parts maker is prepared to do business with Toyota in England by introducing the "just-in-time" system in its own plant. In the latter case, J apanese auto parts makers will launch local production in the EC as either solo or joint ventures. Furthermore there is a possibility that J apanese car makers purchase of parts from local suppliers depends on the exchange rate of Yen. The result will be the same for J apanese parts makers in the sense that their sales in Japan will decline and suffer the hollowing out effect. This is not to deny that the J apanese auto parts industry should be restructured in the near future.

Impacts EC Single Market on the Japanese Economy

17

5. Globalization of enterprises

Foreign direct investment is to be understood in the framework of the globalization of enterprisess. (1) In the first stage of globalization, companies begin with exporting and see what to sell abroad. (2) In the second stage of globalization, they set up overseas marketing networks and see how to sell. Exports are promoted by this strategy. (3) In the third stage, they establish overseas manufacturing facilities through direct investments. Local employment and production increase and exports from the home country decrease as the result. (4) The fourth stage is characterized by the transfer of managers to local enterprises. In this stage the philosophy of Japanese management confront local culture and traditional institutions, which may well affect the tension between empfoyers and employees. (5) The fifth stage is more sophisticated and managers plan to optimize their global operations in thesensethat the intemationally optimallocation of enterprises will be determined by considering all sorts of factors that are related to the optimal decision. These five stages of globalization can be interpreted as arranged in the magnitude of risk. If export is unsuccessful, the costs to be incurred are smallest and partly taken by traders. Additional costs arising from closing down a sales office abroad are not so much as compared with the costs of shutting down a production plant. In the fourth stage foreign operations are far more expanded and the evacuation is a matter of serious decision, but there may remain a survival strategy on the part of the headquarter in the home country. The fifth stage is more crucial and managers are faced with a matter of life or death so that they have to do their best to avoid the bankruptcy with all efforts. Roughly speaking, Japanese foreign direct investments at present have mostly reached the third stage and started to enter the fourth stage. If we examine them by region, recent investments in the United States made by J apanese car makers have the possibility that Japanese passenger cars with US origin will be re-imported to Japan, depending on the exchange rate of Yen against US dollar. This possibility is implied in the paper contributed by Prof. Dr. Sato to this Seminar. 5 Economic Planning Agency: Economic Survey of Japan 1987-88. Printing Bureau of Ministry of Finance, Tokyo 1988, p. 86. 2 Matsugi/Oberhauser

18

Takashi Matsugi

Critical point may be the range of 120-130 Yen against US dollar, below which re-import of cars from the United States would become profitable. Therefore, direct investments in the United States today are planned from such a strategic viewpoint that managers may carry out optimal operations in the world market under changing economic circumstances. The same situation will be observed with respect to foreign direct investment in the European Community within a coming decade. It is also strategic that US origin cars made by the Mitsubishi-Chrysler joint venture are going to be exported to Europe. To the fifth stage of globalization belongs in a sense the so-called horizontal division of Iabor through which J apanese joint ventures in Asian countdes produce and export commodities to third countries. We conclude that the Japanese economy will be deindustrialized and restructured through foreign direct investments when the fifth stage of globalization is reached. Will Japanese enterprises be able to go through this difficulty by finding a counterbalancing strategy?

References Bhagwati, Jagdish: Protectionism. The MIT Press, Cambridge, 1988. Blinder, A.lan S.: Hard Heads, Soft Hearts - Tough-Minded Economics for a Just Society. Addison-Wesley Publishing Company, Inc., Massachusetts, 1987.

Economic Planning Agency: Economic Survey of Japan 1987-1988. Printing Bureau of Ministry of Finance, Tokyo, 1988. Ditto: Economic Survey of Japan 1988-1989 (in Japanese). Printing Bureau of Ministry of Finance, Tokyo, 1989. Gordon, Donaldo D.: Japanese Management in America and Britain, Revelation or Requiem for Western Industrial Democracy? Avebury, Aldershot, 1988.

Institut for Posts and Telecommunications: EC Unification by 1992 and the World Economy. Monthly Report, No. 4, Feb. 1989. The Japan Economic Journal: Japan Economic Almanac 1989. The Japan Economic Journal, Inc., 1989.

Impacts EC SingleMarketon the Japanese Economy

19

JETRO: The Market Integration within the EC by 1992. (in Japanese) Overseas Investigation Series No. 286. JETRO, Tokyo, 1989.

Kishimoto, Shinlaro and Fujiwara,Toyoji: Handbook on EC 1992 (in Japanese). Toyokeizai-shinposha, Tokyo, 1989. Kubo, Hiromasa: Comprehensive View on EC Market Integration (in Japanese). Japan Economic Journal, Inc., Tokyo, 1989. The Long-Term Credit Bank of Japan: EC Unification- Strategies of EC to Japan and Adjustments of Japanese Enterprises to Them (in Japanese). Monthly Report No. 250, June 1989. Ministry of International Trade and Industry: Annual Report of International Trade and Industry (in Japanese). Printing Bureau of Ministry of Finance, Tokyo, 1989. The Tokai Bank: A Survey on EC Unification (in Japanese). Monthly Report No. 492, July 1988.

Japanese Direct Investment in the United States and Related Problems, with Special Reference to Automobile Industry Yoshinobu Sato

1. Introduction The circumstances surrounding the Japanese company have changed considerably during the period of the Yen appreciation. During the slum~ of 1986-87, brought about by the sharp appreciation and the deindustrialization, a large number of the orders of domestic goods decreased. The deindustrialization can be recognized in a broad sense that the transformation of economic structure may happen due to the development of the services industry, making employment shift to the tertiary industry. However, the recent Japanese economy has been growing at a steady pace since 1988. This implies that domestic consumption expenditure has increased steadily to offset the effect of the high Yen on the foreign demand. Generally speaking, deindustrialization presupposes that the negative impact of the strong Yen and the foreign direct investment on employment and profitability will occur. This notion of deindustrialization may one day take place in the Japanese automobile industry. Thus this paper begins with a survey of J apanese car makers' foreign direct investment in the U.S.A.

22

Yoshinobu Sato

2. The condition of local production in the U.S.A. The recent Yen appreciation has given great impetus to the tendency toward car makers' or parts manufacturers' local production abroad. Bothof them are now continuing to make strong inroads into the U.S. market. Here, we will consider several problems conceming local production in the U.S. such as (1) aims, (2) ways of moving out, (3) production capacity and (4) location conditions.

2.1. Aims The greatest of aims is to expand the market share by substituting local production for export. An expansion of sales to make profit in the U.S. market, against a decline in export sales at the Ievel of the strong Yen, has required overseas manufacturing Operations. The operation of enlarged plants were started up to provide competitive products for the U.S. customers from the U.S. production bases, and to increase the reimport of cars to Japan or third countries in case the Yen should even higher (for instance 130 Yen). Therefore, the notion of moving into the U. S. emphasizes the development from local production to globalization.

2.2. Ways ofmoving out The pattern of moving out can be said to have two types of entry: solo entry and joint venture. In 1987 were seven Japanese local production bases in the U.S., namely four solo entries, two joint ventures with the Big Three, and a combined Japanese entry. In the case of solo entries, Japanese local subsidiaries hold the share of over 80% in equity, so as to fasten localization of capital and restoration of profit. In case of joint ventures, the equity ratio for ownership is fifty-fifty for both participants. The merit of these operations is weil recognized, for the J apanese partner expects to get sales channels, sales power and

Japanese Direct Investment in the USA

23

know-how in purchasing power for materials and parts and the American partner is keen to obtain the adequate know-how of production, technology and management. In all the typical behavioral pattern of J apanese overseas manufacturing operations seems to be to move out and enlarge local production step by step, for the purpose of supplying diverse motor vehicles, such as motor bicycles, passenger cars, trucks, in addition to solving marketing and supply problems. 2.3. Production capacity

Having started local production, J apanese car makers have been expanding their production capacity more and more since 1986. By 1990 Japanese car makers will have installed capacity to produce up to 2.45 million vehicles a year in North America, inclusive of Canada. The production capacity of Japanese car makers in the U.S. will reach annually 2.1 million units by 1990, and the annual production capacity in Canada will total at least 330,000 units. With regard to the demand cycle, it can be said that the number of cars demanded in the U. S. has varied from 11 million units at the peak to 8 million units in the trough. Furthermore, as it is predicted that total car sales in the U.S., including import and local production, will reach around 11 million units by 1991, Japanese car makers' supply of imports under voluntary restraint (2.3 million units) and local production must amount to an estimated 4.3 million units or nearly 40 percent of the total sales in the market by 1991. Thus, in the near future, the U.S. market will probably be in an excess supply situation, in which competition would be very hard. However, according to an optimistic view, the tendency for providing American consumers with the more competitive products by active local operations may afford a good opportunity to enlarge Japanese car makers' sales, with the responsibility that the Big Three's car sales or production capacity, and Korean car sales may be reduced through a phase of supply-demand adjustment. In short, in the l990s, it is possible that the American brand cars made in U.S. plants of Japanese car makers will enjoy nearly 30% of

24

Yoshinobu Sato

the U.S. market share. Whereas, needless to say, the U.S. car market cannot possibly absorb all increases in Japanese car supply including imports from Japan, and the competition in the U.S. market will be expected to become fierce. 2.4. Condition of location The overseas location of Japanese car makers originally was concentrated in the Califomia area. The location of production bases was then decentralized over states, especially to the middle part of the U.S., due to a drastic switch to local production as an international policy. In addition, Japanese car makers possibly will build up some corporate group together with Japanese parts suppliers moving into the U.S., especially with subsidiaries and affiliates. The number of J apanese parts suppliers having already moved into the U.S. is now above 140 according to my research. Of course, the corporate groups made up of these suppliers usually center around the production base of each car maker. Next, it should be noted that the conditions have much to do with the success of moving out. So far the following several important points are commonly accepted as favorable conditions of location: (1) to have a good access to convenient transportation, (2) to purchase materials and parts easily, (3) to hire plentiful skilled workers, (4) to be located in comfortable natural circumstances, (5) to have non-union workers and so on. Thus most of these points have been regarded main reasons for moving out, as already noted.

3. A full scale of foreign direct investment - the problern of the high Yen Japanese car makers have expanded their production capacities, such as production of engines, lines of production. high grade cars and reimport of cars and so on. In any case of expansion, it is found that this type of investment is to take the way to serve the U .S. market through local operations, brought about by the sharp rise of the Yen. In fact, when focusing on Japanese car makers' foreign direct investment in North America, that the total investment by Japanese car makers in

Japanese Direct Investment in the USA

25

North America will likely top $5.4 billion by 1990, including S4.6 billion in the U.S .. And employment will reach about 28,000 employees, including 23,000 in the U.S. Especially, the amount of investments for expanding new local production seem tobe considerably affected by the sharp appreciation of the Yen. But these figures do not include the investment in related parts plants, such as Honda's engine factory, Toyota's aluminum wheels factory (in Canada). According to our observations, there is a great difference in the extent of overseas production operations, in the sense that the ratio of overseas production to domestic production was at the extremely low Ievel of 4% in Japan, compared with 20% of advanced countries such as the U.S .. Over the long term the difference between Japan and advanced countfies will become smaller, because it is to expect that the overseas production's ratio will rise to about 8.2% in 1992-1993, according to the annual report of MITI. On the other band, the trend towards the localization of production can be often said to show up more clearly in the field of assembly and processing. It is also found that the overseas production ratio will rise to nearly 16.5% in 1993. Thus Japanese car makers' overseas production would be marked by the rising ratio, so as to come up to the ratio of advanced countries. Consequently, Japanese car makers must be striving to attain the full scale of local production or the localization of production through expanding and integrating their worldwide activities. At present Japanese car makers seem tobe considerably affected by the Yen appreciation. This implies that car makers' current profits fell, as a result of the loss generated by the Yen appreciation, and price competitiveness decreased in the U. S. market because of the increase in export prices. Depending on the Ievel of the Yen's value, most of the producer's prices for automobiles must apparently reach an equilibrium between the U.S. and Japan around the Ievel of 140 Yen, though with possible exceptions. First, in the case of 130 Yen against the U.S. dollar, Japanese cars can be observed to be weakly price competitive because the rate of increase in dollar prices of Japanese cars exceeds that ofU.S. cars. Of

