Section 2 Economic Impacts of Globalization

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Impacts of globalization on corporate activities and the macroeconomy

Changes in the international economic environment, symbolized by the continuing appreciation of the yen from the late 1980s to the early 1990s, had a tremendous impact on Japanese corporate activities and led to progressive changes in Japan's economic structure. For example, overseas direct investment grew in the late 1980s, and overseas production development of companies and foreign investment rose, and the import penetration ratio has been on an upward trend since the early 1990s (Figure 3-2-1).

Figure 3-2-1 Exchange Rates and Companies' Overseas Development

In terms of the exchange rate, the yen began to depreciate in the late 1990s, but appreciated again after the Asian financial crisis. Due to the unstable financial system in Japan, people's concerns were concentrated, during this period, on domestic economic issues such as the disposal of non-performing loans and reducing excess debt. Meanwhile, microeconomic changes in corporate activities, caused by the yen appreciation shock between the late 1980s and early 1990s and other factors, led to structural changes in Japan's international economy. It appears that these changes gradually consolidated a macroeconomic response different from the 1980s.

Many of the things regarded as global problems in Japan today seem to be closely related to the changes that occurred after the 1990s. Hence this section will investigate how macroeconomic responses to exchange rate changes have changed. Next, the impact of exchange rates on corporate profits, trends in overseas business development in Japan's leading export industries and other aspects will be analyzed in order to clarify the relationship between changes in corporate activities during this period and the formation of vertical intra-industry trade in the Asian region. Moreover, the analysis will also include how these changes influenced households in terms of employment, wages and consumption.

The objective of this section is to understand the structural changes that have taken place in Japan since the 1990s from the viewpoint of the international economy and address the issues encountered by Japan as companies become more globalized.

1.Macroeconomic Impacts of Exchange Rates

Exchange rates and corporate pricing behavior

How will changes in exchange rates affect corporate activities? Let us take the case of yen appreciation. Generally speaking, both yen-denominated export prices and yen-denominated import prices fall when the yen appreciates against the dollar. The mechanism that causes these trends is as follows.

Yen appreciation deteriorates the profits of Japanese exporting companies through declines in export prices.(5) This is because when the yen appreciates against the dollar, the yen-converted value of the sales price drops at export destinations. It is necessary to raise sales prices in order to alleviate the impact of deteriorating profits. Although price shifts are not easy when there is stiff price competition with local goods, some price shifting is possible if products have been differentiated as seen in the case of brand-name products. Consequently, even if export prices after yen conversion fall immediately due to the appreciation of the yen, export prices would recover to some extent if price shifts occur in the local currency. At the same time, the volume of exports would gradually decline.

In contrast, yen appreciation improves the price competitiveness of imports from abroad.(6) In particular, foreign companies that export products whose sales are significantly elastic to price changes would like to try to boost their profits by lowering their sales prices in Japan and by increasing export volume. As a result, yen-denominated import prices will progressively fall and the import volume will rise.

As above, there are interactions where macroeconomic changes in exchange rates affect prices and volume of exports and imports through microeconomic corporate activities, which in turn has macroeconomic effects. Considering this interaction between the microeconomy and macroeconomy, the following will examine whether the price and volume of exports and imports, balance of payments and current accounts have responded differently to changes in exchange rates and other factors in recent years.

Changes in the response of export prices: increases in export prices, due to yen appreciation, have become smaller

Firstly, how export and import prices respond to changes in exchange rates is measured.(7) The analysis below is based on the National Accounts including services.

Looking at the degree to which Japanese exporting companies raise local export prices in order to partly offset the decline in corporate profits caused by the appreciation of the yen, it is evident that the markup has been falling gradually since the 1980s (Figure 3-2-2 (left)).(8)

From a microeconomic perspective, the pricing behavior of exporting companies is the result of efforts to limit local price increases in order to ensure profits in light of the stiffening price competition in markets. At the same time, these limitations have encouraged Japanese exporting companies to continue to improve their productivity, thus to enable long-term reductions in markups when the yen appreciates.

