Earn2Trade Blog

Fighting Recession with Free Trade

It came as a shock to the world when its third largest economy shrank more than expected back in early December. Japan’s GDP dropped by 2.5% in Q3. Analysts explained the decline, which was the highest of the past four years, with the number of natural disasters over the course of the year. The country’s economy continued to decline in the final quarter well, dropping by 0.6%, twice as much as previously forecast.

Whether it’s Typhoon Jebi resulting in airports closing or the 6.7 magnitude earthquake in Hokkaido, there’s plenty of reasons to justify the Land of the Rising Sun’s economic decline, however, even if it weren’t for these disasters, Japan’s GDP still may not have necessarily have grown. As devastating as they were, the damage was still relatively small and limited to specific areas. The region hit by the earthquake for example is mainly focused on agricultural production. Although almost 3 million households were left without electricity, luckily the only power plant in the area to suffer damage was coal based. There may not be any exact damage reports yet, however, so far the only visible immediate effect was on dairy production. Agriculture contributes only a mere 4,272 billion yen to the country’s 532,618 billion yen GDP, making it 0.8% of the total economy. Nowhere near enough to fully account for the 2.5% drop in GDP.

The latest detailed GDP report revealed that the most sizable decline was in capital expenditures, showing a 2.8% drop for the quarter. This item represents the amount of money companies active within the country invested into new assets. Government investment declined as well by 2%, even though private investment increased by 0.7%, exceeding expectations by 0.1%. The part that has Japan’s government most concerned is of course the decline of exports by 1.8%

The above figures illustrate how little impact these disasters had on the population at large. They did on the other hand a quite notable and negative effect on both export activity and public spending. As such, the Cabinet of Japan’s reasoning for the decline does not completely hold up, since Hokkaido only contributes 3.594% of Japan’s GDP, meaning almost the entire island would have had to shut down for a full year to produce the kind of losses necessary for a 2.5% decline in the third quarter. This also leads us to believe that there may be factors other than natural disasters hampering corporate investment. The reason cannot be a lack of capital either, as the negative base interest rate should provide them with more than enough cheap credit. One of the hallmarks of Japanese economic policy is the continuous pumping of liquidity into the market to keep both consumption and investment at a constant high. The Bank of Japan (BoJ) has extended this policy to all capital markets, since they’re not only buying bonds at this point, but even stocks as well. It’s almost unbelievable that the central bank could inject 410 billion dollars into the economy every year and still be unable to induce either GDP growth or inflation.

Even after the BoJ deployed the full arsenal of monetary tools at its disposal, the desired result did not manifest, forcing them introduce more economic stimulus programs. Japan is one of the world’s most open economies, they’re always looking for new markets and opportunities to expand their export activities. Their primary way of achieving this is by means of trade agreements, however, they did not succeed in making such a deal with their most important trade partner, the USA. The European Union on the other hand has been open and willing to negotiate. The report on Japan’s declining GDP was released on the very same day the upper house of Japan’s National Diet held its vote on ratifying the EU-Japan free trade agreement. The vote passed successfully, meaning that the deal will go into effect once the European Parliament passes it on their end as well. Washington’s hoping for a similar deal, however the current administration’s tough stance on trade has made it difficult to for them negotiate and find a compromise.

In any case, the significance of the EU-Japan trade agreement is not to be underestimated, since trade between these two economic regions accounts for 30% of all global trade. Both parties are hoping for this deal to greatly expand trade, since it makes 90% of their bilateral trade tariff-free. Japan would clearly like to see a surge of European demand for its automotive products, which forms the backbone of their mutual trade, as seen below.

The chart shows trade balance from the EU’s perspective, so in this case import means products imported from Japan to the Europe. The data based on the European Commission’s figures shows that Japan has a significant surplus in the area of machinery and appliances. In order to retain and possibly expand this advantage, they opened up themselves to receive food products from EU countries without tariffs. Analysts appear to be in agreement on the greatest beneficiaries of this agreement being European producers of dairy products, meat products, as well as high quality cheeses and wines. Japanese consumer habits have changed a great deal in the past 50 years and European food products have ascended to become prestige goods in the country. If opening the market can make this range of products cheaper, then sales are naturally bound to go up as a consequence.

While the current atmosphere of foreign policy appears to favor protectionism, however, Japan and Europe seem to be going against the flow. Both of them are mainly export oriented economies so their primary interest is in getting their products on the market more easily. Common interest may have brought them together for now, but they both still suffered losses from the US-China trade war. For all the benefits of the trade agreement, the effect of declining global trade opportunity on Japan’s GDP may have been almost as devastating as a typhoon or an earthquake.

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