(click on pictures for better viewing)

Last week, we learned that industrial production rose yet again in Japan clocking in at 1.4% month-on-month in September after having increased by 1.6% in August.

Companies said they planned to increase production in October and November as well, indicating the recovery from a record export collapse in the first quarter is holding up. Growth in China is generating sales for manufacturers including Hitachi Construction Machinery Co., which this week said it has worked off stockpiles that piled up during the recession.

“The pace of the recovery is faster than expected,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. in Tokyo. Withdrawal of stimulus in the U.S. and Europe may cause output and exports to slow down this quarter, Miyazaki said, “but so far, today’s production report showed few signs of that.”

This is good news for Japan's economy even if it seems that Japan may simply be re-deploying old tricks in which companies are leveraging external demand but the domestic economy remains unable to pick up on the momentum. As ever, the disconnect between the level and flow of domestic activity (and price pressure) created by the domestic economy and the additional boost from external demand and asset income remains one the main perspective through which to look at the Japanese economy.

Within this context, the notion of Japan being dependent on exports to grow has emerged; initially as a strong market discourse and since in a more formal theoretical light in the form of the humble contribution of yours truly. It still represents a powerful market discourse and in fact, the idea of export dependency or reliance on external demand has been propelled to the main scene of the current economic turmoil as it has slowly but surely dawned on market participants and policy makers that the extent to which global imbalances need to be resolved, we have to find someone to run the deficits. And although this may seem a simple task, it has proved decidedly difficult to make the puzzles match in a world where deleveraging remains a key driving force on both the microeconomic and macroeconomic level.

In this entry I thought it would be interesting to look at a topic which combines the two perspectives above, that is; both the theoretical and the more market oriented narrative. On the former, this analysis would seek to move the analytical perspective down a notch from the pure macroeconomic level to a microeconomic level linking data on the company level (company accounts) with macroeconomic data (national accounts). On the latter, the analysis would provide some empirical foundation for the often cited relationship between a positive reading on industrial production/capex and a pick up in external demand, or more precisely the link between corporate activity and exports.

The analysis will be based on data from the Japanese trade ministry (METI) and OECD and will cover the period 1960Q1-2008Q4 (mail me for the excel sheet). On the company side, I will use data on sales (topline) and as well as profits (operating and ordinary). I will also distinguish between the manufacturing and non-manufacturing sector since one might expect, in Japan's case, the accounts of the former to be considerably more sensitive to external demand than in the case of the latter. With respect to national accounts I am using the OECD CARSA methodology which essentially signifies that we have current prices at annual levels with seasonal adjustment.

In line with the spin traditionally served here at Alpha.Sources, I will be looking at an increase in the connection between corporate sales and profits and external demand as an implicit function of age. This is to say, that this disconnect between domestic momentum and the ability of Japanese companies to generate revenues and thus growth based on external demand is a function of the increase in Japan's median age.

The main results of the analysis can be summarized in the following points.

• The positive relationship between the change in Japanese companies' profits/topline and the change in exports or the current account has increased markedly in a post 1990 and specifically post 1998-2000 context. This effect is predominantly a phenomenon observed amongst manufacturing companies.

• The empirical analysis suggest that Japanese manufacturing companies are now highly reliant on external demand to generate sales, profits and thus in some sense investment activity. 

• The sensitivity of the sales of manufacturers to the volume of exports has increased by a factor of 60% from 0.25% to 0.4% around the period where Japan breaches a median age of 40 years.

• The sensitivity of the ordinary profits of manufacturers to the current account has equally increased markedly in the period where Japan has moved to a median age above 40. In the period after 1997 results indicates that a 1 unit (JPY) increase in the change of the current account has led to a 0.23 unit (JPY) increase in the ordinary profits of Japanese manufacturers which compares with a corresponding non-significant relationship in a pre 1998 context.

A Look at Company Performance, the Current Account and Correlation

Regardless of whether one squares the outlook on the Japanese economy, there is no doubt that the dent which the corporates have taken as a result of the economic turmoil is unprecedented.

Notice that I have indexed the charts with 1995 as a base year and then realize that current nominal value of company revenues has dropped to a level comparative to the one observed in 1993-1994 in relative terms. In absolute terms, the aggregate value of sales of Japanese manufacturers stood at some tn 84 and 82 JPY in Q1-09 and Q2-09 respectively which is value not observed since 1989 in nominal terms. This should give us a clear picture of drop in activity and then also the difficulty with which Japan will have in restoring productive activities back to normal whatever this might mean as we move forward.

With respect to Japan's external balance it is a bit more complicated, but there are some important points to remember as we move through the charts. Japan has been running an external surplus since the beginning of the 1980s, but as I have spent an entire academic paper explaining, it is only in the latter part of the 1990s and into the 2000s that this external surplus seems to be connected strongly with output growth. Moreover, it is important to distinguish between net exports and the income balance since the latter has been particularly important driving Japan's external balance in a from the 1990s and onwards

In light of the graph above, we can say that given the sharp decline in domestic growth in a post 1990 context external demand has take over, so to speak, both in terms of keeping national savings higher as well as contributing to headline growth. It is along the same axis that we would then expect the relationship between Japanese companies and external demand to have increased.

Moving on to some simple correlation analysis the following two charts which show the correlation between company sales and exports as well as the trade surplus/GDP will give us a nice initial overview of the data in question.

The representation is in changes (which is not unimportant) and smoothed by taking the correlation as a 4 year moving average (i.e. 16 quarters). The y-axis is ending period which means that a correlation for e.g. 1997 means correlation between 1993-1997.

Simply eye balling these charts does not seem to provide decisive evidence of the hypothesis of export dependency. Sure, we can easily see that the period 1997-2008 has seen a sharp increase in the relationship between company sales and the flow of exports as well as the share of external demand and GDP, but the key point to take away from these graphs is that they appear to be mean reverting (with a very weak positive time trend in the case of the second). This would mean then that the connection currently observed between exports and corporate sales is not unique. However, if we focus the attention on the second graph, it is also pretty clear that it is only in a post 1980 context that we have observed periods in which the correlation between sales and the trade surplus has been consistently and strongly positive. This would then seem to lend some evidence to the idea of export dependency and how this may be a distinct characteristic of contemporary Japan.

Moreover it would seem that it is not possible (except in the case of the correlation between sales and the trade surplus) to distinguish decisively between manufacturing and non-manufacturing. In later sections and using simple ordinary least squares analysis, it is however possible to differentiate this statement considerably.

Before we come to that though, it would be apt to use the initial conclusion above and have a closer look at the post 1980 period. Moreover, and courtesy of a more richer dataset on the macroeconomic level we can now augment the analysis with the income balance and thus the current account. This may seem trivial, but is very important in Japan's case since the income balance in particular has driven the external balance in recent years. From a company point of view and in order to be consistent, I will correct for the importance of the income balance by including company profits as the main gauge for company performance.