From a macroeconomic point of view, long-term reductions in the markup of Japanese exporting companies have become possible because, when the rate of increase of export prices in Japanese companies is lower than their trading partners and regions, as a result of increased productivity and other factors, the international price competitiveness of Japanese products will increase by that rate.

Nonetheless, the appreciating yen during the late 1980s to early 1990s put so much short-term profit-cutting pressure on Japanese exporting companies that it could not be absorbed by the difference in the long-term inflation rate (Figure 3-2-2 (right) cited above). In particular, it is suggested that the appreciating yen in the early 1990s placed a substantial burden on corporate profits for Japanese companies, which were still plagued with making adjustments after the collapse of the bubble economy.

Figure 3-2-2 Impacts of Exchange Rates on Export Prices

Changes in the response of import prices: declines in export prices, due to yen appreciation, have become smaller

Meanwhile, import prices fluctuate more than export prices. This is because 40% of Japan's imports are composed of food, raw material and mineral, for which prices are highly volatile. Regarding import prices for items besides oil, coal and natural gas, impacts on exchange rate changes in recent years have progressively weakened and import prices do not fall as much as they once did when the yen appreciates (Figure 3-2-3 (left)). As with the case of export prices, this is a reflection of the comparatively high inflation rate among Japan's trading partners and regions. In fact, since price competitiveness is curbed by the inflation gap for foreign companies that export to Japan, it is not easy to lower prices in Japan when the yen appreciates (Figure 3-2-3 (right) cited above).

Incidentally, if the rate of decline of import prices is greater than that of export prices after they have been converted to yen while the yen appreciates, this type of response in export and import prices will allow more imports into Japan based on a certain export value (improved terms of trade). On the contrary, if the rate of decline of export prices is greater than that of import prices, then the possible import volume based on a certain export value will fall (worsened terms of trade). Until the early 1990s, the Japanese economy had a tendency for the rate of decline of import prices to be greater than that of export prices after conversion to yen while the yen was appreciating. However, the rate of decline of import prices has diminished in comparison since the end of the 1990s (Figure 3-2-4).

Figure 3-2-3 Impact of Exchange Rates on Import Prices

Figure 3-2-4 Relative Rates of Decline of Export and Import Prices During Yen Appreciation

Therefore, as seen above, 1） the exchange rate that influences pricing by companies from a macroeconomic perspective is not the currency conversion rate between different countries used for transactions in the foreign exchange market, but the exchange rate which takes into account inflation rate differences between trading partners and regions (called the real effective exchange rate), and 2） changes in the macroeconomic environment are closely related to microeconomic corporate activities.

Growing fluctuations in export and import volume

Under ordinary circumstances, export and import volumes will change when export and import prices change. In other words, export and import prices, which have responded to changes in exchange rates, gradually influence export and import volumes after a time lag. This is called the "price effect" and refers to the impact caused by relative changes in export and import prices.

To begin with, it has been pointed out that the impact of changes in exchange rates on export and import prices has gradually declined. Since export and import prices reflect inflation rate differences that exist between trading partners and regions, as described above, it is necessary to eliminate this factor in order to examine the genuine impacts of the exchange rate on export and import prices. As such, even if the response of export and import prices has declined, it would not necessarily mean that the influence of exchange rates has diminished. When examining the effects of exchange rates, there is a need to include not only the sensitivity of export and import prices, but also the resulting price effects on export and import volumes.

Moreover, export and import volumes are affected by demand trends in trading partners and regions as well as in Japan, in addition to changes in prices. The impact that these changes in income in Japan and overseas have on export and import volumes is called the "income effect."

Dividing the post-1980s period into two phases—the trough in the early 1980s and after the trough in the early 1990s—1） the impacts of changes in exchange rates on export and import prices, 2） the resulting price effects on export and import volumes, and 3） income effects produced by domestic and foreign demand trends are measured for the first phase (from the first quarter of 1983 to the third quarter of 1993) and the second phase (from the fourth quarter of 1993 to the fourth quarter of 2003). The following characteristics are apparent when the results of the first and second phases are compared (Appended Note 3-1).