26

Yoshinobu Sato

course, at this Ievel of the Yen, the merit of reimportation of cars will come out to the full on account of the avoidance of trade friction. For instance, Honda and Mazda reimported about 5000-6000 units from the U.S. in 1988. However, it has often been said that J apanese car exports to the U .S. are not affected by price increases resulting from the Yen appreciation, but by the local production. Thus, the importance of the full scale of local production as weil as the Yen appreciation can be easily recognized. Second, in an extreme case, J apanese car makers cannot be sufficiently price competitive at about 120 Yen Ievel. This implies that car makers must carry forward the localization of Operations more actively, together with Japanese parts manufacturers. After all, in any case, it is found that a full scale of local production can be directly affected by the Yen appreciation. 4. Effect on domestic employment The decrease in domestic production, brought about by full scale local production, appears to be deindustrialization phenomenon in a narrow sense. This movement indicates that the decrease in car exports to the U.S. must be inevitable. Here, Iet us suppose that the domestic deindustrialization will appear if exports from Japan decrease, on the presumption that (1) domestic automobile production will remain unchanged, (2) local production by Japanese car makers will increase as planned, and (3) local production can substitute for previous exports. Upon this, we will discuss the results predicted concerning the effect of J apanese local production on domestic employment. First, according to Toyota's provisional estimates, when Japanese car exports (average price of Yen 1.5 million) decrease by 1.2 million units, which means 70% ofpassenger cars (1.59 million units) to the U.S. in 1990, and 10% of Japanese car production of about 12 million units, the overall job opportunities in Japan will decrease by 130,000 employees, which are 18% of the present Ievel of employment in the car industry. That is, these remarkable decreases can be said todepress real GNP by

Japanese Direct Investment in the USA

27

1%. Therefore, once this evidence is observed, an important feature of deindustrialization stands out: the remarkable decreased in car exports will have a direct effect and rippling effect throughout the economy, for instance on domestic employment. Next, according to a certain Japanese analyst's prediction, when allowance is made for the decrease in motor vehicle production by 2 million units, which are about 80% of the supply to North America in 1990, the employment of the auto industry will decrease by 80,000 employees and, in addition, the employment of domestic parts and automotive related industries will decline approximately by 430,000 employees. Japanese automobile and related industries today employ just 10% of J apanese work force, and some 33 trillion Yen worth of motor vehicles were produced in 1988, which accounted for some 13% of the nation's total manufacturing output. Thus overseas production in the U .S. seems to make domestic employment particularly vulnerable to the effects of the high Yen. The active policy of foreign direct investment, such as for the avoidance of trade friction as weil as the recovery of competitive power, would decrease the exports to the U.S. and the domestic employment of Japan. In other words, automobiles in particular are viewed as an important source of employment. It follows that domestic employment is influenced by local production. The employment opportunities in the home country will decrease as much as overseas employment increases, together with the slow growth of domestic economy, where car makers' local production can gain an advantage over Operations in the home country from the viewpoint of comparative costs. In the above observations, the theory of deindustrialization in a narrow senseisstill preliminary and remains tobe reconsidered.

S. Conclusion This survey reveals two phases of local production in the U.S. and the effect of foreign direct investment on domestic employment, with special reference to the Japanese automobile industry. Firstly, it is

28

Yoshinobu Sato

necessary to consider several conditions conceming local production, namely, the typical pattem of overseas operations required to expand the production capacity. The important features for the success of local production were made apparent. Secondly, we tried to discuss a full scale of foreign direct investment, brought about by the Yen appreciation. As some Japanese papers indicated, the overseas production ratio has a tendency to rise, but is still low, compared ·with the advanced countries. The effective exchangerate of the Yen against the U.S. dollar could be around 130 Yen, in which the merit of reimport of cars would come out to the full for J apanese car makers in the U.S. Thirdly, some insight was provided on the effects of local production on domestic employment. The results discussed above suggested to some extent the possibility of domestic deindustrialization in a narrow sense. In addition, according to our survey, it is found that the localization of money, person and production is actively practiced through the expansion of local production. Finally, as stated above, the automobile industry, in particular, is viewed as an important source of employment in the domestic or foreign country. Thus, the main topics, such as the U.S . -Japan comparative analysis of deindustrialization from the positive point of view, remain unsolved. *Most of the underlying ideas and sources of this paper are partly based on interviews (with 5 car makers), and partly on materials (NOMURA Analyst Paper, the Long-term Credit Bank of Japan's Paper, Japan Automobile Manufacturers Association, etc.).

The Changing Pattern of International Specialization and Economic lnterdependence among Asia-Pacific, the US and EC Economies Soshichi Kinoshita Jiro Nemoto 1

1. lntroduction

Over the last three decades, the world economy has strengthened the economic interdependence among countries or regions. The most obvious index to measure the strength of interdependence is the elasticity of world trade with respect to world income or production. As is shown in Table 1, the long-run elasticity of the world's real exports of manufactured goods with respect to the world's real GDP is larger than one, and ranges from 1.8 to 2.0, depending on the selected sample period. The highest value of 2.01 for the 1963-1973 period seems to reflect the trade expansion encouraged by the formation of European Economic Community. In the process of strengthening interdependence among countries, the changes in the overall trade position of individual countries have been accompanied by shifts in their comparative advantage. Since the mid1970s, US trade performance has continued to deteriorate in terms of the trade account balance and export share in comparison with the world economy. On the other band, Japan outperformed the major industrial countries in terms of export growth and current account balance. 1 We would like to thank participants of the Nagoya-Freiburg Joint Seminar in October 1989 for comments and suggestions. We would also like to thank Wemer Pascha for useful comments and Mitsuo Yamada for assistance in compiling the trade data used in this study.

30

Soshichi Kinoshita/Jiro Nemoto

Table 1: The Elasticity of World Export Volume with Respect to World Real GDP Sampie period

World real GDP

Long-run elasticity

GDP

GDP 1

GDP 2

1952-62

1.026 (2.52)

0.553 (1.30)

0.292 (0.77)

1.87

1963-73

2.478 (3.05)

-0.088 (-0.11)

-0.383 (-0.44)

2.01

1974-85

1.805 (3.47)

-0.164 (-0.22)

0.172 (0.38)

1.81

a:

b: c:

a log-linear relation is assumed between world exports of manufactured goods and world's GDP. t-statistics are shown in parentheses. data source is International Trade 85-86, GATT.

Also, the Asian region covering Asian NIEs and ASEAN has successfully adopted the export-led growth policy and increased their export share significantly when looked at from a collective view. As a consequence of these changes in the world trade structure, a lot of bilateral trade frictions occurred, often resulting in the serious economic issues which could only be resolved by the micro- and macroeconomic efforts of both countries. The purpose of this paper is two-fold in nature. The first is to examine the sectoral changes in the export share and comparative advantage to provide a background for assessing trade conflict problems. The second is to analyze quantitatively the interdependences between Japan, the US, the EC and Asian industrializing countries. A smalllink model will be used for this purpose2 •

2 The model we use in this paper is a crude one for an empirical study on the likely results of 1992 in the European community. A further analysis using a large-scale world trade and industry model is due in the near future. See Kinoshila and Yamada (1989).

Changing Pattern of International Specialization

31

2. Changing patterns of international specialization In this section, the shifts of comparative advantage of major countdes or regions are examined at the two-digit industry classification Ievel. The indices used are the export shares in the world market and the index of revealed comparative advantage constructed by Bela Balassa. The latter index is defined as a ratio of a country' s share in the exports of a particular commodity category to the country's total merchandize exports, which is written as follows: XRCAik =(Xikll:Xik)/(1: Xik/ 1: I: Xik) where X stands for exports, and subscripts i and k refer to the country and commodity (industry), respectively. A value of XRCA greater than one for a particular industry is interpreted as reflecting a comparative advantage in that industry. Likewise, a value less than one implies a camparalive disadvantage3 • The data for these indices are given by the WIT-DATA BASE developed for our world industry and trade modeling. It supplies exports and imports series both in real and nominal terms for the 1970-1984 period. The classification or aggregation of country and industry are made as follows: (1) Country grouping Japan, the US, Korea EC4 (France, West Germany, Italy and UK) Asian NIEs (Taiwan and Hong Kong) ASEAN (lndonesia, Malaysia, Philippines, Singapore and Thailand) ODC (rest of OECD countries) ROW (rest of the world) (2) Industry classification AG: Agriculture MI: Mining. FD: Food and beverage 3 As is clearly stated in BakJSsa (1965), revealed comparativeadvantagereflects not only cost differences but also the level of technology and other non-price factors. A careful discussion should be made in evaluating the observed variations of this index as a relative competitive indicator.

Soshichi Kinoshita/Jiro Nemoto

32

TX: AP: LT: WD: PP: RB: CH: PC: CR: IS: NF: MT: GM: EM: TE: PI: MM: AL:

Textiles Apparels Leather products Wood and furniture Pulp and paper Rubber products Chemieals Petroleum and coal Non-metallic minerat products Iron and steel Non-ferrous metal Fabricated metals General machinery Electrical machinery Transportation equipment Precision instrument Miscellaneous manufacturing All industries

2.1. Share of expons Beginning with the case of Japan, in 1970, the top five industries were occupied by a combination of two light industries (textiles and apparels) and three metal-machinery industries (iron-steel, transportation equipment and precious instruments). After 1980, generat and electrical machinery industries surpassed textiles and apparels, and joined the top five group. With regard to the changing patterns of export share, a significant growing trend was observed in the five industries, that is, rubber products, iron and steel, generat machinery, electrical machinery and transportation equipment, while four industries in the light industry show a declining trend. In the US, no change occured in the composition of the top five industries. The top five consist of agriculture, chemicals, generat machinery, transportation equipment and precious instruments. However, contrary to Japan, the US was losing its export share in the wood and furniture, paper and printing, metal products and machinery industries.

Changing Pattern of International Specialization

33

The EC4 showed the larger shares as compared to Japan and the US in the world market. More than half of the industries have maintain over a 30 % share. This may reflect the cornparatively high trade dependency within the EC region. The top five in 1970 were leather products, nonmetallic mineral products, fabricated metal, general machinery and transportation equipment. In 1984, chemieals ranks among the top five in place of transportation equipment. The decline in the export share is conspicuous in the following six industries: textiles, leather products, petroleuro and coal, general machinery, electricals and transportation equipment. On the other band, the rising share of exports could be seen in mining, food products, wood and furniture, paper and printings and non-ferrous metals. These uneven changes in the export share in the developed countries have been brought about partly by the shifts in their comparative advantage within the developed countries themselves, and partly by the export-oriented industrialization in the Asian industrializing countries or economies such as NIEs and ASEAN.

2.2. Comparative advantage and disadvantage Export share by industry is clearly one aspect of the competitive structure of the individual economies. Revealed comparative advantage takes into account the sectoral cornposition of world exports as weil as that of individual economies. Between 1970 and 1984, Japan lost comparative advantages in the labor-intensive industries, such as textiles, apparels, leather products, non-metallic mineral products and miscellaneous manufacturing. Rubber products and generat machinery have turned into a comparative advantage. Among the industries with a comparative advantage, electrical machinery has strengthened further its comparative advantage, but the competitive position of the iron and steel industry has dropped steadily since 1974. This is due to the introduction of voluntary export restraints in the US and EC markets. The US has kept a comparative advantage in agriculture, chemieals and four machinery industries over the whole period. Transportation equipment, though maintaining a comparative advantage, became less competitive after the first oil crisis. The EC4 shows comparative 3 Matsugi/Oberhauser

34

Soshichi Kinoshita/Jiro Nemoto

advantage in twelve industries in 1984. Rubber products joined the comparative advantage sector, while electric moved to a comparative disadvantage one. The decrease in the share of EC4 exports is explained by the downward trend in the revealed comparative advantage index in the major sectors. Korea, a NIEs member, bad in 1970 a comparative advantage in the unskilled labor-intensive sectors such as food products, textiles, apparels, leather products, wood-furniture, fabricated metals and miscellaneous manufacturing. In 1984, foods, wood-furniture and miscellaneous manufacturing lost their comparative advantage, and the following four sectors moved into the comparative advantage sectors: ruhher products, iron and steel, electricals and transportation equipment (ship building). The remaining Asian NIEs such as Taiwan and Hong Kong followed roughly the same pattern as Korea, and successfully gained a competitive position in some heavy industries. The difference is that Korea has a comparative advantage in iron and steel and ship building, a physical capital-intensive sector, while Taiwan and Hong Kong have specialized in electricals and precious instrument, a skilled laborintensive industry. Comparative advantage in ASEAN is seen mostly in the natural resource-intensive industries, such as agriculture, mining, food products, wood and wooden products, ruhher, petroleum and non-ferrous metal products. In 1984, however, electricals and miscellaneous manufacturing moved into the comparative advantage sector. These changes in the export structure will be contrasted with the favorable results of the export-oriented industrialization process. 2.3. A product life-cycle pattern of comparative advantage

The shifts in the comparative advantage in the individual countdes and region are closely related to the process of economic development and industrialization. The coefficient of revealed comparative advantage in selected industries for four distinct years is plotted by country or region in accordance with its Ievel of industrialization. Among the countdes and regions examined, the ASEAN economy as a whole is at

Changing Pattern of International Specialization

35

the lowest Ievel of industrialization, and the US ranks at the top of the industrialized countries. lt is apparent that the advanced industria-lized countries with a comparative advantage in a certain branch of an industry tend to lose their competitive edge during the course of development, and as a result, newly industrialized countries take over the comparative advantage in the same industry. Then, various factors will cut their comparative edge gradually, shifting the comparative advantage to the next industrializing countries. These changing pattems of comparative advantage across a country can be explained in the framework of the product life-cycle theory4 •

In the case of textiles, a labor-intensive and low-technology sector, the most competitive area is Asian NIEs, followed by Japan and EC4 whose competitiveness decrease sharply over the period. The US has already lost competitiveness in this sector. By way of contrast, ASEAN's competitiveness rises significantly in an effort to catch up with Asian NIEs. Almost the same tendency was seen in wood and wooden products. In 1984 ASEAN ranked top in comparative advantage, while Korea saw a shift from comparative advantage to comparative disadvantage. Also Taiwan and Hong Kong, though having it as a comparative advantage sector, lost competitiveness. Competitiveness in the developed countries has been quite low since 1970, and the most drastic changewas seen in the case of Japan. Comparative advantage in the heavy-goods industry depicts a different picture. First, in chemieals and generat machinery, the US or EC4 ranks top in comparative advantage and maintains its competitiveness throughout the whole period. Meanwhile, Japan succeeded in catching up with Western countries, which began to lose competitiveness against Japan. A huge gap exists in the competitiveness between the developed and developing countries such as Asian NIEs and ASEAN. 4 Vernon's product cycle theory is basically concerned with the shift of site located in the innovating country. From the standpoint of developi..g countries, it may be more appropriate to refer to the "flying-geese" theory of economic development or "catchingup product cycle" theory. See Vernon (1966) and Yamazawa (1984).