This chart (in level form and only for manufacturers) seems to be more supportive of the evidence of export dependency at least if we allow ourself the luxury to look only at the period from 1980s. The chart shows however that the strong positive relationship between the current account and the profits of companies is a relatively recent phenomenon which took off somewhere around 2000. Consequently, in the period from 1983 to 2000 the correlation between the current account and company profits in the manufacturing sector has been negative and in some cases strongly negative.  

From this brief look at correlations, we should be satisfied that when it comes to the period post 1998 (more or less) the performance of Japanese companies have been strongly linked to external demand and income derived from external assets. Yet, this does not provides decisive evidence for export dependency measured as a strong and growing link between the performance of companies and external demand. In order to show this we must turn our attention to a bit more sophisticated statistical techniques although I can promise you that it won't be very fancy.

Some Models to Go With That?

The analysis which proceeds will center on the two following simple models which take the first difference or percentage change as a linear function of the change in either the value of exports or the current account.

The first regression will also be run with the sales of non-manufacturers as dependent variable in order to check the initial conclusion above that it is really not possible to distinguish between manufacturers and non-manufacturers[1].

Now, if you don't care about statistical analysis, you may stop here and move straight to the conclusion or go back to the summary in the beginning where the main results are reported. If you decide however to move on, rest assured that, following the models above, I never move beyond univariate OLS, so things should not get too complicated if you are a little bit familiar with statistical analysis.

Note that throughout the results presented below, the full period will be Q1 1960 to Q4 2008, period 1 signifies the period where Japan had a median age below 40 and period 2 is consequently defined as the period in which Japan had a median age above 40.

If we begin with the first model that plots sales of manufacturers as a linear function of the volume in exports (both in % changes), the results for the full period, period 1, and period 2 regressions return the following results [2].

For those of you who are familiar with the results presented in my earlier work on Japan, these results should be well known. In this way, it appears that the relationship between the sales of manufacturers and the volume of exports has increased markedly, both in terms of the marginal effect as well as in the context of the overall fit of the model. Since this model is a log-log model, we can interpret the coefficient in percentages and in this way, the estimation indicate that the sensitivity of the sales of manufacturers to the volume of exports has increased by a factor of 60% from 0.25% to 0.4%. In words, it means that in the second period the estimation suggests that a 1% increase in exports will lead to a 0.4% increase in the sales of manufacturers whereas the corresponding number is 0.25% in period 1.

Looking at the overall fit of the relationship, the results clearly indicate that this representation leaves out a considerable source of the variation in the sales of manufacturers which is entirely to be expected. As always, it is essentially a qualitative and theoretical question whether the increase in the sensitivity as well as the goodness of fit (from 0.08 to 0.13) represents de-facto export dependency or simply indicates an increased reliance over and above other more important factors.

In relation to the second model which plots operating profits as a linear function of the change in the current account, it is important to note that this model is estimated in the first difference (and thus not log-log) because the current account in some cases has been negative. Moreover, the sample period is shorter than for the first model (1980-2008) since OECD does not have data for the income balance prior to 1980.

On an overall basis these results underpin those from the first estimation although they seem to confirm the hypothesis to a much higher degree. Abstracting from the full period result which serves as an anchor for the overall significance of the relationship, the difference between the model estimated for period 1 and period 2 is striking. Consequently, the first period estimation signifying the period where the median age of Japan is below 40 shows no significant relationship whatsoever, in this sense it appears that the apparent negative relationship implied above from the correlation charts do not pass the simple causality test which OLS represents. The second period regression on the other hand returns a strong and significant relationship which indicates that a 1 unit (JPY) increase in the change of the current account will lead to a 0.23 unit (JPY) increase in the ordinary profits of Japanese manufacturers. On the goodness of fit measure the only thing we can say is that it has increased considerably to signify the increase in relationship between the profits of manufacturers and the current account. However, whether a goodness of fit of 0.15 is high in an absolute sense here is difficult to say without a more thorough and comparative study. But since we have a univariate framework, I believe this result to be quite extraordinary.

Conclusion

I hope by now that I will have either convinced you or scared you off in terms of the importance of whether Japan is dependent on exports to grow or not. I would also hope that the connection to events closer to the market is not too difficult to see. For example, Bloomberg is running the story today that the BOJ, like most other central banks, is either willingly or, dragged kicking and screaming by market sentiment, moving towards the formulation and near execution of the famed exit strategy from extraordinary monetary policy measures. Clearly, interest rates are to remain low for as far as the eye can see, but it is interesting to ponder whether the decision by the BOJ scale back corporate debt purchases is related to optimism on the companies ability to leverage domestic growth or whether it is because they see export markets reving back up in which case it would be back to the same old growth strategy. Another example would be the latest inflation reading which suggests, more than anything, the extent to which the domestic economy in Japan is not able to provide an environment in which companies can operate profitably as well as it indicates how overall domestic momentum is essentially contractory.

It is within this general economic context that the notion of export dependency becomes important and specifically how this might relate to the ageing of Japan's population. In this entry I have tried to take this idea down a notch from the strict macroeconomic level in the form of an analysis of the relationship between external demand measured through national accounts and aggregate corporate accounts. The results, I believe, speak for themselves and strongly suggest I think that Japan indeed is becoming increasingly dependent on external demand to create the growth and income the economy needs to maintain economic growth. Following from this, a number of questions present themselves, not least the most crucial general question relating the issue of export dependency to ageing in a general sense and then on to the discourse on global macroeconomic imbalances. But for now, I will let you digest the data at described and analysed above.

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[1] - Results of this regression is not formally reported in the text; please mail me if you want my excel sheet and results.

[2] - In order to be really rigorous I would have to formally test for the difference between the two periods (e.g. through a Chow Test or related method), but here it will suffice to look at the change over the period without putting a label of statistical significance on it.

(click on pictures for better viewing)

After a nice and entertaining week in Barcelona where I had the privilege not only to hold a seminar at the Universitat Autònoma de Barcelona, but also to meet a host of interesting people, I thought that it would be about time that I finished my piece on the latest data from Japan which admittedly will be a bit backward looking, but hopefully interesting nonetheless. 

Beauty, as they say lies in the eye of the beholder and perhaps this axiom is worthwhile contemplating when thinking about the immediate condition of the Japanese economy or indeed the global economy and her asset markets, but for the sake for simplicity . Consider for example the news, out a week ago, that Japan's current account surplus widened 10% in August over the year. In an economy where external demand is the main driver of economic growth, this is a significant piece of news and should rightly be interpreted as a positive sign. Or should it?