Firstly, the degree of impacts that changes in exchange rates have on export prices after they have been converted to yen is diminishing. Likewise, the degree of impact on import prices is also decreasing. There exists hardly any statistical difference between yen appreciation and yen depreciation with respect to this trend. As for what happens when the yen is appreciating, the rate of decline in export receipts after they have been converted to yen is diminishing because of the gradual increase in local sales prices at the export destination. At the same time, the rate of decline in yen-denominated sales prices of foreign companies in Japan is also decreasing.

Secondly, the price effect, or the impact that export prices have on export volume, is increasing. The increasing price effect is believed to be the result of the growing sensitivity of export volume to the impact of export prices, given the increasingly severe export environment brought about by export competition with Asian companies and production by overseas subsidiaries. The degree of impacts is slightly lower when the yen is depreciating compared to when the yen is appreciating. In other words, the absolute value of the increase in export volume when the yen is depreciating is smaller than the absolute value of the decrease in export volume when the yen is appreciating. This export environment appears to encourage exporting companies to produce more value-added products with a view to stabilizing profits (Figure 3-2-5 (top)).

Meanwhile, the income effect, or the impact of foreign demand on export volume, is decreasing. This is the result of increased product supply by Japanese companies overseas, since the overseas production ratio of Japanese companies grew in response to the appreciation of the yen from the late 1980s to the early 1990s. This situation is also clear in the declining share of exports in world trade held by Japan in the 1990s (Figure 3-2-5 (lower left)).

Thirdly, the price effect on import volume is also rising. The growing price effect is consistent with the phenomenon that occurred when people became sensitive to prices and tended to opt for low-priced goods after the collapse of the bubble economy. The degree of impacts is considerably lower when the yen is depreciating compared to when the yen is appreciating. More specifically, the absolute value of the decrease in import volume when the yen is depreciating is smaller than absolute value of the increase in import volume when the yen is appreciating. This suggests that Japan's economic structure is changing, making it more conducive to accepting imports.

At the same time, the income effect on import volume is increasing. This is the result of the substitution effect on domestic goods caused by the increasing penetration of low-priced imports, which was triggered by the appreciation of the yen in the early 1990s. In fact, there is a correlation between the periods when the yen appreciated and the impacts of exchange rates on the import penetration ratio (Figure 3-2-5 (lower left)).

Figure 3-2-5 Shares of Japanese Exports and Their Added Value

Effects of yen appreciation on reducing the surplus in balance of payments for goods and services have increased

If the impacts of exchange rate changes on export and import prices and the impacts of these export and import prices, in addition to the impacts of domestic and foreign demand trends on export and import volume are combined, what effects would these factors have on balance of payments for goods and services?(9)

If the price effect produced by exchange rate changes (the effect of changes in export and import prices on export and import volume is called the exchange rate effect), fluctuations in export and import volume have a tendency to grow since the 1990s compared to the 1980s (Figure 3-2-6 (top)). This is because even though the sensitivity of export and import prices to exchange rate changes is diminishing, the impact of changes in export and import prices on export and import volume is increasing more than this decline in sensitivity. It is also clear that the impact of changes in exchange rates on net exports (difference in the export and import balance) have become larger (Figure 3-2-7 (top left)).(10)

Meanwhile, there is a slight asymmetry in the impacts on net exports when the yen is appreciating and when the yen is depreciating. In other words, one characteristic that is evident in Japan after the 1980s is that the absolute value of the decline in net exports due to the appreciating yen is larger than the increase in net exports in response to the depreciating yen. Hence, under current conditions, the exchange rate effect of the appreciating yen tends to have a strong influence on narrowing the trade surplus. Given that the import volume when the yen appreciates has been growing since the 1990s, these trends are expected to become even stronger (Figure 3-2-6 (bottom) cited above).

Figure 3-2-6 Effects of Exchange Rates on Export and Import Volume

An underlying factor causing these trends is the changing responses of companies and households to prices from the microeconomic perspective, underlying the rising overseas production ratio and import penetration ratio mentioned above. Consequently, the exchange rate effect actually refers to the ways in which people and the economy respond. When the ways in which people and the economy respond become firmly established, then it is recognized that the economic structure has changed.