36

Soshichi Kinoshita/Jiro Nemoto

Apart from the above two sectors, Asian NIEs gained a competitive edge in such industries as iron and steel, electricals and transportation equipment like shipbuilding. Korea increased her comparative advantage in steel, especially since 1980. The US was affected adversely and lost its comparative advantage. A comparatively weak competitiveness in Taiwan was the result of her industrialization process which laid importance on the skilled labor-intensive industry such as consumer electronics and precious instruments. Comparative advantage across countries in electricals are changing over the whole period. Between 1970 and 1984, Korea and ASEAN made remarkable progress in competitiveness. In 1984, a "geese-flying" pattern named after the late Dr. Akamatsu was clearly seen in the Asian four countries or regions including Japan. Both the US and EC4 lost competitiveness and showed a comparative disadvantage in 1984. Korea's sharp increase in comparative advantage in transportation equipment reflects the development of shipbuilding in this country. Within the developed countries, Japan ranks top in transportation equipment, followed by the US and EC4 both experiencing a declining comparitive advantage.

3. Modeling the interdependence through trade among countries The global shift in the pattern of international specialization examined above affects the economic performance of individual economies in various ways. The most direct channel is through exports and imports. In this section, an attempt will be made to model the economic interdependence among major countries through trade. In the first step, a small macro-model is constructed for the following countries and regions: JP (Japan), US (USA), EC (EEC12), CA (Canada), AN (Asian NIEs), AS (ASEAN). These national or regional models are then linked together with each other using the trade linkage relation.

Changing Pattern of International Specialization

37

A prototype of the national model is specified as follows, Yi = Ci

+ Zi + Ei - Mi

Ci

= C (Yi, pidot, Ci_l)

Mi

= M (Yi, pmi/pyi)

Ei= E (EGi) EGi = EG (XEi, EXUS t) where Yi = real GNP (GDP), Ci = real personal consumption, Mi = real imports of goods and service, Ei = real export of goods and service, EGi = real export of goods, XEi = fixed-weight export demand factor, Zi = exogenaus final demands, pmi = import price, pyi = GNP deflator, pidot = pyi/pyi_l, EXUS = real effective exchange rate of the US dollar. A linkage of national models is made with the following relation between exports and imports, XEi = L aij *Mj (i, j = fom Japan to Rest of the World) where country i 's export demand variable is given by a function of trade partners' imports, and a weight, aij is the market share of country i's exports in country j's imports in the base year. Table 2 shows the estimated coefficients of aij in 1987. It is seen in this table that US import demand is allocated almost evenly among five regions, that is, Japan, the EC, Canada, Asian industrializing region (3 Asian NIEs plus 5 ASEAN countries) and the rest of the world. The larger share of ROW in the case of Japan is due to the crude oil imports from Middle East region. EC12, as a whole, depends heavily on the intra-regional trade, absorbing 60 % of total import demands from member countries. Eight Asian countries depend highly on Japan in the supply of manufactured products as compared with dependency on the

us.

5 Exogenous final demand consists of private capital formation and government expenditure.

38

Soshichi Kinoshita/Jiro Nemoto

Table 2: Trade Share Matrix aij: 1987

~ us

JP

EC CA

AN

AS

ROW

us

JP

EC

CA

AN

AS

-

0.21

0.07 0.04 0.61 0.08 0.03 0.01 0.24

0.68 0.06 0. 12

0.18 0.30 0.12 0.02 0.07 0.07 0.24

0.14 0.22 0.14 0.01 0.10 0.18 0.21

0.21 0.20 0.18 0.12 0.04 0.24

-

0.12 0.04 0.12 0.12 0.40

-

0.05 0.01 0.08

A prototype model is fitted to the annual data for the period from 1975 to 1986. With the estimated national models linked together, two types of simulations are made to quantify the interdependence among the EC and Asian-Pacific economies. Theseare fiscal expansion and import promotion. Fiscal expansion is the autonomous increase in real government expenditure. To standardize the simulation, real government expenditure is increased by 1 % of real GNP and sustained over the whole period. Import promotion is the additional expansion of EC imports in the order of 1 % of the total imports. This simulation is made to examine the positive impacts which the EC may have as a single market after 1992. First, the US impact on GNP (% deviation from the baseline) have the largest effects on trading partner countries, as compared with the EC and Japan. The largest is on Asian NIEs, and the smallest is on the EC. The US impact on Japan are twice as large as that on the EC. This is due to the fact that Japan's exports to the US amount to more than one third of the total, and that the export dependency on the US is higher in Japan than in the EC. Canada is heavily affected by the US expansion as is to be expected. Second, the EC fiscal expansion also affects its trading partners greatly in terms of the GNP multiplier, its size being comparable to that of the US . The EC impact on US GNP are of the same order as the US

Changing Pattern of International Specialization

39

impact on EC GNP. As is the case for US fiscal expansion, Japan is more shocked by the larger impact from the EC than from the US. Third, Japan's fiscal expansion bad a minor impact on the trade partners as far as the estimated models are concemed. This may be explained by the inelastic behavior of Japan's imports with respect to GNP growth. Another factor responsible for the smaller impacts is the small share of exports in the final demand total. Comparing the impacts of respective fiscal expansion on Asian NIEs, the US and the EC show a quite large GNP multiplier, while Japan's impacts are respectively less than one-third of them. ludging from the simulation results, ASEAN economies are not so sensitive to the disturbances in the developed countries as is the case for Asian NIEs. Again the impacts of Japan on Asian economies are smaller than those of the US and the EC, partly reflecting the difference in the size of the respective domestic markets. It is an interesting exercise to simulate the impacts on the world economy of the US federal budget cut to eliminate the fiscal deficit. Simulation was made on the condition that the US cut government expenditure by 1 % of GNP, while both Japan and the EC increased government expenditure by 1 % of their GNP. respectively. The results are: US negative impacts on the Asian economies are offset by the positive effects of both Japan and the EC. This implies that a policy coordination is indispensable among the US, Japan and the EC to resolve the US twin deficits with a minimum shock. Import promotion in the EC has a favorable impact on trade partner countries, especially on Asian NIEs and ASEA~. An additional 1 % increase of EC imports will increase GDP growth in these regions by 0.1-0.2 %. The impacts on the US and Japanare positive, but the own economy is affected negatively in spite of the growth of intra-regional trade. This is because of the leakage of the region's import demand to the outside regions, such as Japan, the US and Asian countries.

6 To quantitatively evaluate the long-run effects of 1992 in the EC, even a small model needs to take account of the supply side mechanism as weil as the demand side one.

40

Soshichi Kinoshita/Jiro Nemoto

4. Concluding remarks It is often stated that the Japanese economy has made significant structural changes since the PLAZA Agreement on the exchange rate and others in 1985. Since then, the Japanese economy has followed a growth path which depends mostly on the domestic demand. Japan's import elasticity with respect to GNP seems to have increased up to over one, and her imports from the Asian economies are on an increasing trend. The study in this paper does not tak:e into account these changes occurring in Japan and trade partner countries, mostly because of data availability. A further study must be made to model the relation between trade position and economic performancenot only at the macro Ievel but also at the sectoral one.

References Balassa, Bela, Trade Liberalization and Revealed Comparative Advantage, in: The Manchester School of Economic and Social Studies, May 1965 Kinoshita, Soshichi and Mitsuo Yamada, The Impacts of Robotization on Macro and Sectoral Economies Within a World Econometric Model, in: Technological Forecasting and Social Change, Vol. 35, No. 2-3, 1989 Vernon, Richard, International Investment and International Trade in the Product Cycle, in: Quarterly Journal of Economics, May 1966 Yamazawa, lppei, Japan's Economic Development and International Division of Labor (in Japanese), Tokyo (Toyokeizai) 1984

On the lntricacies of Specialization and lnterdependence - A Comment on S. Kinoshita's and J. Nemoto's PaperWerner Pascha

First of all, I have to apologize: I am no econometrician or quantitative economist. So I am not in a position to fully appreciate all the effort and expertise which was used to undertake the study of Kinoshita and Nemoto. In this comment, I will rather try to draw attention to some of the wider meanings of the study, not to the technical characteristics of the models employed or to the data base used. The Kinoshita/Nemoto-paper is divided into two parts- one dealing with international specialization and discussing comparative advantages, the other tracing international interdependence; moreover, there is a short introduction. I will divide my comments accordingly. In the introduction, Kinoshita and Nemoto speak of "the process of strengthening interdependence among countries" (p. 29). If one wants to analyse this process, one should be aware of the complexities involved. For instance, strengthening interdependence is not a secular process valid for all times and places. In the early decades of this century, interdependence as measured by the ratio of external trade to domestic product actually decreased for most leading industrialized nations. Consequently, increasing interdependence is no "eternallaw" which can be assumed as self-evident. If one analyses interdependence in a given regional setting, for instance, one cannot neglect the underlying factors (technological change, organisational change, etc.), which finally lead to a certain level or dynamics of interdependence. Moreover, interdependence is complex in that it not only relates to trade, but also to other international economic activities like direct

42

Werner Pascha

foreign investment, joint ventures, licensing agreements, etc. As is weil known, these other forms of activities have recently increased in importance, also with respect to Pacific-Asia. The success of John Dunning's eclectic theory of international economic activities (e.g., Dunning 1979) is due to the fact that trade and foreign investment, to mention but the two, in today's world can only be understood if seen as substitutes and/or complements of each other. Of course, I am weil aware of the difficulties of taking these aspects into account in a quantitative study. Internationally comparable data on direct foreign investment, for instance, is not easily obtainable. This is a very serious gap in the reporting of international statistics by the UN organisations or OECD. It would be extremely helpful, ifPacific cooperation schemes like PECC (Pacific Economic Cooperation Conference) could help to close this gap. However, this aspect cannot be elaborated upon here. Still, one should ask oneself what quantitative studies restricted to trade figures can really teil about the actual process of changing interdependence among Asian-Pacific, the US and the EC economies. A "qualitative" chapter on how other dimensions of interdependence influence the image of the whole process one subscribes to may prove helpful. Turning to the chapter on "changing patterns of international specialization", I find this part most interesting. The different competitiveness of countdes in several branches seems to correspond well with their Ievel of industrial development (ASEAN - Korea - NIEs -Japan- EC 4- USA). As the authors suggest (pp. 34-36), this seems to support the hypotheses of the "flying-geese" theory of industrial development or, to use a different name, the "catching-up product cycle (CPC)" theory 1• This approach is not weil known yet in the West. Usually, I have to defend myself against doubts when discussing evidence in terms of the CPC (e.g., Pascha 1987). This time, I am in the happy position to speil out myself some of the issues which need further scrutiny. A clarification of matters is important to develop the CPC further and to adequately determine its importance in international economics. Let me concentrate on three topics. (1) What does the CPC explain that Balassa's (dynamic) stage theory of comparative advantages (Balassa 1981) is not able to explain? To put 1

Forasummary of this approach see Yamazawa 1984.