Once we read beyond the immediate headlines it becomes clear that what we are really seeing in Japan is, in fact, a pendant (even if less severe) to the Spanish situation where the improvement in the external balance comes, not from a sustained and independent pick-up in external demand, but rather from the fact that domestic demand is contracting faster than external demand thus pushing up the current account. In Japan, exports slid 37.1% on the year but as imports shed a corresponding 41.2%, the current account improved as a result. Naturally, some would want to insert the point here that since Asia (and in particular China) seem to be the locus of small, but definitely noticeable, upbeat signs in the global economy, Japan should be at the forefront to snap up the gains. Surely this is true, and one wonders how far exports would have tumbled on the year if China had not been there to pick up the slack; yet, as we can see from the figures above; the downward momentum remains in spit. It seems, that beauty indeed is a subjective concept.

With respect to the most recent event as it were in the Japanese economy, the BOJ meeting held last week did not really bring much new to the table with respect to policy measures as rates were kept in QE mode. However, and as Societe Generale's Gleen Maquire points out in a recent publication (the weekly monitor) the point is moving closer with respect to whether the BOJ will extend its extraordinary credit measures or stop them. This would then be a discussion about the much debated exit strategies by part of especially the G3 central banks; how it will be conducted and equally as important when. The current message seems to be that while it is difficult to see the BOJ abandoning ZIRP any time soon, the BOJ is not going to extent the current measures of credit support in the form of the purchase of corporate bonds and commercial paper as well as a special funding program for corporate finance facilitation from the point of view of banks. As Maquire correctly points out and regardless of whether ZIRP is set to continue or not, a withdrawal of these measures would naturally represent a de-facto policy tightening and it is unclear just what the effect will be on the Japanese economy.

Moving on to a piece by piece look at the recent monthly data, August's numbers did bring with it a bit of light (September number will be out at the end of October) although the fundamentals have hardly changed.

Kicking off with domestic consumption, the headline figure reported by the statistical office clocked in a nice increase of 2.6% y-o-y which is of a magnitude not seen since January 2008. It is interesting to differentiate the headline figure of 2.6% (which is a real figure) is in somewhat stark contrast to the nominal decline in the consumption of workers' households of 1.4%. At this point, the average monthly change on an annual basis for the overall consumption index in Japan is -1.2% (up from -1.8% before the 2.6% figure reported from August); I will hold off any premature conclusions of a sustained pick-up in consumption before seeing what is in store in the coming months.

With respect to prices, Japan now looks thoroughly entrenched in deflation;

The general core index thus declined 2.2% over the year with the core-of-core index declining 2.6%. So far in 2009, the core-of-core index has declined 8.3% with an average monthly decline of 1%. This is a strong testament to the strong downward momentum in the domestic economy and underpins the following very reasonable assessment by Glenn Maquire; 

Realistically, it will be very difficult for the Bank to forecast positive inflation over the next two to three years. The Consumer Price Index continues to fall sharply and the output gap remains extraordinarily large by any metric. With the yen now appreciating and political opposition to a stronger yen having passed with the Liberal Democratic Party losing power, Japan is likely to remain more at risk of deflation than inflation over the entire period including calendar 2012.

Especially the point on the output gap is important even if we don't observe this specific data point. I would add the qualifying comment that one thing is the size of the output which in some sense would signify the immediate damage incurred by the Japanese economy in the context of the financial crisis and another thing is the speed (and ability) with which Japan can close this output gap on the basis of domestic activities alone. A point that I would especially emphasise here is the simple fact that the potential growth rate of Japan is likely to be in an almost perpetual decline due to the demographic situation. In this sense, it may increasingly become a question of what in fact the potential growth rate is based on domestic activity (i.e whether it is positive at all) than a matter of closing the output gap.

On the labour market, things improved rather surprisingly in August with the unemployment rate declining from 5.7% in July to 5.8% in August.

In the context of the financial crisis, the unemployment rate has so far increased roughly 2% and although the number in no means is alarming in a relative sense, the prospect of a continuing increase is sure to make cautious consumers even more cautious.

Turning finally to the corporate sector, industrial production has recovered somewhat after the absolutely horrid decline observed in the first half of 2009. The question is the extent to which we should see this as a decisive positive sign or not.

Once again, this is a matter of interpretation but when for example the Swedish bank calls it a "new dawn" for industrial production after looking at the graph above I find it difficult to see exactly where this dawn is. Consequently and while it is certainly true that the index for industrial production has recovered some ground after bottoming out in February 2009, it is still situated 18.3% lower than its average value (measured from January 2003 to July 2009). This compares with an index for all industrial activity running some 7% below its historical average. These numbers are innocuous in themselves, but the important thing is the level of activity which can be supported by the Japanese economy and although we are certain to see some recovery in the data the underlying momentum may ultimately disappoint.

The chart to the right taken from JPMorgan's Global Datawatch is perhaps the clearest picture of what export dependency means in the case of Japan and how it drives the level of industrial activity.

With respect to the Tankan, the survey showed a pick up in sentiment which follows leads nicely the pick up in real economic activity. Pessimists still outweigh optimists by a rather large margin and it shall be interesting to see whether the apparent (and indeed lingering) positive sentiment among global market participants will spill over forcefully into expectations and investment plans moving forward.

Summary - A Beauty or a Beast?

Some of you may feel that I am spinning the story of Japan too much towards the negative sign. I don't believe this is the case however, and although I can see that some positive signs have emerged, I remain skeptical that it will be enduring. Call me a permabear, but 3-4 years of Japan watching has taught me to be careful when it comes to emphasizing positive news on the Japanese economy, and especially so when it comes to the momentum of the domestic economy.

This brings us to the global economy and the simple fact that the extent to which one would narrate the outlook on the Japanese economy in relative positive light would be tantamount to the extent that one also sees a relative benign outcome for the global economy. Here I am also skeptical which is ultimately also why I remain cautious on Japan and especially so in an environment where the JPY does not seem to benefit from low volatility and risk proneness to the same extent as before the Fed engaged in QE. But that is certainly a discussion for another day; for now, I will leave you my dear reader with the judgement on the immediate outlook for Japan's economy remembering full well that beauty indeed lies within the eye of the beholder.

As the discourse is slowly but surely tilting towards exit strategies, by part of central banks, from ultra low interest rates and unconventional measures the BOJ opted to day to maintain a very cautious stance towards the incoming green shoots and whether they will prove enough to lift Japan out of the mire.

(quote: Bloomberg)

Officials kept the benchmark overnight lending rate at 0.1 percent, and maintained their emergency lending programs to banks and companies. While describing the economy as “showing signs of recovery,” an upgrade from the “stopped worsening” assessment last month, the Bank of Japan said in a statement in Tokyo today that it still sees “downside” risks to growth. Today’s statement reflected global doubts about the strength of a recovery from the deepest recession since the Great Depression. A Bloomberg News poll of U.S. households published today showed Americans plan to refrain from boosting spending even after the biggest drop in consumption in 29 years.