The net export effect is obtained when the above-mentioned exchange rate effect is combined with the income effect, which is the result of the impacts of domestic and foreign demand trends. As for the income effect, if it is assumed now that the increase in the real growth rate is the same in Japan as in its trading partners and regions, the trend after the 1990s compared to the 1980s is that the growth in the export volume is relatively limited while the import volume rises. Therefore, it is clear that the exchange rate effect is changing to bring down net exports (Figure 3-2-7 (upper right) cited above).

To generalize the exchange rate effect and income effect on net exports and the balance of payments for goods and services, it is clear that since the 1990s, compared to the 1980s, the exchange rate effect and income effects have had a greater impact on reducing net exports and the balance of payments for goods and services when the yen appreciates. At the same time, there are hardly any changes in the impact that the exchange rate and income effect has on increasing net exports and the balance of payments for goods and services when the yen depreciates (Figure 3-2-7 (center and bottom) cited above).

Therefore, based on the results of the analysis above, the following trends are evident in the Japanese economy after the 1990s compared to the 1980s: that 1） although there are no changes in the impact of increasing balance of payments for goods and services in response to the depreciating yen, there is a greater impact on reducing the surplus in the balance of payments for goods and services due to the appreciating yen because the appreciating yen has a greater impact on decreasing exports and increasing imports, and 2） since growth in foreign demand has less of an impact on increasing exports while growth in domestic demand has a greater impact on increasing imports, the relative increase in Japan's economic growth has a larger impact on reducing the surplus in the balance of payments for goods and services.(11)

Figure 3-2-7 Impacts on Balance of Payments for Goods and Services

Changes in the structure of the current account surplus

The analysis offered above illustrated that the Japanese economy is changing into a structure that is more prone to declines in the surplus in the balance of payments for goods and services. Why is the current account balance growing? This sub-section will explore this issue.

The current account balance is the difference between domestic savings and investment. The income obtained from overseas as a current account surplus usually becomes the capital account deficit, because it will be used for overseas investment and loans in the form of excess savings. The major items composing the current account balance are trade account, services account and balance on income.

The trade account and balance on services become part of GDP in the form of net exports (difference in the export and import balance) since it is newly created added value.(12) Although the trade balance has been in the black, the balance on services has been in deficit due to the purchase of services such as transport, tourism and insurance. On the other hand, balance on income, which consists of payments such as interest and dividends on direct investment and securities investment, is not included in GDP. This is because it is profits generated from net external assets, which is in fact added value previously created within Japan accumulated in the form of the current account surplus.

The current account surplus marked a record-high of 15.8 trillion yen in 2003. Nonetheless, since economic transactions are proportional to economic size, when discussing the size of economic transactions, it is necessary to compare economic transactions and economic size rather than the amount of transactions. Accordingly, the following characteristics are apparent when the current account balance and its major components are examined as a share of nominal GDP.

First of all, at present, the current account balance as a share of nominal GDP is nearly equivalent to the peak level in the first and second half of the 1990s. On the other hand, the trade balance as a share of nominal GDP has been lower than the current account balance since the end of the 1990s. Moreover, considering the timing correlation where the exchange rate after being adjusted for inflation is about six quarters ahead of shifts in the trade balance, the growth in the trade balance surplus appears to have been influenced by the depreciation of the yen since 2000 (Figure 3-2-8 (upper right)). In addition, the growth in the trade surplus may have reached its peak for the time being.

Secondly, the trade balance, including the balance on services, as a share of the current account surplus has declined from about 90% in the mid-1980s to 53% in 2003. Meanwhile, the balance on income as a share of the current account surplus has increased from over 10% in the mid-1980s to 53% in 2003, the same level as the balance of payments for goods and services (Figure 3-2-8 (lower left) cited above).

Japan's net external assets, or foreign liabilities subtracted from foreign assets, have been increasing. This is an indication that the structure in which Japan has obtained income from abroad through net exports is changing to a structure in which it acquires income from abroad through net external assets. This situation has also been reflected in changes in net income including return on investment from abroad, or the difference between GDP and gross national income (GNI, the concept replacing the formerly used GNP) (Figure 3-2-8 (lower right) cited above).