Intricacies of Specialization and Interdependence

43

it differently: What is the excess empirical (and/or) theoretical content of the CPC in comparison to competing theories of the so-called "new orthodoxy"? As is weil known, Balassa explains changing comparative advantages through changes in factor endowment, particularly through the increasing availability of capital (and technological capability), which changes the relative factor prices and the comparative advantage structure in favor of capital- and technology-intensive production. Of course, such a simple dynamic stage theory is not able to explain all changes, particularly if one moves down the industrial classification scheme to narrowly defined industries with similar factor endowment and yet totally different competitiveness indices. Still, does the CPC fare much better? Already on the Ievel of distinguishing industries in the Kinoshita/Nemoto-paper, one finds, for instance, that ASEAN has a slightly more "advanced" timepath of competitiveness in generat machinery industry than Korea. I find this hard to explain in terrns of the simple CPC approach. (2) To what extent does the CPC offer a competing explanation of industrial change, which offers truly new insights into the dynamics of industrial change as compared to the "new orthodoxy"? In the Kinoshita/Nemoto-paper, the CPC is (legitimately) utilized as a helpful means to describe complex historical changes, but its explanatory capacity is not treated in as much detail (p. 35). This may be symptomatic for much of the work on the CPC. Tobe honest, I have some conjectures of my own on the explanatory power of the CPC, which lean heavily on the tradition of political economy; this is not the place to discuss this further, though. Still, I am very curious as to what eminent quantitative economists like Kinoshita and bis associates think on this matter. (3) If one thus considers the aspect of explanation or causation, one would also have to ask what is actually measured as the effect-variable. Kinoshita/Nemoto use Balassa's RCA to measure comparative advantage. This is widely done and acceptable. Still, one should consider it carefully, because it has a considerable impact on the conclusions drawn from the study. The RCA is an ex-post measure of the actual trade performance. Thus it measures "revealed specialization" rather than "revealed comparative advantage". It is quite open, what actually causes a certain pattern of specialization, whether it is trade policy, industrial policy in a wider sense, the "autonomous" competitive power of the private sector or something eise - or a combination of all

Wemer Pascha

44

of these factors. This has important repercussions for the utilization of the CPC . .ifthe CPC is distinctly helpful to describe Pacific-Asian timepatterns of industrial competitiveness better than with more conventional approaches, than this may not (only) be due to the relative competitiveness of the national private sectors, but to government policy. To put it even more strongly: if the CPC is particularly appropriate to the case of Japan, then this may be due to the specific mix of private entrepreneurship and government policy found in this country. As a simple consequence, this implies that international specialization among Asian-Pacific, the US and the EC economies can hardly be dealt with without reference to government policies. On a more encompassing and political Ievel, one would have to ask whether the CPC, which is currently used to develop a theoretical basis for economic cooperation in the Pacific Basin, is truly compatible with a "free trade philosophy", to which the PECC, for instance, still subscribes2 • However, this is a subject which goes well beyond what Kinoshita and Nemoto try to do in their paper. Let me close with three remarks on the chapter on "interdependence through trade among countdes". This part contains a small macroeconomic model, which proves helpful in discussing a couple of topical policy issues. (1) The national models and their linkage employ a rather short-term perspective, with income and its components as the crucial variables. This contrasts with the chapter on specialization, which takes a Iongerterm Iook at changes in competitiveness. The authors seem to be well aware of this, as they use the macro model to simulate rather short-term effects of import promotion and fiscal expansion. Still, it may be important to underline this difference in the two parts, because it may have important consequences. For instance, from a theoretical perspective it is interesting to note that the Ionger-term perspective intrinsically encompasses a sectoral analysis, whereas the short-term model does not (although the authors mention that this may be an important addition- p. 40). I fully agree that for long- term analysis a sectoral approach is crucially important - this follows immediately from a CPC point of view. It may be even more important for long-term than for short-term analysis, although this may overstress the point. 2

For the state of this discussion, seeJapanNational Committee ... , 1988.

Intricacies of Specialization and Interdependence

45

However, such a Standpoint is not self-evident. Many economists may disagree, and it may be helpful for the authors of the paper to be even more outspoken on their position. (2) The distinction between short-term and long-term view is important in another respect. This is related to the general topic of the 12th Joint Seminar Nagoya/Freiburg: regional economic cooperation in the 1990s. I would argue that regional integration schemes have tobe analyzed with a long-term perspective in mind. Policy-makers are frequently interested in dynamic effects, which go well beyond the scope of short-term modelling. Unfortunately, short-term analysis is often the main content of scientific studies. This holds for the well-known Cecchini Report (Cecchini 1988) in the case of European integration. Would it be fair to argue that this also holds for quite a few J apanese studies on Pacific-Asian economic integration and that too much stress is frequently laid on rather short-term trade interdependencies and multiplier-effects? If there is some truth in this, the reason may be that such effects are easier to model quantitatively. The authors do not directly discuss this issue, but I wonder whether they would agree to a conjecture- perhaps somewhat overdone, for argument's sake- that an analysis of the long-term patterns of specialization is much more relevant to regional integration issues than models of economic interdependence. (3) Finally, I am very much impressed by the circumspectness of Kinoshita and Nemoto in discussing the simulation results of their macro model not only from the point of view of advanced countries, but also from the perspective of ASEAN and the Asian NIEs. I would like to draw attention to their conclusion that policy coordination among the leading nations is important to resolve the twin deficits of the USA with a minimum shock for other economies, including the (Asian) developing ones. Very often, when international economic policy coordination is discussed, this aspect is totally disregarded. This may be understandable for politicians, who have to serve their voters, but it should not be acceptable for scientists (as long as they work under no special consulting assignment). I am glad to note that Kinoshita and Nemoto have taken a very responsible viewpoint in discussing some of the most important topics in international economics of our time.

46

Werner Pascha

References Balassa, B.: The Newly Industrializing Countries in the World Economy, New York et al. (Pergamon Press) 1981 Cecchini, P.: The European Challenge 1992. The Benefits of a Single Market, Brussels (EC) 1988 Dunning, J.H.: Explaining Changing Patterns of International Production: In Defense of the Eclectic Theory, in: Oxford Bulletin of Economics and Statistics, vol. 41, no. 4, 1979, pp. 269-295 Japan National Committee for Pacific Economic Cooperation: Review on Pacific Cooperation Activities, Osaka 1988 Pascha, W.: On the contribution of phasing to the analysis of East Asian economic development, International Economic Conflict Discussion PaperNo. 32, Economic Research Center, Nagoya University, Nagoya/Japan, June 1987

Yamazawa, 1.: Nihon no keizai hatten to kokusai bungyo (Japan's economic development and international division of Iabor), Tokyo (Toyo Keizai) 1984

On two Ways or Recycling Japanese Trade Surplus Takashi Matsugi Alexander Bernhard

I. Japans's recent roreign direct investment 1. lntroduction

It is true that, according to the statistics, Japan today belongs to one of the riebest countries in the world. But there are those who point out just the opposite, based on other statistics. This wealth has been generated from the trade surplus from exporting high-technology products. It seems to be a way of collecting money, which could be called a sophisticated version of mercantilism, or a high-tech based mercantilism. It is widely argued that the accumulated money in Japan should be recycled to contribute to the economic development of the world. One type of expenditure is foreign direct investment which will be sketched in Part I; the other way type is official development aid which will be dealt with in Part II. 2. Export and economic development

Past experience shows that export plays a very important role in the economic development of a country. It depends on competitiveness in the world market, so that the country which is in a state to produce highly competitive commodities has good prospects of economic development. This statement can be applied to explain why a country that once prospered tend to decline.

48

Takashi MatsugilAlexander Bernhard

The author of "Britain in Decline" says that British decline can only be understood, andin some sense only perceived, when it is related to the world economy which Britain once dominated and to which it has remained chained long after its dominance had passed away. Table 1 and 2, made in an attempt to measure British decline, show productivity growth and shares in the value of world exports of manufactures. The position of the United Kingdom gives an interesting picture compared with that of the United States which followed the UK. Germany and Japan seem to be going the same way as the US. The oil shock of 1973 gave rise to changes in economic performance between Germany and Japan. The export structure of Japan has changed much and the share of processed goods has increased. This change can be measured in terms of the coefficient of structural change in trade as is shown in Table 3. The coefficients for both J apanese exports and imports are larger than those for West Germany. Further evidence is shown by the percentage of high-tech products' exports in total manufactures' exports. Here the percentage for Japan has been increasing at a higher rate than that of EC since 1975, particularly in 1980s. Thesefacts imply that Japanese manufactures are apt to adjust themselves to changing circumstances much faster than those in West Germany /EC.

Table 1: Phases of productivity growth (GDP per man-hour), 1870-1976 (annual average compound growth rates)

France Germany Italy Japan United States United Kingdom

1870-1913

1913-50

1950-76

1.8 1.9 1.2 1.8 2.1 1.1

1.7 1.2 1.8 1.4 2.5 1.5

4.9 5.8 5.3

1.5

2.3 2.8

Source: A. Maddison, "The Long Run Dynamics of Productivity Growth", in W. Beckermann (ed.), Slow Growth in Britain (Oxford University Press, 1979) p. 195

49

Recycling Japanese Trade Surplus

Table 2: Shares in tbe value of world exports of manufactures, 1899-1979 (percentages)

United Kingdom France Germany Japan United States

1899

1929

1937

1950

1960

1970

1977

1979

33.2

22.9

21.3

16.5 9.6 19.3 6.9

10.8 8.7 19.8 11.7

9.3 9.9 20.8 15.4

9.7 10.5 20.8 13.6

21.6

18.5

15.9

15.9

-

-

-

25.5 9.9 7.3 3.4

-

-

27.3

-

-

-

-

Source: London and Cambridge Economic Service, The British Economy, Key Statistics (London, 1970) and NIESR Quarterly Bulletin, Mai 1980

Table 3: Coefficients of Structural Change in Trade (1970-83) Japan

USA

West Germany

Export

50.8

37.7

27.1

Import

41.1

37.9

29.6

The coefficient of structural change in trade is defined as the sum of absolute values of difference between the share of export/import value in 1983 and that in 1970 calculated for manufacturing Source: MITI: Annual Report 1986

Note:

4 Matsugi/Oberhauser

50

Takashi Matsugi/Alexander Bernhard

3. Japan 's foreign direct investment in recent years The reason for direct investment abroad is in general to sell and produce more in foreign countries. However Japan's recent direct investment aims to mitigate trade conflicts to the extent that local production helps the recipient countries to create jobs more and to import goods less or in some cases to export goods more. Investments have accelerated since the J apanese Yen Started to be appreciated against US dollar at a tremendously high rate. The volumes in 1988 amounted to US$ 47 billion and were four times as large as those in 1985. The United States shares the largest and North America, Asia and the European Community are the three largest regions, of which shares are increasing above all in developed regions. Comparing J apanese foreign direct investments with those of West Germany, one observes a couple of characteristics. (1) Japan invests more in non-manufacturing (71,3% in 1987) and less in manufacturing (25,9%), whereas the share of manufacturing in West Germany is absolutely larger in 1982 and relatively in 1987. From 1982 to 1987, non-manufacturing gains shares in both countries. (2) The main recipient regions of Japanese direct investment are the United States and Asia, but the share of German investments is the largest in Europe and the second largest in the USA. (3) As for Japanese direct investment, it should be mentioned that recent increases in financial transactions in the world money market make it necessary for Japan to invest more in the financial sector in the USA and in Europe, because these regions function as the centers of money flows. In addition to this the soaring Yen appreciation induced Japanese investments in real estate in the USA. These are the reasons for the rising share of non-manufacturing. In manufacturing, objectives of Japanese foreign direct investments vary by region. The main objective of US and EC investment is to supply goods to the local market, while export to third countries and to the home country (to Japan in this case) are considered far less important. As regards the direct investment in South-east Asia, the structure varies greatly and shares of exports to the home country and to third countdes are considerably larger (Chart 1). It is interesting to see the relation between export and local produc-

tion. Export increases in the first stage and then reaches a peak. Up to this point trade conflicts gradually come out and local production starts

51

Recycling Japanese Trade Surplus

to operate. In the second stage the development of local production is followed by an increase in parts' exports and then also peaks after some years. In the third stage only local production goes on increasing and exports of finished products as well as of parts tend to decrease. TV set production of Japan is going through the third stage and deindustrialization would be coming to the surface without the active domestic demand. The automobile industry seems to be entering the second stage and export will soon be substituted by local production. It is now the time for J apanese automotive parts' makers to move out and start local production. De-industrialization of the automobile industry in Japan will be a real problern in due course.

Chart 1:

Japanese FDI in:

Delivery Structure of Local Products by Region and by Destination

Export to: the Horne the Third Country Countries

Local Sales

Southeast Asia North America Europe

30

40

50

50

Source: EPA: Economic Survey of Japan 1989

70

80

90

10096

52

Tak:ashi Matsugi/Alexander Bernhard

II. Use of Japan's official development assistance (ODA) for ASEAN countries' economic development Recently, Japan's ODA was particularly disbursed under the point of view of economic development. Next to a theoretical overview of the conception of foreign assistance, two Observations will be discussed. First, that the ASEAN countries bad been the major recipients of Japan's ODA, and second, that the economic infrastructure projects bad played a major role in Japan's ODA distribution. By focusing on the two ASEAN countries, the Pbilippines and Thailand, it will be sbown bow Japan's economic infrastructure projects were distributed over the two countries. Finally, this paper will end up with a brief conclusion and outlook on Japan's future ODA targets.