“Most countries are experiencing a recovery, but few can be confident about the sustainability of those recoveries,” said Yoshiki Shinke, a senior economist at Dai-Ichi Research Life Institute in Tokyo. “Japan will be the last country to raise its interest rate” because it has the added problem of deflation, he said. Bank of Japan Governor Masaaki Shirakawa told reporters in Tokyo today that while stimulus measures have helped the economy improve, “we’re not confident about the strength of private final demand after those effects fade.” He added that central bankers are monitoring the appreciating exchange rate, which is contributing to the drop in Japanese consumer prices.

Japan's problems are many fold but the most severe issues in the context of reading the tea-leaves of the recovery is the uncertainty attached to question of whether the current above par environment will linger beyond the last effects of the stimulus (which was front loaded due to the elections) as well as any inventory bounce which may come as Japanese companies rebuild their empty shelves in Q3.

It is difficult not to sympathize with the BOJ in its careful approach here since if you take a look at the underlying demand conditions they are, to put it mildly, sluggish! Only a week ago, I discussed the situation on the corporate level where companies were hit by falling top line sales on the domestic market and, as a result, only very carefully expanding capex. Moving on to other key economic indicators it is pretty poor reading if we look at the domestic economy in isolation.

By far, the most preoccupying problem has to be the fact that Japan's inflation rate is moving beyond sub-zero and essentially into the abyss which is a painful and almost, if you will allow me to be dramatic, tragic outcome after two decades of fight against this very malaise. Now, I know that we are observing one-off effects from high oil prices in the summer of 2008, but try to have a look a the actual numbers. Consequently the index that actually includes energy is currently running (in July) at a rate of decline of 2.2% whereas the index which excludes energy and fresh food is running at an annual decline of 2.6% and thus more than the headline gauge. Clearly, the BOJ would like to see this figure correct or even stabilize over the summer before contemplating tweaking nominal interest rates.

With respect to consumption, the figure tracked as a headline gauge for domestic demand on the consumer side is quite volatile, but it should not escape our attention that despite its volatility, it has been consistent below the 0% growth mark throughout 2009. Thus the average annual growth rate on a monthly basis has been -1.8% so far in 2008 which suggests as a simple yardstick the negative drift we need to apply to the evolution of domestic demand in Japan.

Finally there is the labour market where the unemployment rate has increased rather harshly since the beginning of 2009 following a mean reverting pattern around 4% throughout 2008. 5.7% which was the reading in July certainly won't make any headlines comparing to the eye-popping figure we are seeing in e.g. Spain or elsewhere, but it is worthwhile contemplating this in a relative sense and thus the effect it is likely to have on the behaviour of already cautious households.

Where Goes the JPY?

If the round-up above suggest, in a real economic context, the current shaky condition of the Japanese economy it seems that Japan now has a new issue to deal with; the unduly appreciation of the JPY. Now, of course these days it may be of less use to look at the JPY measured against G7 currencies rather than for example against China, but the graph below should still capture much of the essence.

I think it is very interesting here to observe that in a post-crisis context the JPY has gained about 20% against the Euro and Buck where it has been ranging since the latter part of 2008. Clearly, this has an effect on the real economy in so far as it reduces the competitiveness of Japanese companies relative companies in the US and Eurozone (not to mention the UK); and remember, deflation here is becoming a zero sum game since at the moment the US, the Eurozone, and the UK is also suffering from a bout of deflation or very low inflation.

Of course, this presents Japan with a whole new problem in the sense that while Japan could hitherto expect to get a double boost from an increase in risk aversion as carry trade activity took hold lowering the Yen and allowing Japan to export away, this route is getting increasingly crowded. More specifically, Bernanke has entered the scene and as analysts and commentators start talking about the new "victims" of the global carry trade punt in the form of those brave souls among central bankers who dare raise interest rates before movement in the G3, Japan cannot be certain to be the exclusive funding currency. It has a rival in the form of the USD and notwithstanding the obvious consequences for the global economy that Bernanke is putting up a 0% interest rate on the world's most liquid fiat instrument, Japan might find itself pinched here.

Of course, there is a solution here even though it seems unlikely at the moment, I believe, that it will come to pass.

It was still telling that the branch of RBS in Japan (RBS Securities Japan Ltd) was quoted, by Bloomberg yesterday, personified by chief economist Junko Nishioka for noting, rather dryly I'd might add, that the most efficient way to spur growth in Japan would be through a devaluation. Hmm, that would be fun wouldn't ... a devaluation amongst the G3! Once again, we are left guessing as to just what value of the benchmark USD/JPY that will jolt the MOF and BOJ into joint action; 90, 85, 80, 75 ...? I will leave my readers to do the rest of the guesswork, especially since yours truly has burnt his prediction powers once too many trying to call JPY intervention. So far though, most bets seem off as the incoming Finance Minister Hirohisa Fujii made it quite clear that there will no such nonsense of intervention to weaken the Yen. Also, if Macro Man is right and this is predominantly a Dollar story rather than a Yen story, then what can they do as MM put it earlier this week.

In a general sense, it shall be most interesting to following both intra G3 currency movements and FX in general if and when some economies venture into a decisive tightening mode over the second half of 2009. And for Japan, well she will try to muddle through of course. I am watching the inflation picture closely as well as of course we must watch the extent to which Japan can really couple on to the Asian growth spurt we are currently observing. With respect to policy decisions, I feel confident that the BOJ is locked in at this point to, if not continue QE, then at least to keep nominal interest rates at or very close to the zero bound.

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[1]: Note, if you correct for stationarity the co-relationship dissipates so I may be over-stepping my bounds here.

Much pomp and circumstance was certainly made in relation to the fact that Japan actually grew in the second quarter at a full annualized 3.7 percent in the second quarter of 2009. Yet, the underlying numbers to suggest a recovery are still sorely missing. Deflation now seem to have taken hold, unemployment is rising fast and although the recent manufacturing PMI provided us with an upbeat signal, the underlying trend still is still that of a very tepid recover, if at all, or just a plain slump.

(quote Bloomberg)

Japanese businesses cut spending for a ninth quarter as the global recession squeezed profits, underscoring the challenge for the incoming government to sustain a recovery from the country’s worst postwar slump. Capital spending excluding software fell 22.2 percent in the three months ended June 30 from a year earlier, after dropping a record 25.4 percent in the previous quarter, the Finance Ministry said today in Tokyo. Profits slid 53 percent.

Sales fell 17 percent, the second-biggest drop on record, indicating global demand hasn’t recovered enough to encourage companies to buy more plant and equipment. Sanyo Electric Co. and Seven & I Holdings Co. are among businesses scaling back. “Companies have too many resources, and until that situation changes, they won’t have to invest in more equipment and they won’t need to hire more people,” said Seiji Shiraishi, chief economist at HSBC Securities Japan Ltd. in Tokyo.

