This paper presents the results of an empirical investigation of the impact of exchange rate variation on the exports of three major Japanese industries—motor vehicles, consumer electronics, and iron and steel. The study is a disaggregated one, with the following five major Japanese exports chosen for analysis: subcompact passenger cars, color television sets, galvanized steel sheet, heavy steel plate, and tin plate.
Determining the extent to which the exchange rate influences trade flows is especially relevant for Japan. One motivation for the adoption of protectionist measures by some of Japan’s major trading partners may be doubts as to the efficiency of the yen exchange rate for adjusting Japan’s trade account. Between 1976 and 1978, in particular, while Japan’s real effective exchange rate appreciated by 24 percent, the surplus on merchandise trade grew from US$2.4 billion in 1976 to US$9.7 billion in 1977 and US$18.2 billion in 1978.1 In 1979 Japan’s trade balance finally deteriorated, registering a deficit of US$7.6 billion, but its real effective exchange rate depreciated in that year by 22 percent.
With comparable rates of technological progress and of foreign and domestic inflation assumed, the magnitude of the impact of the exchange rate on exports depends on how far an exchange rate change is passed through to foreign currency prices of exports and how far export volumes then respond to such price changes. In recent years increasing attention has been devoted to estimating the adjustment of export prices and volumes over the short run as well as over the long run. Volumes have in general been found to adjust less rapidly than prices, leading to perverse short-run movements in merchandise trade balances following an exchange rate change, or “J-curves” (Branson (1972), and Magee (1973)). Thus, this analysis places emphasis on the explicit measurement of the time lags involved in the response of export prices and volumes to exchange rate variation.
Among others, researchers at Japan’s Economic Planning Agency (EPA) have devoted considerable attention to Japan’s trade adjustment problems during the late 1970s (Komine and others (1978) and EPA (1978)). Based on the Agency’s quarterly macroeconomic model, with revised export and import equations to account for lags in adjustment, various simulation exercises were conducted within a general equilibrium framework to estimate the effects of exchange rate changes on various aspects of the Japanese economy. The results of these simulations indicated perverse short-run effects of changes in the yen exchange rate. For example, in fiscal year 1977/78 (April 1977 through March 1978), during which Japan’s nominal effective exchange rate appreciated by an estimated 22 percent and its real effective exchange rate appreciated by an estimated 13 percent (according to the International Financial Statistics of the International Monetary Fund), J-curve effects were estimated to have yielded a US$3.2 billion increase in Japan’s trade balance (EPA (1979, p. 393)). The estimated positive impact amounts to roughly one third of the US$9.7 billion increase in Japan’s trade surplus in 1977/78 over that of the previous year.
Whereas the EPA’s analysis incorporated lags in the adjustment of Japan’s exports and imports to exchange rate changes, Wilson and Takacs (1980) took the analysis one step further by estimating the impact of exchange rate expectations, or leads in adjustment, on the behavior of Japanese trade flows. Specifically, they estimated the extent to which expected appreciations of the yen exchange rate may have led to an export acceleration and import deceleration that exacerbated the perverse movement of the Japanese trade balance during the late 1970s. Their results were rather striking: the estimated J-curve for Japan’s trade balance continued to move in a perverse direction for several quarters subsequent to an exchange rate change and, for most of the adjustment period, implied a considerably larger perverse movement than that implied by a J-curve that incorporated only adjustment lags. Such a result suggests that, between 1977 and 1979, traders’ expectations of a further yen appreciation gave rise to perverse movements in the trade balance that overwhelmed the adjustment of trade flows to past exchange rate changes. Following the approach of Wilson and Takacs, this analysis also incorporates the impact of expectations of relative export prices on the demand for Japan’s exports.
As mentioned previously, this paper examines the response of Japanese exports to changes in the yen exchange rate at a highly disaggregated level, looking at specific major export products. From a theoretical viewpoint, such a disaggregated analysis avoids the aggregation problem of biased elasticity estimates made famous by Orcutt (see Orcutt (1950) and Learner and Stern (1970)). One such problem arises because the response of export prices to exchange rate changes varies across industries, since suppliers differ in the extent to which they maintain prices in line with those of foreign competitors; an aggregate demand equation therefore implies biased estimates. Another reason for the disaggregation is that tensions between Japan and her trading partners have tended to focus on specific industries, such as steel in the late 1970s and automobiles, electronic equipment, and machine tools in the 1980s. Exports of the industries sampled—that is, motor vehicles, consumer electronics, and iron and steel goods—accounted for 34 percent of the U.S. dollar value of Japan’s total exports during the 1975-79 period and have, in addition, all been involved in recent disputes between Japan and her trading partners.