1. General conception offoreign assistance As there is no generat theory of foreign assistance, following Cbenery, the main objective of foreign assistance programs can be seen in the long-term economic development of developing countries that requires transforming the structure of production and trade1• While donors and recipients can agree with this long-term objective that can be acbieved more readily if donors and recipients collaborate in the design and execution of aid programs, disagreements arise in a sbort run over the magnitude of aid provided, its allocation among countries and the ways in wbicb the resource transfer is made. In macroeconomic terms, the sbort-term functions of foreign assistance are twofold: to add to the two limited resources available for investment, skills and saving Iimits; and to augment the supply of foreign excbange to finance imports in order to exploit the possibilities of acbieving self-sustaining growth wben the balance of payment Iimit is effective2 • In the 1970s, the distributional aspects of this process bave been stressed by both donors and recipients, implying that greater weigbt 1 H.B. Chenery, 1987, Foreign Aid, p 400, in: The New Palgrave, A Dictionary of Economics, ed. by J. Eatwell et al., Vol.2, London et al. 2 H.B. Chenery, 1987 pp 401 and H.B. Chenery!A.M. Strout, 1966, Foreign Assistance and Economic Development, p 681, in: The American Economic Review, Vol. LVI, No. 4, Part 1

Recycling Japanese Trade Surplus

53

should be given to the reduction of poverty than to the mere growth of total income3 • Although development is now understood to reduce poverty and the structural changes needed to sustain these processes, Chenery points out that there is a core of agreement between donors and recipients that the main purpose of this transfer will be to promote Iangterm economic development as the overriding requirement to readjust the production and trading structure of the oil-importing countries".

2. 1he share of Japan 's ODA

a) To ASEAN countries Even today, Japan still allocates her largest share of ODA to the South-east Asian region with specific preference to ASEAN countries. From 1977 until 1986 Japan's share of ODA to ASEAN countries reached between 23.8 and 35.9 per cent of her total ODA budget. Reasons for this strong concentration can among others be found in Japan s close economic relationship with East and South-east Asian countdes and ASEAN countries efforts to promote their industrial development. Japan's close economic relationships can be underlined by the fact that a perceptible shift of industrial patterns is taking place among Asian countries. Some resource-based heavy industries and those requiring semi-skilled, well-known processes are being given less importance in Japan, while such industries are being undertaken in East and South-east Asia:~.

Similarly, the Asian Newly Industrialized Economies including Singapore, which had already established themselves as important exporters of light consumer goods by the beginning of the 1970s6 , are shifting away from unskilled, labor-intensive industries, while increasing

3

H.B. Chenery, 1987, p 400

4

H.B. Chenery, 1987, pp 402/403

'

S. Naya/M.K. Sa."nuel, 1983, Asian Development Strategies in aChanging World

Economy, p 5, in: Asian Development Review, Vol. 1, No. 2

6 S. Naya, 1983, Asian and Pacific Developing Countries: Performance and Issues, p 4, in: Asian Development Review, Vol. 1, No. 1

Takashi Matsugi/Alexander Bemhard

54

numbers of such industries are being set up in South-east Asia, specifically in ASEAN countries7 • Furthermore, this setting up of industries in ASEAN countries is accompanied by efforts to promote industrial development that requires assistance from industrialized countries. Due to Japan' s above mentioned close economic, but also geographical, historical and political relationship with ASEAN countries8, Japan provided the necessary foreign assistance to assist ASEAN countries industrialization efforts. In order to reduce their dependency on exports of primary commodities and to create employment opportunities for their growing labor force, ASEAN countries were using different combinations of tax and financial incentives to facilitate direct foreign investment, liberalization of trade policies, and the construction of an economic infrastructure, in particular export processing zones and industrial estates9 • This fact takes us to the second observation in this paper.

b) Economic infrastructure As shown in Figure 1, Japan is spending a high share of ODA for the economic infrastructure, such as roads, railways and other transport facilities, as well as communication and energy facilities 10• From 1985 to 1986, Japan's ODA share in economic infrastructurereached 37.5 per cent, the highest share amongst the Development Assistance Committee members. Japan's ODA sharewas beaten only by the World Bank with 41.2 per cent in the same period. ASEAN countries were using the construction of economic infrastructure next to tax and financial incentives and liberalization of trade policies to promote their industrial development. A large share of their economic infrastructure facilities were provided by Japan as they

7

S. Naya/M.K. Samuel, 1983, p 5

MFA, 1988/1, Ministry of Foreign Affairs, Japan's Official Development Assistance 1987 Annual Report, p 54, Tokyo 8

9

S. Naya, 1983, pp. 10-11

OECD 1987 Chairman's Report, 1988, Organization of Economic Cooperation and Development: Development Co-operation, 1987 Report, p 95, Paris 10

1977

/

.•..

- ·.

I

I

'78

' ......·

.·

\ \

\

'79

'80

I

II

'81

'83

""""/

"

'84

/

/

.......

'85

,-"'

Source: MFA, 1988/1, p 59

'86

____....

.....

'), .....

~

...... .....

'-u----' ~

Not Allocable

.-----r'

)2--~"'-...

'82

..,....o----

\

..___... ........

,...

'\

.· ..·. ~.... ............. ~· ..... .

.....

,.-----..... .......... . . .

~---..:~

.... ·..1' / ./'

.,___

I

~

Notes: BHN (Basic Human Needsl includes education, health, social infrastructure and welfare, agriculture and fisheries. Not Allocable includes commodity loan, food aid and debt relief.

0

20

50,_

%.-------------~~~-----------Industry and Development of --+-- BHN -a- Public Utilities ···...... Mining

Figura 1 : The Transition of ODA Allocation by Sectors

VI VI

f

{1.1

~

f

5'

OQ

j

Takashi Matsugi/Alexander Bemhard

56

arevital inputs to a country's industrialization process11 • Furthermore, these are facilities that can be provided by foreign assistance in contrast to the incentives and trade policies that have to be pursued by the ASEAN countries themselves. While assisting the ASEAN countries in their industrial development, Japan intended to provide scope for adequate specialization, economies of scale and enough competition in these countries. Thus, competition from abroad forces companies to cut costs, improve quality, and seek new ways of producing and selling their goods, whereas contacts through trade ease the flow of capital and speed the acquisition of new technology12•

3. Japan 's ODA to ASEAN countries' economic infrastructure: the case of the Philippines and Thailand From the early seventies until the early eighties, Japan's ODA economic infrastructure projects to the Philippines and Thailand accounted for around 60 and 70 per cent, respectively, of all allocated project loans 13 • Economic infrastructure projects were generally distributed all over the two countries. However the largest projects, accounting more than 15 billion Yen, were mainly allocated within and around the two capital cities of the Philippines (Manila) and Thailand (Bangkok) respectively, and areas such as the provinces of Cagayan and Leyte in the Philippines, as well as the Eastem Seaboard in Thailand; or in nationwide projects such as the Philippines-Japan Friendship Highway 14 • To support both ASEAN countries' efforts in promoting their industrial development, Japan's ODA economic infrastructure projects were located close to the locations of both countries' export-oriented industries. In both countries, those industries are primary located within 11

World Bank, 1987, World Development Report 1987, p 2, Washington DC

12

World Bank, 1987, p 2

13 OECF/PHILIPPINES, 1984, The Overseas Economic Cooperation Fund Japan's Contribution to Economic Development in the Republic of the Philippines through OECF Loans, p 14, Tokyo; and OECF/THAILAND, 1983 The Overseas Economic Cooperation Fund- Japanese Contribution to Economic Development of the Kingdom ofThailand through OECF Loans, p 10, Tokyo 14

OECF/PHILIPPINES, 1984 and OECFITHAILAND, 1983

Recycling Japanese Trade Surplus

57

and around the capital cities of Manila and Bangkok, but also in other regions such as Central Luzon and Southem Tagalog which are close to Manila and the Central Region which is close to Bangkok1!!.

4. Conclusion and the outlookfor Japan 's foreign assistance As shown, Japan's ODA is assisting ASEAN countries in their efforts to promote industrial development in sofaras Japan provides a large share of those countries' economic infrastructure facilities, one element in the industrial development process. These assistance efforts are reflected in Chenery's short term functions. Japan's ODA economic infrastructure facilities add to the ASEAN countries' skills and saving Iimits as weil as prepare those countries, to increase the supply of foreign exchange as they promote the export-oriented industrialization process. However, Japan's ODA economic infrastructure efforts arestill far from fulfilling the long-term economic development of those countries, which includes a stronger collaboration with the ASEAN countries than the mere assistance of economic infrastructure. In the light of this fact the Japanese Government has critically reviewed its own foreign assistance. To improve the foreign assistance program, Japan recently formulated the following targets: further quantitative expansion and qualitative improvement of her ODA; more elaborately worked out aid programs adapted to each recipient country's circumstances; implementation of a comprehensive economic cooperation with the public's participation, including Japan's private sector; and improving the implementation structure necessary to support Japan's assistance16•

15 World Bank, 1980/1, Philippines- Industrial Development Strategy and Policies, A World Bank Country Study, Washington DC and World Bank, 1980/2, ThailandIncome Growth and Poverty Alleviation, A World Bank Country Study, Washington DC 16

MFA, 1987/1, pp 11-23

58

Takashi Matsugi/Alexander Bernhard

References J. Ajananl, et al., 1986, Trade and Industrialization of Thailand, Social Science Asso-

ciation of Thailand, Bangkok

B.O. CampbeU, 1987, Asian and Pacific Developing Economies: Performance and Issues, in: Asian Development Review, Vol.S, No.1 H.B. Chenery, 1987, Foreign Aid, in: The New Palgrave, A Dictionary ofEconomics, ed. by J. Eatwell et al., Vol. 2, London et al. H.B. Chenery/A.M. Strout, 1966, Foreign Assistance and Economic Development, in: The American Economic Review, Vol. LVI, No. 4, Part 1 CRC, 1987, Center for Research and Communication: Philippines Economic Prospects in 1988, Can we hack it?, Pasig, Metro Manila EPA, 1988/1, Economic Planning Agency, Japanese Govemment: Economic Survey of Japan 1987-88, Tokyo R. Find/ay, 1984, Trade and Development: Theory and Asian Experience, in: Asian Development Review, Vol.2, No.2 T. Kinashita, 1988, Investments Gild ASEAN Aid Package, in: The Japan Economic Journal, July 23, 1988 J. P. Lewis, 1987, Asian Development- The Role of Development Assistance, The Asia

Society, Asian Agenda Report 7, New York

MFA, 1988/1, Ministry of Foreign Affairs: Japan's Official Development Assistance 1987 Annual Report, Tokyo MFA, 1988/2, Ministry ofForeign Affairs, Economic Cooperation Bureau: Outlook of Japan's Economic Cooperation, Tokyo

S. Naya, 1983, Asian and Pacific Developing Countries: Performance and Issues, in: Asian Development Review, Vol. 1, No. 1 S. Naya/M.K. Samuel, 1983, Asian Development Strategies in a Changing World Economy, in: Asian Development Review, VoLl, No.2 OEGF/Thailand, 1983, The Overseas Economic Cooperation Fund - Japanese Contribution to Economic Development of the Kingdom of Thailand through OECF Loans, Tokyo OECF/Philippines, 1984, The Overseas Economic Cooperation Fund - Japan's Contribution to Economic Development in the Republic of the Philippines through OECF Loans, Tokyo

Recycling Japanese Trade Surplus

59

OECD 1987, Chainnan's Report, 1988 Development Co-operation, 1987 Report, Paris RP-Japan Joint Study, 1979, Philippine-Japan Joint Study on Japanese Development Assistance: Philippine Development Performance and Japanese Development Assistance, Manila K. Shibagaki, 1985, Japan's Development Aid Policy as Motor for Asia-Pacific Coope-

ration, Berliner Institute für vergleichende Sozialforschung, West Berlin

World Bank, World Development Report 1987, Washington DC World Bank, 1980/1, Philippines - lndustrial Development Strategy and Policies, A World Bank Country Study, Washington D.C. World Bank, 1980/2, Thailand - Income Growth and Poverty Alleviation, A World Bank Country Study, Washington D.C.

On Some Processual and Structural Problems of an European System of Central Banks Hans-Hermann Francke

1. lntroduction In my Freiburg inaugural lecture last year I criticised the intention of some European politicians to replace the European Monetary System (EMS) by a European System of Central Banks (ESCBY. Not only from a German point of view, but also from a Common Market monetary standpoint the various construction and performance features of the EMS seemed to be superior. I have not changed my opinion so far, but since the political environment has progressed in irreversibly the initial question dealing with the mere existence of an ESCB, tumed out to be irrelevant. One can probably assume that the creation of the ESCB will be an "irreversible process" in the terminology of the new branch of evolutionary economics. Hence, I intend to focus on some processual and structural questions in respect to the institutional intricacies of a European central bank. In the center of public discussion have been concerns that a European central bank would jeopardize the development of internal purchasing power because of the institutional framework and the selfishness of ESCB decision-makers. Although the recently published Delors Reporf clarified the record in favor of an European central bank and convinced even more stability-oriented countries by the proposal of an autonomaus ESCB, there are still some institutional arrangements left that require

1

Francke, 1989

2

Ausschuß zur Prüfung der Wutschafts- und Währungsunion, 1989

62

Hans-Hennann Francke

further discussion. I feel, however, that institutional as well and questions of European monetary strategy should be handled together. These strategic problems consist mainly of the "degree of autonomy" of the ESCB which is itself a result of technical feasibilities and international monetary restraints. I would like to address some major problems that arise from this context. Firstly, I would like to point out some processual difficulties resulting from imperfections within the 1992 Common Market. One cannot simply transfer the regularnational monetary transmission model to a fully integrated European currency area. Secondly, I will criticize problems of the degree of autonomy in connection with questions of possible ESCB monetary rules. Finally, I will discuss if and how these possible rules could be coordinated on a worldwide Ievel.