(click on graphs for better viewing)

On a y-o-y and q-o-q basis, the sales of Japanese companies fell 17% and 4.5% respectively. Especially, manufacturing in general and machinery and equipment producers saw a rapid decline in sales. Investment in plants and equipment fell back sharply on an annual as well as a quarterly basis at 21.7% and a full 39.1% respectively. The pronounced fall in Q2 investment owes itself to an abnormally large outlay in Q1 2009 which has consequently been paired in the period just ended. As can be seen in the graphs to the right, the manufacturing sector has been hit much harder than the non-manufacturing sector which is not difficult to understand if you think about the fact that it is this sector of the Japanese economy which is most exposed to the external environment. This is to say, that the manufacturing sector's  top line is very sensitive to external conditions on the margin. Between Q4-08 and Q2-09 the cumulative drop in Japanese manufacturers sales was a whopping 35% almost double that of the non-manufacturing sector's corresponding toll of a drop of 18%.

With respect to investment in plants and equipment (corporate capex) the picture is, interestingly, the reverse with the investment by the non-manufacturing sector falling much more sharply during the present turmoil. On a four quarter moving average basis, the change in investment in plants and equipment for of the non-manufacturing sector has been falling ever since the first quarter of 2006 with a cumulative drop of 37%. The corresponding number for the manufacturing sector shows that the investment of plants and equipments have been falling since the third quarter of 2007 with a cumulative drop of 19%.

Finally, in the context of operating profits (that is, profits derived soled from the company's primary operations), the non manufacturing sector is still well in the black whereas the manufacturing sector has moved from a figure much below average in Q4-2008 to outright red figures in Q1-09 and Q2-09. Between Q1 2000 and Q3 2009 the average quarterly profit (nominal) for Japanese manufacturers was a little over 4 billion Yen.

In Q4 2008, the consolidated profit read 761 million yen and in Q1-09 and Q2-09 the numbers had turned into an outright decline with negative profit of 3.5 billion and 645 million respectively. Conversely, the non-manufacturing sector was, albeit still below average, performing much more strongly with solid black numbers throughout the crisis.

No Recovery Here

While there certainly may be places the newly elected party to rule Japan can look for green shoots and evidence of an impending recovery in Japan, corporate capex and profit numbers are not one them. Neither are, of course, the labour market, the deflation debacle, as well as the household sector which leaves us with the obvious question of where then? Second quarter clocked in better than most had expected and ironically, despite the analysis fielded above, upbeat signals from industrial production and the manufacturing sector in general are cited as the main reason. I will let my readers judge for themselves by perusing the graphs above and then also note the following crucial point made by Soc Gen's Gleen B. Maquire in one of their recent economic outlook reports (my emphasis);

The bulk of the contribution to growth came from net exports. Exports increased by 6.3% qoq while imports declined by 5.1% qoq. Overall, net exports contributed 1.6ppt to Q2 growth. The recovery in the Japanese economy is starting to look eerily similar to the 2001-03 recovery when Japan emerged ahead of Europe and the US. This is largely a China dynamic with Japan’s exports to China (and indirectly to the rest of Asia) recovering in step with China’s stimulus measures coming on line.

(...)

Industrial production is responding to robust demand from China for capital equipment and
industrial goods as well as tentative signs of a recovery in the durable goods cycle within Asia and globally.

So, this appears to be an export story in which case positive news from Japan should not surprise us at all. Macquire goes on to argue that since Q2 did not see a bounce back in inventories from the sharp de-stocking of Q4-08 and Q1-09 this, expected, bounce in inventories. I remain skeptical of this claim since I don't necessarily believe that the new level of growth will necessarily support any rapid re-stocking of inventories, but time will of course tell very soon.

Finally and specifically in relation to the analysis above, it is also interesting to ponder the discrepancy between the manufacturing and non-manufacturing sector in relation to the idea of Japan being dependent on exports to grow. Clearly, the manufacturing sector's higher sensivity with respect to the financial crisis and its top line makes sense since external conditions deteriorated very rapidly. Conversely, the domestic economy of Japan was not struck by a major, and relatively large, credit crunch. Hence, we see the top line of non-manufacturers relying more on domestic demand decline less. On the other hand, in relation to corporate capex the manufactures' slump in investment is very exclusively tied to the financial crisis while that of the non-manufacturers seem much more broad based. Once again can we rationalize this through the idea that the manufacturers remain tied to external conditions while that of the non-manufacturers is increasingly tied to the domestic market.

So, does this last niggle make sense? I am not sure, but it would be an interesting thing to check.

I am rushing but would be remiss, of course, if I did not mention Sunday's landslide victory of the DPJ in Japan which marks an end to a +50 year reign of the conservatives.

The DPJ has won 300 seats in the 480-seat lower house, ending 50 years of almost unbroken rule by the Liberal Democratic Party (LDP), NHK TV says. DPJ leader Yukio Hatoyama hailed the win as a revolution and said people were "fed up" with the governing party.

Prime Minister Taro Aso has said he will resign as head of the LDP, taking responsibility for the defeat. Japan is suffering record unemployment and its economy is struggling to emerge from a bruising recession.The DPJ has said it will shift the focus of government from supporting corporations to helping consumers and workers.

and here is the Economist;

IN A land of volcanoes and earthquakes the seismic shift is all too common. But for decades Japan’s political landscape has not reflected the country’s geological uncertainty. A general election on Sunday August 30th should change all that. Opinion polls suggest that when voters go to the polls for the powerful lower house of the Diet (parliament), the opposition Democratic Party of Japan (DPJ), will trounce the Liberal Democratic Party (LDP), thus ending over 50 years of nearly continuous rule.

The magnitude of the defeat facing Taro Aso, the prime minister and LDP leader, is startling. A poll in Thursday's Asahi Shimbun suggests that the LDP’s representation in the Diet could be more than halved to about 100 seats. The DPJ could take as many as 320 of the chamber’s 480 seats.

Needless to say, this is significant not least for its economic ramnifications which I hope that I will have some time to deal with later this week (meanwhile see this by Edward).

A preliminary apology is in order. What follows is uber wonkish and should be consumed preferably in small quantities. In fact, I am not sure that I have gotten everything right yet. Of course, we never are but in this case it is an important point to make up front. The argument is loosely built on my upcoming master's thesis which seeks to explore the connection between ageing and capital flows and specifically how and whether the former may lead to a state of export dependency; where export dependency is defined as a high and increasing sensitivity of the rate of change of national income to the rate of change of the current account. This is something I have discussed extensively on AS, but in this case I am trying to give it a thorough theoretical spin which means that any non econ-wonks are likely to be lost in translation.