Figure 3-2-8 Background of Current Account Surplus Increases

The balance on income consists of return on direct investment, return on securities investment and other return on investment. In 2003, the surplus in the return on securities investment accounted for about 85% of the total balance on income. This is the result of life insurance companies, banks and investment trusts taking the alternative and expanding their foreign bond investment to the US and Europe due to the asset management difficulties brought about by low interest rates in Japan (Figure 3-2-9 (left)). With the growing risk that the value of foreign currency-denominated assets would fall after being converted to yen because of the appreciating yen, life insurance companies and others are making large foreign bond investments using financial technology in order to prevent exchange rate losses in the futures market. As a result, it is assumed that returns on securities investment are growing in response to the increase in total income from medium- to long-term bond interest rates (Figure 3-2-9 (right) cited above).

Figure 3-2-9 Growing Surplus in Portfolio Investment Income Balance

As explained above, the growth in the current account surplus since the end of the 1990s reflects the structural changes that have occurred since the 1980s, namely that the share held by the balance of payments for goods and services has declined. In the meantime, the share held by the balance on income has increased due to the growth of net external assets. In particular, one characteristic of the rising balance on income in the past several years is the increasing vigor with which foreign bond investment has been made as an alternative to investment in yen assets.

Changes in the macroeconomic response

The preceding discussion has illustrated that the Japanese economy since the 1990s has responded differently than in the 1980s to changes in exchange rates as well as domestic and foreign demand, in light of the progress that has been made in structural change regarding the international economy.

The characteristics of the differences can be summarized as follows. Firstly, although the Japanese economy since the 1990s compared to the 1980s has experienced no changes in the surplus increase effects of the balance of payments for goods and services in response to the depreciating yen, there are greater surplus reduction effects of the balance of payments for goods and services due to the appreciating yen because export reduction effects and import increase effects have increased with the appreciation of the yen. Secondly, since export increase effects brought on by the growth in foreign demand have declined while import increase effects brought on by the growth in domestic demand have increased, surplus reduction effects brought on by the relative increase in Japan's economic growth have been increasing.

The reasons the current account surplus has grown in recent years under these circumstances are as follows: 1） the trade surplus expanded due to the depreciation of the yen, among other factors, after 2000, 2） the share held by the balance of payments for goods and services has diminished since the 1980s, and 3） the share held by the balance on income is growing in response to the increase in the net external assets.

What does this mean?

Firstly, the fact that Japan's relatively high growth rate is boosting the effect of diminishing the surplus in the balance of payments for goods and services suggests the importance of measures aimed at realizing sustainable economic growth in Japan and ensuring that the global current account imbalance does not increase.

Secondly, if exchange rates are considered as asset prices determined by investors' global portfolio selection, the increase in Japan's net external assets will lower foreign currency demand since foreign currency-denominated asset holdings will grow relative to yen-denominated assets. This leads to pressures on the yen to appreciate. Exchange rates are determined by a wide range of market forces in the short term. However, it is desirable to control extreme fluctuations in exchange rates in the short term and to determine exchange rate levels based on economic fundamentals in the medium- to long term.

Since Japan made the transition to the floating exchange rate system, the yen has been on an appreciating trend in the long run. Pessimism about the economy suffering a blow every time the yen appreciates tends to spread, but a positive aspect of the appreciating yen is that it has enabled Japan to buy imports at low prices and increased Japan's purchasing power. On the other hand, companies have taken a vigorous approach in dealing with the appreciating yen, since a sharp appreciation of the yen serves as a profit-dampening force for exporting companies and will inevitably have a negative impact on economic trends. Based on the analysis above, it is necessary to continue to closely observe the impact of the appreciating yen on the macroeconomy. The appreciating yen has both positive and negative aspects, and an appreciating trend of the yen in the long run, together with deepening globalization, has had a significant impact on Japan's corporate and household activity. The following will offer an analysis of these impacts.