Simultaneous-equations models of the supply of and demand for both exports and domestic sales of each product considered were estimated. The theoretical model specifies the following dynamic elements in the adjustment process: the extent to which an exchange rate change is passed through to foreign currency export prices over time; leads and lags in the response of export orders to relative export price changes; and delivery lags between orders and shipments. Although the analysis does take into account the indirect impact of exchange rate shifts on export prices through changes in prices of imported raw materials, the study is partial equilibrium in nature in the sense that foreign prices, wages, inventory accumulation, and the exchange rate are treated as exogenous. Given the unique characteristics of the Japanese labor market, the tendency for wage increases to be linked to profitability of firms, and the observed flexibility in real wages in Japan, the assumption of exogenous wages may not be overly restrictive. (See Komiya and Suzuki (1977) and Shinkai (1982).) In addition, wages account for a small proportion of total variable costs for all of the sample products, as indicated by input-output coefficients (see the Appendix).
APPENDIX: Data Sources and Methodology
The data employed in the empirical analysis were obtained from a number of sources and were constructed as described below.
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Branson, William H., “The Trade Effects of the 1971 Currency Realignments,” Brookings Papers on Economic Activity: 1 (1972), The Brookings Institution (Washington), pp. 15–58.
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Wilson, John F., and Wendy E. Takacs, “Expectations and the Adjustment of Trade Flows Under Floating Exchange Rates: Leads, Lags, and the J-Curve,” International Finance Discussion Paper No. 160 (Washington: Board of Governors of the Federal Reserve System, April 1980).
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)| false Wilson, John F., and Wendy E. Takacs, “Expectations and the Adjustment of Trade Flows Under Floating Exchange Rates: Leads, Lags, and the J-Curve,” International Finance Discussion Paper No. 160( Washington: Board of Governors of the Federal Reserve System, April 1980).
Mr. Citrin, currently the Fund’s resident representative in Jamaica, holds degrees from the University of California, Berkeley, and from the University of Michigan. This paper was prepared while he was a member of the Asian Department.
See Gregory (1971) for an extensive treatment of the impact of nonprice elements on trade flows. Gregory considers only the effect of domestic nonprice rationing on import demand, but the same arguments may be used for including a domestic cyclical variable in the export demand equation; see also Ahluwalia and Hernández-Catá (1975) and Hooper (1976).
Although this approach is rather ad hoc, a rigorous formulation of the adjustment path of the contract price may be extremely complex because of the conflicting nature of the various goals and the fact that the additional longer-run goals are motivated by entrepreneurial preferences not easily measured by traditional economic variables. The approach is motivated by similar formulations found in Artus (1974) and Ahluwalia and Hernández-Catá (1975).
The presence of lagged endogenous variables coupled with the expectation of serial correlation, reflecting estimation over monthly time series, implies that the usual two-stage or three-stage least-squares estimation techniques are inconsistent. Estimation was therefore conducted by applying an iterative modification of a two-step procedure developed for such models by Hatanaka (1976). Distributed lag structures were incorporated according to the method derived by Shiller (1973).
The t-statistics cannot be interpreted in the usual way for the distributed lag coefficients estimated according to the Shiller lag method (1973), a Bayesian procedure that imposes prior constraints on the shape of lag structures. Thus the statistical significance of the various lag structures was tested by calculating appropriate F-statistics for their group influence.
The estimated variances of the long-run elasticity estimates were calculated according to Kmenta (1971, equation (11.40), p. 444).
Using coefficients from Japan’s 1975 input-output table (Japan, Administrative Management Agency (1978)), the EPA estimated the exchange rate elasticity of raw material prices at a sectoral level; the relevant estimates are transport equipment, 0.09; electrical equipment, 0.12; and iron and steel products, 0.23 (see EPA (1978)). The variable input cost terms are adjusted according to these estimates, with the adjustment assumed to take place smoothly over a three-month period.
The exchange rate effect on export volumes would be less during periods when exports accounted for a higher share of total sales, since the offsetting influence of the non-price-rationing variable would be greater.