Japan Weathers Big Rise in Yen--Until You Look Beneath Surface

Many foreigners continue to express amazement that, in spite of the strong yen, Japan continues to maintain hefty exports and low unemployment. Some even conclude from this situation that exchange rate adjustments are ineffective in correcting trade imbalances with Japan.

It is indeed difficult to find many overt signs of recession in this country today. Most people are still well-dressed, well-fed and going to work every day in the most orderly fashion. This stands in sharp contrast to places like New York City, where one is confronted by a large number of homeless people begging for money in the streets and subway stations, even during times of healthy economic growth.

In Japan, however, unemployment and bankruptcy rates are the wrong places to look for the adverse effects of the strong yen.

To understand where to look instead requires some background.

Japanese companies adopted the system of lifetime employment sometime after World War II. This made their cost structures inflexible. But these companies were still exposed to normal business cycles, where revenues and profits fluctuate widely.

To reconcile these two, Japanese companies decided that during the good times, they would keep the profits within the company in various forms; they could live off the accumulated assets during the bad times. Thus they have been able to weather fluctuations in business conditions while maintaining lifetime employment.

This is in sharp contrast to many American corporations, which distribute profits liberally during good times and lay off their workers on the shortest of notices during bad times.

Japan’s approach, together with its rapid economic growth over the last 50 years, has allowed companies--particularly well-established companies with large cross-share holdings and valuable real estate--to accumulate a thick protective layer of assets. By liquidating some of these assets, many of these companies have been able to cover earnings shortfalls to pay their wage bills.

So the asset cushion has allowed both the bankruptcy and unemployment rates to remain low. And in turn, the low level of unemployment allowed many in policy circles to remain complacent.

Such complacency is dangerous, however, in three ways:

* First, the negative effects of the strong yen are showing up in the dismal growth rate of the Japanese economy. Over the last three fiscal years, Japan has experienced no growth at all: 0.3% in 1992, minus 0.2% in 1993, and 0.6% in 1994. This is an alarming development for such a growth-oriented economy. And it has occurred despite billions of dollars in various fiscal stimulus measures and low interest rates. Without this help from the public sector, the growth rate would have been much worse.

The reasons for this dismal growth performance are not hard to find. With the renewed yen appreciation that began in early 1993, few Japanese companies have seen any reason to invest in at home. Although firms are investing, most of the money is heading out of the country, especially to Southeast Asia. So even though domestic machinery producers might be busy, the machines they make are no longer generating income and adding value in Japan. And that has meant slower growth. Under current circumstances, zero growth might become the norm rather than the exception.

* The second way in which complacency is dangerous is that by the time Japanese companies get to lay off workers, it may be too late to restructure those companies. This is because labor unions, the mass media and the Labor Ministry will allow a company to lay off people only when there is no means to pay them. With asset bases so depleted, it is difficult to imagine those companies taking off in a new direction. In other words, when the unemployment rate does go up in Japan, the situation will be vastly more serious than in other industrialized countries with a similar level of unemployment.

In contrast, when American companies lay off workers, it is usually part of a restructuring process designed to make the firms leaner and meaner. Also, their assets remain largely intact.

* The third way in which complacency is dangerous is that companies might survive, but the national economy might not. With the strong yen, the fortunes of some of Japan’s best companies and that of the national economy are diverging. That stands in sharp contrast to most of the postwar years when their fates were almost indistinguishable. In those days, if Japanese companies were doing well, so was the Japanese economy, and vice versa.

At the current exchange rate, however, many companies have no choice but to leave Japan when it comes time to expand. Given the much freer and less-expensive operating environment abroad, it would not be surprising if the profitability of some companies actually improves. After all, they clearly have the necessary technology, management skills and product recognition.

The fact that companies headquartered in Japan are surviving and sometimes prospering, therefore, does not necessarily mean the Japanese economy is also prospering. With the country’s most powerful locomotives all gone abroad, the domestic economy and those companies that are tied to it will find the pie getting smaller and smaller. The government, in particular, will experience rising expenses and falling revenue.

On the surface, the Japanese economy seems to be weathering the strong yen well. Deep inside, however, the entire economy is living off its past, and its once-hefty reserves are disappearing rapidly. Without correcting the fundamental source of these problems--that is, its huge trade surplus and the resultant strong yen--the present stagnation of the Japanese economy is not likely to go away any time soon.