I should stress immediately that this is not a virtue but rather a vice, but I do think that exploring  conventional economic theory (and moving beyond?) is an important part of the process. In the end, the argument should be amendable to plain English and, as it were, plain common sense and intuition as well as, of course, empirical falsification. One thing which I can promise though is that there will be no mathematical models; at least there, I should have provided some comfort. If you want the math, you will have to wait for the thesis.

The best way to frame the following argument is perhaps to insert it in the chronology of the thesis where it appears, in the end, as a perspectivation on aggregate global capital flows. What precedes this is thus an, hopefully convincing, account of the fact that Germany and Japan are effectively dependent on exports to grow as a result of their demographic profiles.

Some Thoughts on Export Dependency

First it would be worthwhile taking a look at the following sketch (click to enlarge) which captures a lot of the issues that will be discussed below. Essentially, it attempts to show, as nastily and brutishly short as possible, what export dependency means in the context of what we could call conventional economic theory.

For non-econ wonks it is likely to be quite difficult to read, but in fact; it is fairly simple. The X-axis  represents the age of an economy here exemplified in the phases of the age transition derived from a study by Malmberg and Sommestad that discusses the demographic transition as a transition in age structure (and not population growth). But really, it could just as well be median age where a median age of 40-50 would the limit to the right and, let us say, about 20-25 to the left. The Y-axis is adopted directly from Higgins (1998,  e.g. table 1, p. 350) who uses empirical estimations to model the effect from age on, in this case, the current account. As I, Higgins also use age on the x-axis (age distributions) and on the y-axis he has age coefficients. This basically means that a negative value signifies that the age structure in the economy influences the current account negatively (i.e. pushing the CA towards a deficit) while the reverse is true for a positive value. Essentially, we need not, initially, bother with the numerical value of such age coefficients here, but merely note whether it is positive or negative and then secondarily we may look at the level effect (i.e. whether the effect is numerically large).

I should immediately point out that there are no direct empirical basis for the curves. The line which is labeled trajectory of export dependency is basically a cubed function designed to show a more less linear association between export dependency and ageing with the added and important feature (hence the cubed functional form) that export dependency tends to increase exponentially when you move into very old age. The blue line naturally do contain some empirical foundation in that it originates from an empirical study Higgins (1998) where it is constructed based on empirical estimations. I shall not go into Higgin's empirical framework here since it would take us into the dark world of time series econometrics but merely point out that Higgins manages to come up with what we could call the textbook representation of the effect of ageing on the current account and it is worth pointing out that he is not the only one. Also Supan et al. (2007), Bryant (2006), Henriksen (2002) and Summers et al. (1990) (among a myriad of other studies) postulate either through theoretical elaborations or empirical estimations a relationship which may be approximated by the chart above.

In theoretical terms, the basis for this "hump-shaped" relationship between ageing and the current account is derived in the context of the simple, yet crucial, intuition derived from Modigliani's life cycle hypothesis which states that consumers spend their working age years saving for retirement where they will dissave those accumulated assets. Then, at some point during working age there is a "peak" which is characterised by the time when the saving rate is highest and thus also, indirectly, where the effect on the current account should be largest. Following convention, this is modeled in economics through the idea of overlapping generations and often in the form of a neo-classical growth theory framework or simply a general equlibrium representative agent framework. I shall not open pandora's box and discuss the merit of these methods here but merely point out that I think it is very difficult to argue against the the basic intution which lies behind these models and thus, as it were, the intuition from the life cycle hypothesis.

In essence of course, the real issue is one of calibration and thus one of empirical analysis to see just how this postulated hump may materialise as well as of course realizing that ageing is not the only variable which influences the current account. It is also here that the fun begins and where things very quickly become very complicated. 

In this respect, it is worthwhile focusing the attention on the so-called dissaving phase which should be a natural result of the move towards an ever higher share of the elderly in the population. The basic mechanism here is simply that in standard economic models "old" economic agents will dissave their entire asset and thus as the old cohorts increasingly will outnumber the young cohorts the dissaving of the former will trumph the saving of the latter and lead to dissaving on an aggregate level. All sorts of ill prophecies have been proposed in the context of this dissaving hypothesis, not least that we are facing an asset meltdown scenario in 2050 because there will be far too many elderly wanting to offload their assets to a much smaller base of younger cohorts who cannot support a satisfactory price (yield) level.

Now, the problem here is that empirical studies have shown that the idea of dissaving, while intuitively strong, is difficult to verify to the extent that theoretical models suggest. This is not difficult to imagine I think. By very nature of the uncertainty of the mortality schedule people do not (cannot) dissave to 0 and beyond this there are may be bequest motives. In an open economy context this further creates the rather dubious situation in which economies well into their old age will have to run persistent external deficits because, presumably, savings will have decline far faster than domestic investment demands. I say dubious here because this is exactly where I have chosen to take my stab at trying to amend the theoretical framework.

Consequently, I am not so sure that this is a plausible end point in the context of continuing population ageing. Specifically, I would like to ask the simple question of whether it is actually optimal for any society to dissave as the theory postulates. I don't think it is and while it is certainly not unlikely that economies may actually dissave (defacto) they will still be dependent on exports to grow and thus the difference between the two curves into the latter age transitions represents an externality. This is also why I think that economies, in stead of responding with dissaving, will fight the point at which they reach this stage since when they do it is effectively game over. Imagine for example how the likes of Germany and Japan would ever be able to finance an external deficit brought about solely on the basis of the fact that savings has declined so fast as to not even be able to meet domestic investment demand which in itself will be declining. In this situation, wouldn't it be much smarter to maintain savings persistently higher than domestic investment demand which can of course only be materialized in an external surplus. I think it will and it is this point which you need to keep in mind as we move forward.

Implications for Global Capital Flows

With these considerations in mind, the key question then becomes; what happens when more and more economies grow to become increasingly like Germany and Japan? (As we know they will, at least in the context of the OECD). Naturally, not everyone can maintain excess exports over imports at the same time so something, as they say, has got to give and it is this something, as it were, which is the topic of this entry.

The focus on the implication of ageing on aggregate global capital flows is not new and is, in fact, an integral part of the analysis in Supan et al. (2007), Higgins (1998) and Bryant (2006) which were also mentioned above. However, in the following we are going to relax the condition of dissaving normally assumed in e.g. OLG models and accept that the propensity to run an external surplus will increase as an economy ages.

If we do this, it should not require too much imagination to see the issues that may rise. For starters, I want to reiterate yet again the trivial fact that not all economies can run an external surplus at one and the same time. This means, quite naturally, that what might be optimal from the point of view of a single economy (i.e. maintaining a surplus as it ages) may not be viable or optimal from the point of view of the global economy.

In order to frame the discussion it is natural to take our point of departure in the discourse on global macroeconomic imbalances.