2. The process or monetary transmission: some major issues

2.1. Monetary centralisation may imply reduced speed of adjustment 1.) Comparing features of fixed and flexible exchange rate systems two main - but linked - differences become apparent. On the one band, monetary interdependence between two currency areas is achieved via different transmission variables with the result that the intemal process of adjustment differs in real terms as weil as in money terrns. On the other band, processual feasibility and limits of national central banking in the two kinds of exchange rate systems are to be distinguished by their various economic and political constraints. In the case of a fixed currency system, transmission takes place through mutual adjustments of the inflation rates. The process of adjustment can be viewed as a by-product of compulsory exchange rate intervention caused by the system. These interventions affect the money supply as well as interest rates leading eventually to a convergence in inflation. In contrast, a system of flexible exchange rates allows for a separate development in inflation rates since exchangerate fluctuations need not be compensated by national central banks. However, no system provides for a complete international separation in real terms. While the adjustment process is different, the final result is not.

Problems of an European System of Central Banks

63

A comparison of the relative advantages of fixed and flexible exchange rate systems on theoretical grounds leads to an ambivalent result. Flexible exchange rates appear superior on first sight, since they grant more power to policy-makers in terms of steering the money supply and interest rates. This monetary power is even extended by the fact that in a flexible exchange rate system the central banks are able to control exchange rates by interventions. This way, eventual effects of exogenaus shocks can be reduced by controlling the transmission variable in order to prolonge momentarily undesirable adjustments. However the central bank's selection among different strategies of adjustmenf implies substantial risks. Firstly, problems arise when determining the optimal adjustment in respect to various structural parameters4 , namely to solve additional coordination and information problems~. Secondly, there is no force towards stability-directed international policy coordination since the central bank is not obliged to react to volatile exchange rates. On the other band, compulsory monetary discipline is the essential advantage of a fixed rate system which helps to diminish the risk of too little policy coordination. Since the participating central banks are to maintain a certain exchangerate with a given money supply and interest rate strategies, they do not have full scope to act. If interventions in foreign exchange markets are needed, "weak currency countries" are compelled to sell scarce reserve currencies or use international credit tranches. This process is accompanied by a convergence of inflation rates to a worldwide Ievel. According to national preferences such a mechanism may be desirable. In contrast, the internal purchasing power in an economy may be endangered because disturbing inflationary shocks cannot be absorbed by exchange rate variations. 2.) The overallpositive performance of the EMS can be explained6 by its very construction features and the so-called "German monetary anchor of stability". Therefore, the EMS is able to provide the best of the two worlds of exchange rate regimes. Being at heart a fixed rate system the EMS and its compulsory interventions in the foreign 3

Bender, 1987, S.157

4

Koromzayfl.lewellyn/Potter, 1984

'

Bender, 1987, S.l57

6

Critically cf. for example lssing, 1988

Hans-Hennann Francke

64

exchange market guarantee for monetary discipline among weak currency countries7 • On the other band, eleven realignments from 1979 up to the present prove the system to be flexible enough to leave the choice, to accommodate international relations or not, to the centrat banks. All the more so, since the EMS-block is floating against other currencies. Not surprisingly, the properties of the EMS help to satisfy even most different interests of the centrat banks involved. One can assume additional political acceptance by weak currency countdes because of the "anchor-effect" stabilizing influence in respect to the expected inflation rate. Those countries may utilize this "German anchor of stability" in order to create real effects of monetary policy which would be offset in the case of perfect anticipation (in the sense of the rational expectation hypothesis) of the home countdes easy-money policy. At any rate, the existence of an increased "surprise effect" of monetary policy appears to be convincing for weak currency countries8• The intended remodeHing of the EEC to a fully integrated currency area under the guidance of an European Centtal Bank would certainly reduce the present internal flexibility. A monetary union ofthat kind can be viewed as an irreversible fixed rate system with the result of improved monetary discipline. The convergence of the internal inflation rate towards the externally determined inflationrate leads to faster real adjustments via relative price changes. In other words, formerly relatively independent national banks would loose their ability to generate "surprise effects" as well as the freedom to autonomously accommodate changes in monetary variables. Despile certain structural differences the EEC's economic area is forced to react similarly to monetary shocks no matter whether they have been caused by autonomous ESCB decisions or by international factors. As a result, the EEC as a whole suffers a lack of flexibility. Hayek's book "The Denationalization of Money" 9 already describes this lack of flexibilty as the main objection against large currency areas. As a very likely political consequence of this shortcoming one can assume that the lost independence of national banks could be replaced by direct, 7

Bojinger, 1988

1

Melitz, 1989, Francke, 1989

9

Hayek, 1977

Problems of an European System of Central Banks

65

yet generat directives of a European Centrat Bank towards a subordinated system of dependent national monetary authorities. Without an exogenously given "anchor of stability" monetary decision-makers cannot easily reject such public directives.

2.2. Monetary transmission and efficient control ofmoney supply 1.) Against the background of rather familiar effects of monetary policy in more homogenaus currency areas the monetary measures undertaken by an ESCB policy-maker could Iead to an even more uncertain monetary performance in terms of its intensity and temporal consistency. Some generat reflections on the determinants of the mechanism of transmission may illustrate my point.

Karl Brunner, in an often quoted work10, explains economic actor's adjusting reactions to monetary shocks as caused by information and transaction costs. Delayed price changes and rigidities in stock which might Iead e.g. to unemployment can be viewed in this context as a result of individual optimizing behavior. Contracts (union agreements, etc.) can be understood as conventions which help to avoid information and transaction costs by reducing the expenses of immediate adjustment. This way, inefficiencies as weil as a delayed effect of monetary policy can be interpreted properly in a price theory framework 11 • However, even after 1992 and numerous efforts of economic harmonization, there will be still some characteristic regional regulations and contractual relations left. These differences seem tobe appropriate since they mirror distinct regional and structural population features. If this variety of contractual relations is subjected to a single monetary concept, one may find monetary transmission hard to predict. To put it differently: the reaction patterns and efficacy of monetary policy in an economic area as large and heterogenaus as the EEC cannot possibly be compared to those patterns we know from morehomogenaus areas.

10

Brunner, 1970

A similar theoretical explanation of the importance of contracting for monetary transmission can be found in the discussions about rational expectations, cf. Fischer, 1977 and McCallum, 1977 11

S Matsugi/Oberhauser

66

Hans-Hermann Francke

2.) Understandably, one could believe these difficulties to be transitory since it is likely that the regional behavior in contractual relationswill be adjusted to the new macroeconomic setting. But such an adjustment is followed by two important consequences which are in sharp contrast to the present EEC concept of European economic integration. Firstly, one is to say "Farewell" to the nowadays popular political idea of an "Europe of Variety". A common macroeconomic setting will evoke reactions towards a convergence of microeconomic contracting rules. Butthis by no means implies a "similarity of living standards" all over the EEC as was recently set out as a goal in the Delors Report. Especially if the macroeconomic setting becomes similar, existing differences in real structure (geographic situation, cultural attitudes, etc.) will cause separate Standards in the supply with goods. As a consequence, in an integrated Europe economic differences might be widened. As also set forth in the Delors Report, a forced regional fiscal policy - conducted by the central Brussels authority - should be applied in order to even out these differences. This plan appears to be counterproductive since - similar to rigidities caused by contracts - it would preserve differences in economic structures because of the supression of independent regional efforts to cope with the new setting of information and transaction costs. Moreover, final effects of monetary policy will be even barder to predict. '

3. Central bank autonomy and monetary policy rules 3.1. Issues ofthe independence of an ESCB 1.) The fact that the Delors Report was approved by even most sceptical countries like Germany can certainly be explained by its proposal to provide this central bank with autonomous rights. This autonomy connected with the recommended obligation to minimize the current inflation rate mirrors the seemingly common consensus to copy the German central bank model. The Delors Report also postulates monetary autonomy in the sense of an explicit prohibition of central bank credits to governments, a second reason why even hard-currency-countries were able to consent. Why should an

Problems of an European System of Central Banks

61

autonomous European Central Bank not be as successful as the proved German Bundesbank? However such hopes disregard three points: firstly, the Bundesbank's legal autonomy is not constitutionallaw and cannot explain sufficiently its success in stabilizing purchasing power. Secondly, it is more difficult to create an autonomous ESCB for a European monetary union than for a nation. This is quite evident, since with increased structural differences in a larger currency area, the political and economical arguments against an independent monetary policy are to be taken more seriously. Finally, the international importance of an ESCB might be a major constraint of its political independence. The latter argument against exaggerated aspirations to provide an ESCB with far-reaching autonomy is presumably the most important one. I will focus on this aspect in my concluding remarks. 2.) The German Bundesbank's legally restricted independence from the national government is reflected by the rules of German Central Bank Law (Bundesbankgesetz). Despite the guarantee of monetary autonomy the Bundesbank also is obliged to support the government's economic policy. If conflict arises between the Bundesbank and the government - a quite realistic scenario in the past12 - there are, however, no rules as to how to solve these conflicts. Finally, one must point out that the Bundesbank can be politically forced to obey because the Bundesbankgesetz can be changed by a simple parlamentary majority. Hence, for practical purposes the Bundesbank enjoys only a de-facto-autonomy13 • In the past, this autonomy was successfully used for stability-directed policy by monetary decision-makers and a supportive public which made it politically impossible to alter the independent status of the Bundesbank. Without this special support of the traditionally stability-minded German population a serious violation of the Bundesbank's independence might have been occurred14 • Furthermore on a European Ievel, one could only imagine rules of a comparable de-facto-autonomy working as long as there were no

12

Woll, 1988, Francke 1984

13

Francke, 1989

Politicians' critical distance towards the Bundesbank's autonomy is expressed in, for example, Ehrenberg, 1988 14

Hans-Hermann Francke

68

serious conflicts between the national administrations and the central bank. The currently existing central banks in Great Britain and France are subordinated to a high degree to the government. The Banque de France is subordinated to the Ministry of Finance, the Bank of England to the Treasury15 • The current, very apparant British rejection of an European Central Bank is therefore not based on inflation fears, but on the notion that Britain could eventually loose her sovereign rights. On the other band, one has to concede to critics of an autonomous European Central Bank that their objections gain importance on an European Ievel. Usually four familiar arguments are put forward 16 • Since monetary policy could be used successfully in the short run for policies aimed at employment, growth and distribution targets, it should not be separated from government decisions on priorities of economic policy (priority argument). Above all, fiscal policy's efficacy is crucially connected to monetary measures (fiscal policy argument). Therefore, monetary policy - as a part of general economic policy - ought to be included and coordinated in a hierarchy of legislation and administration (coordination argument). Finally, an autonomous central bank cannot comply with the rules of a democratic system, especially if its decisions arenot in accord with prevalent preferences (democracy argument). If the described hypothesis that in an integrated European market the effects of monetary policy are stronger (due to reduced flexibility), and also barder to forecast (because ofvarious rigidities in contracting), then the priority argument acquires greater importance. lf an uniform monetary policy is faced by different target priorities of numerous decision-makers (i.e. national parliaments) the task of coordination between monetary and fiscal policy will become more important and more difficult. The Delors Proposal to subject national fiscal policies to binding rules in respect to budget restrictions appears to be impossible from a constitutional viewpoint. Most of all, our common feelings towards democracy are being contradicted. Hence, a de-facto-autonomy based only on a European central bank law cannot be maintained in the case of conflict. Additional rules will be needed. 15

Cäsar, 1988

16

Schmilz, 1988

Problems of an European System of Central Banks

69

3.2. Monetary rulesfor an ESCB 1.) The tradition arguments in favor of monetary rules can be classified in three categories: 17 - Firstly, interest of monetary politicians differ occasionally from those of their principals' long-run preferences, (i.e. the public). - Secondly, the private sector of an economy provides sufficiently efficient and self-guiding mechanisms to render discretionary monetary policy inefficient or even redundant. - Thirdly, political decision-makers Iack the ability to predict with sufficient precision the system's reactions to planned measures with respect to steps of regulation already taken.