2.Impact on Corporate Activities

Changes in the activities of exporting companies

The discussion up to this point looked at how Japan's macroeconomic response to the exchange rate has changed since the 1990s, and indicated the possibility of how microeconomic corporate and household activity in the context of globalization. The following subsection will more directly examine the changes that have occurred in corporate activity in Japan's leading export industries.

Firstly, this subsection will look at how Japan's exporting companies have averted the negative impacts on corporate profits caused by changes in exchange rates and indicate the role that overseas production played in this process. Next, the underlying factors in the growing number of companies withdrawing from their overseas operations and business expansion, as well as other aspects, will be explored by analyzing the factors that led companies involved in overseas production development to decide on whether to continue or withdraw their overseas operations. Moreover, it will become clear that overseas production development brought about changes in the value-added structure of Japan's exports and imports and led to progress in vertical specialization in the Asian region.

The objective of the series of analyses introduced here is to suggest the issues that Japanese companies have had to face in light of globalization by revealing the impacts that cross-border corporate activity has had on economic structure.

Controlling the risk of exchange rate fluctuations and easing the impact on corporate profits

As previously described, Japanese exporting companies have been lowering the markup of local currency-denominated export prices, despite the fact that the appreciating yen reduces corporate profits. Even if the long-term external competitiveness of exporting companies is maintained as a result, if the decline in export prices, after conversion to yen, is not fully shifted to local prices when the yen appreciates, then corporate profits should have posted losses in the short term. How have Japanese exporting companies responded to the risk of exchange rate fluctuations, namely the risk of fluctuations in value after local profits have been converted to yen tailored to the change in exchange rates?

To begin with, the following will take up three industries—transport machinery, electric machinery and general machinery—as Japan's leading export industries and measure the impact that exchange rate fluctuations since the 1990s have had on corporate profits (Appended Note 3-2).(13)

This degree of impact on corporate profits may be regarded as the risk of exchange rate fluctuations faced by exporting companies. This illustrates the magnitude of the impact on increasing profits from exchange rate fluctuations when the yen depreciates as well as the magnitude of the impact on decreasing profits from exchange rate fluctuations when the yen appreciates. Nonetheless, generally speaking, if it is accepted that companies find it desirable when earned revenue is not significantly different from preliminary forecasts, then it is likely that exporting companies will try to minimize the risk of exchange rate fluctuations.

The following characteristics are evident from the results of the analysis (Figure 3-2-10).

Firstly, the level of the risk of exchange rate fluctuations reflected in corporate profits is largely associated with the magnitude of the export ratio and yen-denominated export ratio as a share of domestic production in various industries. This is because the larger the share of domestic production that is directed at exports, the larger the share that overseas transactions account for in sales, and the risk of exchange rate fluctuations increases as a result. Meanwhile, if the yen-denominated export ratio is high, then fewer overseas transactions will be exposed to the risk of exchange rate fluctuations if most overseas transactions are settled based on the yen. Export industries, in descending order of their exposure to the risk of exchange rate fluctuations, are as follows: transport machinery, electric machinery and general machinery.

Figure 3-2-10 Impacts of Exchange Rates on Corporate Profits

Risk of exchange rate fluctuations has significantly declined in transport machinery

Next, the differences in each of the three industries will be elucidated.

Firstly, the risk of exchange rate fluctuations has dropped substantially in transport machinery. This appears to have resulted from the decline in the export ratio by gradually raising the overseas production ratio since the 1990s. Moreover, the risk of exchange rate fluctuations has been under control since 2000. This is because overseas production was further boosted in order to respond to another increase in the export ratio, which was caused by the growth in foreign demand and the rise in the yen-denominated export ratio.

Secondly, in light of the progressive growth in the export ratio since the 1990s, local sales of electric machinery were strengthened in Asia through overseas production development in the Asian region and an export structure with Japan and the US as its export base was established in Asia. Consequently, as described in more detail later, exports from Japan to Asia increased and exports from Asia to the US increased. This was the result of so-called vertical specialization, or the trading of parts, intermediary goods and finished products within the same industry. Since the collapse of the IT bubble in 2001, Japan's exports to the US have been declining while Japan's exports to Asia have been growing against the backdrop of strong demand from China. Under these circumstances, raising the yen-denominated export ratio for Asia seems to be controlling the risk of exchange rate fluctuations brought about by the increasing export ratio.