As so many other things, the financial crisis has completely dislocated this system but it still worthwhile to ponder the nature of the global financial system in a post Asian crisis perspective and up until now. Consequently, the global macroeconomic landscape has long been characterized by what many has termed Bretton Woods II in which a large batch of especially Asian and oil exporting economies have been pegging their currencies to the US dollar who in turn have been running a large current account deficit to match the savings surplus in emerging markets such as China, South Korea, the Petroexporters, Brazil and Russia. In fact, if we cut a lateral line through this argument we could say that the world has hitherto been characterized by the Anglo-Saxon economies running external deficits to match surpluses in big emerging markets as well as Japan and Germany.[1] That however changed abruptly with the advent of the financial crisis and it is interesting to note the initial response by market participants and many scholars in their interpretation. Consequently, as it became clear that the US economy had been mortally wounded on the back of the subprime mortgage debacle the US Fed slashed nominal interest rates significantly. As a result the USD plummeted which led many commentators to hail the US economy’s fall from grace and specifically coined the notion of decoupling in which the Eurozone economy and Japan were pinned as the ones taking up the slack in steering forward global demand. Initial versions of the decoupling thesis thus centered on the shift in emerging market exports from the US to Japan and, especially, the Eurozone and thus in the process also a shift from the US dollar to the Euro as a global reserve currency. As it turned out this was nothing but a mirage masked by the fact that US policy makers essentially acted preemptively to a crisis which turned global during the summer 2007 and now most major central banks in the OECD have slowly bitten the bullet and followed Bernanke into quantitative easing to combat the risk of deflation which would be devastating in the context of the debt overhangs some economies face. Moreover, and as a general point, the global economy already decoupled from the US, and indeed OECD, economy a long time ago. Consequently, it is an irrefutable fact that the global economy is undergoing a fundamental change in which emerging economies such as India, Turkey, Brazil, China; Chile etc will ascend to account for an ever larger share of global GDP and growth. The crucial question is then; how will this process and the process of global ageing be transmitted to the global economy through capital flows?

As a starting point to answer this question I would like to draw the attention to comments made by two of the most prominent members of the global financial punditry in the form of US economist Paul Krugman (PK) and the Financial Times’ chief economics commentator Martin Wolf (MW).

Starting with the former[2] he recently pointed to the fact, in the context of Japan, that external demand was instrumental in ending the slump and providing a relative bounce between 2003 and 2007. As PK further goes to argue, this may present a rather ominous outlook since the extent to which we are all, in the OECD, currently stuck in a “Japan-style” liquidity trap the way out may constitute a rather crowded route. As PK poignantly points out at the end of his small piece;

(...) needless to say, we can’t all export ourselves out of a global slump. So, how does this end?

Krugman 2009

This is indeed a good question and MW makes a similar argument in a recent column[3] where he points towards the fact that the global imbalances themselves may prove to be an impediment to a swift global recovery.

 In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.

Martin Wolf (2008)

This is of course a very appealing proposition and also goes to heart of idea that, at least, one part of the solution of the current global crisis lies in the resolution of global macroeconomic imbalances. But prey tell, how are these surplus countries going to revert towards a growth path characterized by a more balanced external account and perhaps even an external deficit?

It is in this context that the argument presented in this thesis becomes important. Consequently, there is a big risk that these surplus economies (e.g. Japan and Germany) simply will not be able to heed the call of MW. The main reason for this inability is then, in part, exactly to be found in the economic profile of a rapidly ageing economy with a median age pushing 40 year mark and beyond. Japan and Germany as well as the economies next in line to reach their age bracket cannot achieve growth based on domestic demand in a way which would allow them to suck up excess global capacity through an external deficit.

This is a very important point to stress in the context of the global economy and must be stressed with great emphasis.

Some Charts to Go With This

In order to try to make sense of all this consider the supply/demand chart below which plots the supply and demand for savings in the global economy. Following convention, the X-axis represents quantity and the Y-axis represents price. In this specific case, the X-axis can be seen as the total demand (from deficit nations) for excess investment beyond the level which can be achieved through domestic savings. The Y-axis then becomes the price[4] (interest rate) which equates this demand with the level (supply) of excess savings provided by the surplus nations beyond the level which can be absorbed by domestic investment demand

(click to enlarge)

As a natural consequence of the intuition underlying this small model, equilibrium is a forced (and always binding) condition since, by definition, the sum of external deficits must equal the sum of external surpluses in the global economy. 

If we accept the idea behind the theoretical framework presented in this thesis it is very easy to see the implications of a sustained global process of ageing. As is shown in the diagram the supply of excess savings (external surpluses) will increase with ageing [S(1) to S(2)]. But this is not the only effect. Following the simple intuition of a closed system an increase in supply must be meet by a decrease in demand too since we assume that economies are moving from a position as external deficit nations to a position of external surplus nations. In this sense, the constant level of output (quantity) is largely a simplifying trick in the sense that we let the entire adjustment process occur on the return of the excess savings of surplus nations rather than the quantity of excess widgets they can produce to sell abroad.[5] This produces an effect whereby ageing reduces the price of excess savings in equilibrium.

In order to move forward from here we need to mentally relax, as it were, the idea that deficits need to equal surpluses in equilibrium. In concrete terms, we need to understand the idea of equilibrium does not capture the notion of dependency on exports/foreign asset income to grow.

This is amended in the following graph; (click to enlarge).

The key here is the notion of the critical price level [6]. This should be seen as the level needed to sustain an acceptable level of growth in ageing economies and is thus a direct proxy for export dependency. As the global economy ages and assuming that equilibrium must hold at all times, the supply of excess savings and the demand for these savings decrease both lowering the equilibrium price and quantity. However, the critical price level remains. One key implications of this is a systematic oversupply of savings, or glut if you will, produced by the process of ageing and it is very important to understand that this oversupply is very tangible. It represents the value of external surpluses which would be enough for the likes of Germany, Japan etc to maintain a growth rate consistent with expectations and essentially the maintenance of their market economies. In the jargon of the theory, it represents the point at which ageing economies are optimally smoothing consumption and saving as a function of their intertemporal preference for the latter over the former. Of course, it cannot exist as a real entity but it may still have real implications.

The first obvious effect is to make the variation of ageing economies’ output very sensitive to the variation in out of deficit nations and thus global output. In its strictest form, this is how export dependency emerges. Another notable effect would be that it drives down the return in ageing economies to such an extent that it may fuel so called carry trade flows in which traders borrow in low interest rates currencies and invest in high interest rate currencies. Another example would be how these savings may be used to fund temporary and unsustainable build up of credit expansion in economies running external deficits. This is to say that if the equilibrium depicted above essentially is binding in the long run the implied existence of this excess pool of savings may lead to sudden outward jumps of the demand curve and thus the creation of credit bubbles. The main key to take away from this small economic model is thus the idea of an externality of ageing on a global level. This externality arises as a direct function of the implied existence of an excess of savings over demand as the global economy ages. In the context of the theoretical framework above the externality should be seen as function of the crowding of economies in one end of the spectrum on intertemporal preferences for consumption and saving. Crucially, it also means that what we might find to be optimal in the context of a single economy is not optimal on a global level a point which is certain to make standard economic modeling of aggregation from the representative economy level to the global economy very difficult. In empirical terms it means that what one might find to be the optimal path in a time series perspective of one economy may turn out to have radically different implications in the cross section when more or all global economies are involved.  