These arguments seem generally to contradict central banks' autonomy. They therefore should be added to the criticism made above. However, a more detailed analysis shows that these objections imply a reduction of central bank autonomy in that the autonomy should be bound to rules in order to reduce the arbitrariness and possible mismanagement of discretionary policy. From this viewpoint monetary rules are not to be seen in contrast to autonomy, but as specifying the Iimits of action of an independent central bank. At the same time, the above mentioned objections against central bank autonomy are at least partly diminished. One could construct binding rules which take into account priorities of general economic policy (e.g. by further conditions and/or provisos). Fiscal policy measures can be planned more efficiently if, through given monetary rules, monetary restrictions can be more precisely anticipated. Above all binding rules - because of the reduced Iimits of action - seem appropriate to reduce reservations against central bank autonomy. They are a result of our common feelings towards democracy. In order to maintain a de-facto-autonomy monetary rules serve an important supportive function. Moreover, all three classical arguments in favor of monetary rules for a homogenous currency area in Europe will gain in importance. Possible conflicts between monetary decision-makers and the public will be certainly more severe than in national economies with more homogenous economic structure. As mentioned above, monetary transmission in an integrated currency area is barder to predict. 17

Bofinger, 1989

Hans-Hermann Francke

70

Therefore, a European centrat bank should avoid discretionary measures in order to reduce the danger of mismanagement. At any rate, in the face of Europe's heterogenous economic structure private self-guided mechanisms seem to be more efficient than a discretionary centrat monetary policy. 2.) In recent publications a new argument in favor of binding monetary rules is put forward which runs under the technical terms "time inconsistency", respectively "credibility problem" 18 • Theseterms try to explain why - in the case of discretionary monetary policies - the equilibrium long-run inflation rate is systematically higher than socially desired (an optimum could be zero). In the framework of rational expectations theory this can be explained by the fact that the economy will perform at a higher inflation rate because a lower rate could provoke monetary politicians to to aim at short-run gains in output and/or employment by unexpected monetary expansion. From a welfare point of view such a policy could be advantageous if positive output and employment effects would compensate the negative effects of a high inflation rate as weil a possible loss in credibilityl9 • If benevolent politicians aim at such a discretionary surprise effects, a higher inflation rate than that socially desired2D will be the result. This is quite obvious because rational individuals will adjust their inflationary expectations in anticipationofthe plans ofpoliticians. Thus, discretionary policy has the systematical flaw of a too high inflation rate and Iack of credibility. Welfare gains would be feasible if the introduction of a binding monetary rule could prevent such behavior by politicians. The empirical relevance of this hypothesis of interdependent reactions between monetary politicians and the public depends whether politicians really are tempted to cause inflation by well-meant surprise effects aimed at temporary gains in output and employment. It also depends on whether

18

An excellent survey on recent Iiterature can be found in Loef, 1988

19

ibid. pp.362

20 In accordance with game theory we speak of a Nash-equilibrium. This derivation is based essentially on the assumption that the preferences of monetary decision-malcers and the public differ. Bojinger/Frenkel, 1989, pointout correctly that one therefore can not assume that politicians' behavior is characterized by unselfish altruism. Thus there is a certain theoretical inconsistency. One can observe in reality that politicians think themselves better infonned and neglect the public's preferences.

Problems of an European System of Central Banks

71

the public is willing to believe politicians who dishonestly announce a strict anti-inflation policy. lt is quite realistic to assume that past policies of formerly weak currency countries within the EMS were aimed at such targets. The repeated effort to create real gains through monetary shocks is reflected by various peaks in those countries' money growth followed by realignments. Three arguments also underline the existence of a necessary potential for surprise effects21 • Firstly, the stable key currency DM has also created additional confidence in expectations among other EMS member countries. Secondly, confusing interventions by central banks aimed at stabilizing nominal parities Iead to high costs in forming rational expectations. Thirdly, the timing, dimension and conduct of these realignments were surprise effects in themselves because they resulted from spontanaus and secret negotiations. Such tools will not be available to a future European central bank because the potential for surprise effects will not be given to the same extent as it is now in the EMS. The present public scepticism towards the new institution would Iead to an irreversibility in expectations since monetary decision-makers would have lost their credibility. To prevent them from doing so, or in order to adjust the actual inflation rate to the socially desired "optimal" rate - according to the hypothesis of inconsistency - appropriate monetary rules for an ESCB are required.

4. International coordination of European monetary policy 4.1. 1he reasons for and the risks ofpolicy coordination 1.) Even though essential arguments for monetary rules can be usefully applied to an autonomaus ESCB the implementation of these ideas is bindered by a fundamental obstacle, namely the proposal of an increased international monetary policy coordination. This proposal is a result of the fact that with a homogenaus European currency area the biggest and most powerful international monetary system would emerge.

21

cf. Francke, 1989

72

Hans-Hennann Francke

In addition to generat political constraints there are two economic arguments requiring further international coordination of European monetary policy. On the one band, coordinated measures can better diminisb negative external effects (spill-overs) because of the special impact of European monetary policy on the rest of the world. These effects can be explained in various ways: via the transmission of undesirable inflation and employment stimuli on foreign countries; via price signals disturbing rational expectations, etc. International coordination (concerted actions, mutual considerations) could possibly reduce these negative extemal effects as well as foreign counter reactions, wbicb would otherwise affect the European currency area. On the other band, internal coordination could also improve the internal efficiency of European monetary policy as well as protect the economy from external sbocks. Therefore monetary decision-makers will take new strategic options. Finally, international coordination could fulfill a positive political supportive function. This could be accomplisbed either by the centrat bank's ability to establisb the required public consensus or by more appropriate monetary decisions, since the tasks of coordination migbt force additional Iegitimation and controls. 2.) Opportunities and risks of international policy coordination bave been in the center of intense academic studies22 for a few years. Economic summits ofthe G-7 and G-10 were frequently concerned with severe international imbalances and aimed at coordinating national fiscal and monetary policies in order to find suitable excbange rate target zones. Past attempts to coordinate policies as weil as scientific researcb on the efficiency of policy coordination bave not led to satisfactory results. In theoretical discussions conflicting opinions of pol itical participants wbicb can be explained by differences in social welfare functions and structural features bave been empbasized. Theoretical uncertainties and resulting dissensions Iead to seemingly insoluble problems of information and difficulties in coordinating decisions. Instead of coordination, cooperation based on mutual and more general agreements, recommendations and briefings could be the second best result. 22 Remarkable studies have been done by Frenkel/Goldstein/Masson, 1989, also Wilüamson, J./Miller, M.H., 1987. Following survey articles are recommended: File, 1988, Reszal, 1986, Kösters, 1988

Problems of an European System of Centrat Danks

73

Finally, policy coordination is accompanied by a general discomfort for reasons of legitimacy. World governments are necessarily less democratic, they free politicians from justifying their policies and are in favor of nationalist emotions. The results of empirical researcharealso not satisfactory. The IMF's "Multimod" model, for example, reflecting macroeconomic interdependencies between the G-7 leads to an ambivalent resulf3. On the one band, it is obvious that national policy spill-overs deserve close attention. Monetary and fiscal measures in the USA, Japan and the Federal Republic of Germany are linked so intensely that the advantages of coordination become apparent. On the other band, econometric simulations show (assuming, for instance, target zone strategies) that policy coordination could not stabilize important macroeconomic key figures. Tothis extent, empirical research supports theoretical doubts. Thus another basic problern of future European monetary policy becomes apparant. Due to its international impact, monetary policy cannot completely avoid proposals in favor of coordination. However the implementation of such proposals is questionable. Policy coordination also implies that advantageous internal rules might be discretionarily neglected if international agreements and political considerations are given priority. This could ultimately jeopardize the central bank's de-facto-autonomy. 4.2. Monetary rules andlor coordination

1.) The problems of combining internal monetary rules with international policy coordination invite the search for alternative solutions. One might ask whether coordination could be adequately replaced by monetary rules, or whether it would be more appropriate to create those rules as a substitute for coordination. If coordination leads to discretionary policies, the arguments stated above will hold. Only if policy coordination can be derived from the rules of a new world-wide monetary order, then it appears to be a useful replacement for monetary rules of European monetary economics. The

23

Frenkel/Goldstein/Masson, 1989, Table 1

74

Hans-Hermann Francke

presently discussed proposals24 are controversial: firstly, basic targets are estimated in different ways. Secondly, the heterogenity of international structural features has grown. Thirdly, its political feasibiliy is debatable, as shown below. With respect to different target priorities, there is no consensus as to whether the currency order should be geared towards a free-market system with stability-oriented mechanisms or towards the interventionistic aim of the worldwide accommodation of monetary policy. The structural heterogenity is most extreme between industrial and developing countries, which raises the question ofthe extent and the responsibilities of integrating international currency order. Problems of political feasibility are directly connected with these problems; above all becuase working currency orders rely heavily on efficient systems of incentives and disincentives. From an European viewpoint only free-market mechanisms should enter the discussion, even if this means that only developed countries can acquire membership of the world currency system. Nowadays possible mechanisms25 for a new currency order will be represented by a fixed rate system like either a commodity or foreign exchanged standard, or an internationally supervised monetary rule'-6. But since both systems - without a working system of incentives - will hardly be able to gain ground, their implementation in the near future appears highly unlikely. 2.) Thus monetary rules for an ESCB will be a more realistic alternative. The German Bundesbank's current strategy ofincreasing the money supply according to real growth would also appear to be a fruitful approach on a European Ievel. Externally, an ESCB would be linked via floating exchange rates with other currencies. Of course, this would not imply far-reaching monetary coordination, but if a timely announcement together with reliable execution of the monetary rule were feasible, the ESCB would at least send out useful signals. The question as to whether the ESCB can possibly avoid political pressure

24

A short survey can be found at Hasse, 1989

25

Brunner, 1981, pp.7

26

Hasse, 1989, pp.36, Francke, 1989

Problems of an European System of Central Banks

75

remains unanswered. If it cannot, this might mean the end of a European central bank's de-facto-autonomy.

References Bender, D. (1987}, Monetäre Transmissions-und Steuerungsproblemein offenen Volkswirtschaften, in: 1hieme, H.J. (ed.) Geldtheorie - Entwicklung, Stand und systemvergleichende Anwendung, Baden-Baden Bojinger, P. (1988}, Das Europäische Währungssystem und die geldpolitische Koordination in Europa, in: Kredit und Kapital, 1988, p. 317ff. Bojinger, P.!Frenkel, M . (1989}, The Social Welfare Approach to Monetary Policy Reconsidered, Working Papers des Instituts für Geld und Währung der Universität Frankfurt, Gebauer, W. (ed.}, No. 13 Brunner, K. (1970}, Eine Neuformulierung der Quantitätstheorie des Geldes, in: Kredit und Kapital, 1970, p. lff. Brunner, K. (1982}, Konzepte der Geldordnung in einer freiheitlichen Wirtschaftsordnung, in: Starbatty, J. (ed.}, Geldordnung und Geldpolitik in einer freiheitlichen Gesellschaft, Tübingen, p. 7ff. Caesar, R. (1988}, Bundesbank-Autonomie: Internationale Bedrohungen, in: Wirtschaftsdienst 1988/111, p. 124ff. Delors, J. et al. (1989}, Bericht zur Wirtschafts- und Währungsunion in der Europäischen Gemeinschaft Ehrenberg, H. (1988}, Autonom bis zum europäischen Ende, in: Wirtschaftsdienst 1988/III, p. 119ff. File, W. (1988), Kooperation als Voraussetzung zur Stabilisierung des internationalen Währungssystems, in: File, W. et al. (eds.), Herausforderungen der

Wirtschaftspolitik, Festschrift für C. Köhler, p. 213ff.

Fischer, S. (1977}, Long Term Contracts, Rational Expectations and the Optimal Money Supply Rule, in: Journal of Political Economy, Vol. 85, p. 191ff. Francke, H.H./Hudson, M. (1984}, Banking and Finance in West Germany, Beckenham/Sidney

76

Hans-Hennann Francke

Francke, H.H. (1989), Politische Interessenstrukturen in der Europäischen Währungsordnung, in: Riese, H. et al. (eds.), Geldpolitik und ökonomische Entwicklung- Ein Symposium, Regensburg, 1990, p. 137ff. Frenlcel, J.A./Goldstein, M.!Masson, P.R. (1989), International Economic Policy Coordination: Rationale, Mechanisms, and Effects, Paper presented at the Konstanz Seminar 1989 Hayek, F.A. von (1977), Entnationalisierung des Geldes, Tübingen Hasse, R.H. (1989), Ansätze zur Neuordnung des internationalen Währungssystems, in: Aus Politik und Zeitgeschichte, Beilage zur Wochenzeitung Das Parlament, B20-21/89, p. 33ff. Jssing, 0. (1988), Wechselkursstabilisierung, EWS und Weltwährungssystem, Harnburg Koromz;ay, V.!Llewellyn, J.!Poner, S. (1984), Exchange Rates and Policy Choices: Some Lessons from Interdependence in a Multilateral Perspective, in: AER-Papers and Proceedings, 74, p. 13lff. KtJsters, W. (1989), Transmission und Koordination nationaler Wirtschaftspolitiken bei weltwirtschaftlicher Entwicklung, in: Kredit und Kapital, 1989, p. 18ff.

Loef,

H-E. (1988), Diskretionäre Geldpolitik, rationale Erwartungen und Politikglaubwürdigkeit, in: Jahrbuch für Sozialwissenschaft 39 (1988), p. 36lff.

McCallum, B. T. (1977), Price Level Stickiness and the Feasibility of Monetary Stabilization Policy and Rational Expectations, in: Journal of Political Economy, Vol. 85, p. 627ff. Melitr., J. (1988), Monetary Discipline, Gennany and the European Monetary System, in: Kredit und Kapital, 1988, p. 48lff. Resr.at, B. (1986), Wutschaftliehe Interdependenz und internationale Kooperation, in: Hamburger Jahrbuch für Wirtschafts- und Gesellschaftspolitik, 1986, p. 267ff. Schmitz, W. (1989), Der Beitrag der Währungspolitik zum Binnenmarkt, in: Aus Politik und Zeitgeschichte, Beilage zur Wochenzeitung Das Parlament, B20-21/89, p. 1Sff. Williamson, J./Miller, M.H. (1987), Targets and Indicators: A Blueprint for the International Coordination of Economic Policy, Policy Analysis in International Economics, No. 22, Washington, D.C., Institut for International Economics Woll, A. (1988), Die Unabhängigkeitder DeutschenBundesbankmuß gesichert werden, in: Wutschaftsdienst, 19881111, p. 122ff.

Impacts of the EC Single Market 1992 on Japanese Danks and Securities Firms Jun'ichi Senda

1. lntroduction The EEC (European Economic Community), which began in 1958 made a great progress in the 1960s, in integrating the economies of member countfies through the liberalization of movements of commodities, capital, labour and services within its borders. It was reorganized into the EC in 1967. In the meantime it became a customs union by adopting common external tariffs in July 1968, in addition to the establishment of the common agricultural policy. In the 70s, however, the EC's movement towards economic integration stagnated due to the influence of the two oil crises. Even in 80s the EC's recovered from the after-effects of the oil crises was still delayed, resulting in its falling behind the U.S. and Japanese economies especially in high-tech industries. Following these circumstances the view emerged in the EC that a greater degree of integration should be pursued in order to revitalize the EC economic integration. With this encouragement the EC has resumed its effort to establish the single market not later than the end of 1992. In this paper, we will focus on the integration of financial systems in "EC Single Market 1992", and investigate how Japanese banks and securities firms perceive and respond to it.

78

Jun'ichi Senda

2. Extension of Japanese banks and securities firms into Europe While the recent internationalization or globalization of the Japanese economy is well-known, this phenomenon can be seen most clearly in the external extension of Japanese corporations. Table 1 shows the numbers of extemal extension of J apanese corporations (all industries). As is clear from Table 1, in recent years the EC is the third most important destination for direct foreign investment by Japanese corporations, Asia being the most important and North America in second place. In contrast, Table 2 show the number of external extensions of Japanese financial institutions (banks, securities firms and insurance companies). The forms of extension include branches, locallyincorporated subsidiaries and representative offices. Apparently in recent years the EC has been the most important for the J apanese financial services industry as the area where branches, etc. should be established. What are the purposes of these extension to Europe? The main ones are as follows. (1) To do banking and securities business for Japanese companies operating in Europe, whose parent companies have been their eHentele in Japan. These make loans to, accept deposits from, underwrite the bonds issued by, and give various kinds of informational and consulting services to Japanese companies operating in Europe. The contents ofthe services have been gradually changing from simple foreign exchange business to loans concerning foreign trade, investments and loan in general, and finally to merchant banking. As far as these businesses are concerned, it can be said that financial institutions are followers of the internationalization of other Japanese industries. In this connection, Table 3 shows the planned extensions to Europe of Japanese banks during the firsthalf of 1989. It is noticeable that we can see the name of Birmingham three times alongside with the names of Frankfurt, Amsterdam, and Brussel. This is because Birmingham is near Derbyshire where the Toyota Motor Company is going to build a factory, and Japanese banks are going to follow it.

171

(19 .6)

(25.5)

132

(15.6)

.4)

141

(14.0)

(23.2)

150

(14.7)

188

(31.6)

322

239

(31.2}

424

1,603

(28.1}

874

(100.0)

847

(100.0)

1,007

(100.0)

1,020

(1 00.0)

(100.0)

1,018

143

(39.2)

(35.9)

(38.2)

(100.0)

(100.0)

9,859

(17.4)

(12.1)

1,360

1,720

164

--------- --------- --------- --------- --------- --------- ----------

167

Total

159

533

365

3,770

(16.3)

--------- --------- --------- --------- --------- --------- ---------(23.6) (18.8) (19.0) (19.1) (14.0)

238

286

194

340

Other

453

439

(17.6)

--------- --------- --------- --------- --------- --------- ---------(45.0) (40.1) (43.0) (32.7)

(18.5)

--------- --------- --------- --------- --------- ---------- ----------

(28.6)

216

175

237

250

1988. 1

2,776 --------- --------- --------- --------- --------- --------- ---------(17

Asia

EC

North America

11971-7311974-7611977-7911980-8211983-85 11986-881

Note:

1. * indicates the outstanding tatals as of 1988. 2. The figures in parentheses are percentage ratios to the total. Source: Toyo Keizai lnc., Overviews of Overseas Establishments of Japanase Corporations, 1989, 3.

I

Table 1: The Number of the Newly-Founded Overseas Establishments of Japanese Corporations (All lndustries}

;(!

~

tJj

0 :I

3:

'["'*

{I)

s·

()

ttl

~

0

......

f

Other

Asia

EC

North America

(27.8)

(29.9)

72

(100.0)

77

(100.0)

(100.0)

50

(20.0)

(100.0)

82

(19.5)

16

(26.8)

(100.0)

150

(22.0)

33

(26.0)

39

(30.0)

45

(22.0)

(100.0}

221

(23.5)

52

(19.0)

42

(29.4)

65

(28.1)

(100.0}

993

(22.1)

219

(26.8)

266

(29.2)

290

(22.0)

218

--------- --------- --------- --------- --------- --------- ----------

(26.4)

(15.6)

10

(42.0)

22

(25 .6)

21

(28.0)

62

--------- --------- --------- ---------- --------- --------- ----------

19

(36.1)

(46.8)

12

26

36

21

(20.0)

10

(18.0)

33

--------- --------- --------- --------- --------- --------- ----------

20

23

(9.7)

(7.8)

23

--------- --------- --------- --------- --------- --------- ----------

7

6

9

1988.

--------- --------- --------- --------- --------- --------- ----------

11971-7311974-7611977-79 11980-8211983-8511986-881

Note:

1. * indicates the outstanding totals as of 1988. 2. The figures in parentheses are percentage ratios to the total. Source: Toyo Keizai lnc., Overviews of Overseas Establishments of Japanese Corporations, 1989, 3.

Total

I

Table 2: The Number of the Newly-Founded Overseas Establishments of Japanese Banks, Securities Firms and lnsurance Companies

1

~

{12

~

... §

0

00

Impacts of the EC Single Market on Banks

81

Table 3: The Planned Extensions of Japanese Major Danks into EC Countries During the First Half of 1989 Sumitomo Bank Fuji Bank Sanwa Bank Tokai Bank Mitsui Bank Taiyo Kobe Bank Tokyo Bank Daiwa Bank Industrial Bank of Japan Long-Term Credit Bank of Japan Mitsubishi Trust Bank Toyo Trust Bank Chuo Trust Bank

London Agent Amsterdam Subsidiary Birmingham Office, Munich Branch Birmingham Office, Amsterdam Subsidiary Birmingham Office, Amsterdam Subsidiary, Frankfurt Subsidiary Frankfurt Subsidiary Birmingham Branch Madrid Office Paris Subsidiary, Milan Branch Frankfurt Subsidiary Dublin Subsidiary Frankfurt Office, Brussels Subsidiary Brussels Subsidiary

Source: Nihon Keizai Shinbun, 1989.6.29, and other.

(2) For banks, to do securities business, and for securities firms, to do banking business. As is weil known, Japan adopts the Separation system between banking and securities business, whereas the so-called universal banking system has been adopted in European countries. So, Japanese banks can do the securities business in Europe that they cannot do in Japan, and the same for securities firms. Banks are particularly eager to engage in the investment banking business these days, as firms are increasingly raising funds by issuing bonds and stocks rather than by borrowing from banks. In fact, Japanese banksoften become co-underwriters of bonds issued in Switzerland as weil as in London, even though suffering from some restrictions imposed by Japan's Ministry of Finance. The banks can do securities business throug:t a subsidiary, but not through a branch. This is because domestic legal restrictions do not 6 Matsugi!Oberhauser

82

Jun'ichi Senda

allow J apanese banks to engage in securities business through an overseas branch, even if the host country authorizes it. This is the main reason why, as Table 4 shows, the percentage of the number of extensions through a subsidiary is higher in the EC than in the north America where the separation system of Japanese type is adopted. (3) To grow internationally and globally, in order to serve their clientele betteras weil as to malce more profits for themselves. Japanese banks not only transfer Yen funds to Europe and take foregin funds into Japan through their European branches or subsidiaries, they also raise and use funds within Euro-money markets and globally. To put it concretely, Japanese banks in Europe are raising funds by taking the Eurodollarfunds and placing CDs. They use these funds to participate in syndicated loans and underwriting securities, etc. J apanese securities firms are also engaging in the international securities business by originating and underwriting the issue of securities such as convertible bonds, warrants bonds, and others. In diversifying the way of finance, European markets, notably London and Switzerland, are very important for Japanese corporations, investors, and consequently for Japanese banks and securities firms. (4) Toserve European enterprises. As mentioned already, Japanese banks came to Europe mainly to serve Japanese corporations operating in Europe. However they have now begun to serve European local enterprises and multinationals. But it is not easy for Japanese banks to serve 5uropean customers because they do not have the relationships with and information about European firms, which are necessary for banking business. So it is said that Japanese banks do not play a major role at least as far as bank loans in Europe are concerned. On the other hand, Japanese securities firms, such as Nomura Securities Co. and others, are very active and powerful in originating and underwriting securities of European enterprises and multinationals.

34

21

426

246

267

Total

939

127

55

280

230

247

Total

107

3

4

26

56

18

Subsidiary

80

8

8

27

28

9

Representative Office

Securities Firm

187

11

12

53

84

27

Total

Note: Banks as of 1989.6.30, and Securities Firms as of 1988.6.30 Source: The Weekly Journal of Banking and Public Finance, 1988.8.1. and 1989.8.7.

81

23

23

Other

0

144

54

82

Asia

Oseania

77

88

65

90

Europe

60

Representative Office

97

Subsidiary

North America

Branch

Bank

Table 4: The Number of Overseas Branches etc. of Japanese Banks and Securities Firms

~

i

0

:I

~

~

cn 5"

(")

tc

0

e-

....0

f

84

Jun'ichi Senda

3. Implications of the second banking coordination directive for Japanese financial institutions I apanese financial circles have paid much attention to the Second Banking Coordination Directive which was proposed by the EC Commission in February 1988 and adopted by the Council in Iuly 1989. The Directive has three main points. The first is a single banking license, the second is a universal banking system, and the third is reciprocity to third countrys. Lefs take a Iook at them one by one.

3 .1. Single banldng license

In this system, a financial institution authorized in any member state will be able to carry on all banking activities by freely establishing branches anywhere in the Community. Moreover, a financial institution which extends activities into other member states is supervised by the competent authorities of its home member state, not of its host member states (principle of home member state control). Consequently a bank can do all its business in a host country, including business which is not permitted to a host country bank. It seems certain that in this system the financial systems of member states tend to converge to the least regulated one and will contribute to the formation of a single integrated financial market among EC countries. I apanese institutions have shown two kinds of reaction to the single banking license. Firstly, Iapanese banks and securities firms which already have at least a locally-incorporated subsidiary in EC will welcome the new system, for they will be able to freely expand branches of a subsidiary thoughout the Community. On the other band, those which do not yet have a subsidiary in the EC will try to establish it, because once a subsidiary is authorized, it will become the foothold for EC-wide financial business.

Impacts of the EC Single Market on Danks

85

3.2. Universal banldng system (ajull range ofbanldng services) According to the Directive, a bank granted the single banking licence can engage in a wide range of financial services which consist of traditional banking services as well as Ieasing, portfolio management and advice, investment, and securities business, etc. In Japan, similar to the U.S., banks arenot allowed to do business relating to securities except for public bonds and commercial papers. So Japanese banks welcome the adoption of the universal banking system in EC. Moreover, they begin to strengthen the request to abolish Article 65 of the Securities and Exchange Law of Japan, using the Directive as one of the grounds for their argument. On the contrary, J apanese securities firms have watched the development of EC financial system with anxiety. They stress the "defects" in universal banking system, citing the fact that in Germany, which should be regarded as the mother country of the universal banking system, the volume of issues and transactions of stocks and bonds are rather small. 3. 3. Reciprocity to the 1hird country Article 7 of the Directive sets out special procedures for the authorization or acquisition of a banking subsidiary in the Community by outside banks. Namely the competent authorities ofthe member state concerned should suspend decisions on the authorization or aquisition of a banking subsidiary by a third country, untill it becomes apparent that the credit institutions of all member state are enjoying reciprocal treatment in the third country. What does reciprocal treatment or reciprocity mean? This was a matter of Japanese financial circle's concern for a while. Banks argued that reciprocity basically meant to require the third country to adopt a same system as the Community, a universal banking system. Securities firms, however, opposed such a strict interpretation of the term. On April13th 1989, the EC Commission published a revised version of Article 7 of the Second Directive. In this new version, the term "reciprocity" itself disappeared and was replaced by the phrase

86

Jun'ichi Senda

"effective market access and competitive opportunities". More concretely, instead of a reciprocity test, three tests are propose