Further studies should attempt to develop this idea further since it provides a useful venue of analysis as an alternative to the traditional idea drafted from life cycle theory that global ageing will entail dis-saving on an aggregate level.

List of References

David M. Cutler & James M. Poterba & Louise M. Sheiner & Lawrence H. Summers (1990)
"An Aging Society: Opportunity or Challenge?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990-1), pages 1-74.

Henriksen, Esben (2002) – A Demographic Explanation of U.S. and Japanese Current Account Behavior, Graduate School of Industrial Administration, Carnegie Mellon University

Higgins, Matthew (1998) – Demography, National Savings, and International Capital Flows, International Economic Review, Volume 39 (1998) Issue (Month): 2 (May) pp 343-69

  Borsch-Supan, Axel H; Alexander, Ludwig; and Krüger Dirk (2007) – Demographic Change, Relative Factor Prices, International Capital Flows and their Differential Effects on the Welfare of Generations, NBER Working Paper No W13185

[1] With the German surplus mainly materializing itself in an intra-European imbalance.

[2] Paul Krugman (2009) – The Eschatology of Lost Decades, NYT blog post

[3] Martin Wolf (2008) – Global Imbalances Threatens the Survival of Free Trade

[4] Which is assumed to be exogenously determined for all involved economies through the equilibrium in this system.

[5] Remember that I am assuming that quantity is fixed and that the entire adjustment takes place on the price. In a more realistic representation the adjustment would of course take place on both the price and quantity.

Edward is already plugging this article by Daniel Gross over at Demography.Matters but I think it is important enough to deserve circulation here at Alpha.Sources too. Basically, Daniel gets to the heart of the matter in terms of Japan when he argues that one of the principal reasons that Japan is not rising is that it has failed to do the homework in the human capital department or as Gross phrases it; while Japan is still leading in engineering, this is not the case with respect to social engineering.

Japan still retains its lead in engineering. A showroom at Panasonic's headquarters displayed a heated, multifunction toilet seat that conserves energy. (Wouldn't leaving the seat cold conserve even more?) The sleek Shinkansen bullet trains roll up to their appointed spots on time. TKX, an 87-year-old Osaka-based company that makes abrasives, has adapted its expertise to cutting silicon ingots into wafers for solar panels.

But social engineering is proving more challenging. Japan's population peaked in 2004 at about 127.8 million and is projected to fall to 89.9 million by 2055. The ratio of working-age to elderly Japanese fell from 8-to-1 in 1975 to 3.3-to-1 in 2005 and may shrivel to 1.3-to-1 in 2055. "In 2055, people will come to work when they have time off from long-term care," said Kiyoaki Fujiwara, director of economic policy at the Japan Business Federation.

Such a decline is cataclysmic for an indebted country that values infrastructure and personal service. (Who is going to maintain the trains, pay for social benefits, slice sushi at the Tsukiji fish market?) The obvious answers—encourage immigration and a higher birthrate—have proved difficult, even impossible, for this conservative society. In the United States, foreign-born workers make up 15 percent of the work force; in Japan, it's 1 percent. And, official protestations to the contrary, they're not particularly welcome. One columnist I met compared the standard Japanese attitude toward immigrants to that of French right-winger Jean-Marie Le Pen. In the 1990s, descendants of Japanese who had emigrated to South America early in the 20^th century returned to replace retiring factory workers. Now that unemployment is on the rise, Japan is offering to pay the airfare for those who wish to return home.

Japan doesn't particularly want to import new citizens, but it doesn't seem to want to manufacture them, either. It's become harder to support a family on a single income, and young people are living at home for longer. And Japan isn't particularly friendly to working mothers—pre-K day care is not widely available, and the phrase work-life balance doesn't seem to have a Japanese translation. (The directory of the Japanese Business Federation, a showcase of old guys in suits, makes the Republican Senate caucus look like a Benetton ad.) The upshot: a chronically low birthrate. Too often, demographic change was described to me as a zero-sum game—rather than being seen as potential job creators, women and immigrants are often seen as taking jobs from men.

As Gross goes on to argue, Japan seems awfully passive about this and while there is certainly merit in discussing whether the size of the Japanese population is moving in the right direction it is the composition which really matters here. You only need to move back one entry here at this space get some kind of indication of the outlook for Japan's population composition. There is really no need to get into the whole discussion about whether economic growth is a goal in itself or whether Japan shouldn't have the right to conduct the policies it wants. Evidently, it has. However, for all those who believe that aggressive population management is desirable either be it through deliberate policies (a la China) or by simply allowing the demographic transition to run its course (i.e. Germany, Japan etc) they should also provide an answer towards the question of what to do with the market economy defined, as it were, by a social contract between generations, some form of paygo pension system, as well as a wide batch of centrally provided goods.

Gross' analysis is not far from the view presented in a recent article by me and Edward published in the summer edition of JapanInc. In this article, we argue that Japan is dependent on exports and that this dependence is a function of its age structure.

We also emphasise that Japan, for all intent and purposes, may be stuck in so far as providing a strong response towards the challenge of ageing;

While it is certainly true that the Japanese economy is currently struggling, it is not entirely true that there is no line of defense. Japan still has both monetary policy and fiscal policy tools at its disposal. The problem is that having spent a decade and a half attempting to fight the twin problems of deficient internal demand and ongoing deflation, the force of these tools has been steadily ground down. Interest rate adjustments, after many years when Bank of Japan (BoJ) rates have been held near zero levels, have little additional push to offer, while less conventional tools (like simply printing even more money via quantitative easing) or strong fiscal stimulus face clear limits in a country where gross debt to GDP is forecast by the OECD to hit 193 percent in 2009. So what can Japan do? Well besides simply grinning and bearing it, the tragedy is that there is not a lot that can be done in the short term. Evidently the Japanese government should give what support it can through highly targeted spending programs. The Bank of Japan, meanwhile, should be moving ahead with an aggressive policy of quantitative easing to provide as much relief as possible to Japan’s struggling households and corporates. But the only real way forward here is to try to slow the rate of population aging, and that means a change in national discourse and priorities, giving more support to those Japanese women who want to have children and radically changing the mindset about the extent to which Japan needs to promote an active immigration policy.

However, if we can all agree that the situation is difficult, it is hardly an excuse for not moving forward on the issues which ultimately will need to be adressed. Japan will need to foster a more conductive policy for increasing fertility as well as a substantial changed is discourse is needed with respect to immigration.