Thirdly, although the export ratio for general machinery (computers, machine tools, etc.) has been on an upward trend, the level of risk of exchange rate fluctuations has been kept relatively low due to the high yen-denominated export ratio. Since the overseas production ratio is also low, it appears that the risk of exchange rate fluctuations has been contained by setting the yen-denominated export ratio high. Furthermore, the overseas production ratio and yen-denominated export ratio appear to have shifted relatively flexibly for general machinery compared to other industries. For instance, even though exports to Asia were increased by lowering the overseas production ratio in the beginning of the 1990s and the overseas production ratio was raised in the late 1990s, steps were taken to expand export revenue by taking on the risk of exchange rate fluctuations when the yen was depreciating. Additionally, with respect to the appreciation of the yen after the Asian financial crisis, the yen-denominated export ratio was raised in order to prevent declines in corporate profits. In recent years the trend has reverted from overseas production development to exports toward Asia given that the yen-denominated export ratio has been lowered against a backdrop of a continuing flat overseas production ratio.

As evinced thus far, 1） the level of the risk of exchange rate fluctuations to corporate profits has been lowered primarily through overseas production development in transport machinery and electric machinery, 2） efforts were made to improve corporate profits in general machinery by overseas production development and shifting the yen-denominated export ratio relatively flexibly.(14) What is clear is that despite the individual factors to consider, Japanese exporting companies have advanced overseas production development overall. Furthermore, it is important to note that one issue that Japanese exporting companies have encountered since the late 1980s is where to locate their production and sales bases in order to respond to changes in the business environment including the exchange rate. The following will examine the characteristics of the approach that these exporting companies took in overseas business development.

Responding to changes in business after overseas entries: micro survey analysis

The overseas entries of Japanese companies, which experienced a surge in the early 1990s, plummeted after the late 1990s. At the same time, the number of companies withdrawing their overseas operations has been rising (Figure 3-2-11). One of the characteristics of entry and withdrawal by Japanese companies is that the Asian region is the region which many companies enter and subsequently withdraw their overseas branches. Secondly, regarding the manufacturing industry, a large proportion of companies in transport machinery, electric machinery including information and telecommunications machinery (hereinafter referred to as "electric machinery") and general machinery enter and withdraw their overseas operations. Thirdly, many manufacturing companies that have withdrawn their overseas operations are in electric machinery.

Figure 3-2-11 Trends in Corporate Overseas Entries and Withdrawals by Region and Industry

Accordingly, the factors that influenced whether companies with head offices in Japan that had launched overseas operations decided to continue or withdraw their overseas operations will be analyzed using microsurvey data obtained from the Basic Survey of Overseas Business Activities for FY1996, FY1999 and FY2002, which have a comparatively large number of data.

To be specific, by looking at the association between the decision that companies with overseas operations made to either continue or withdraw operations in 1999 and 2002, and their finances and situation concerning exports and imports over the past three years, the characteristics of companies will be revealed (Appended Note 3-3).(15) Since the year 1999 was after the Asian financial crisis and 2002 was after the collapse of the IT bubble, a look at this association will also offer a deeper understanding of the impact that these macroeconomic shocks had on Japanese companies that had launched overseas operations.

Worsening debts and rising capital costs were factors leading to withdrawal

The major factors that impacted the decisions of companies to either continue or withdraw operations are described below.(16)

The first factor is the deteriorating debt conditions. This was an important factor both in 1999 and 2002 that impacted the decision of companies with overseas operations, to withdraw operations. In 1999, the growing debt ratio in general machinery and transport machinery particularly in the Asian region appears to be a factor that strongly influenced the decision of companies to withdraw operations. This is presumably because the business expansion sustained by foreign currency- denominated funding up to that point turned into excess debt due to the depreciation of Asian currencies.

Meanwhile, a worldwide characteristic after the collapse of the IT bubble in 2002 was the growing debt ratio in electric machinery. Looking only at the Asian region, the rising debt ratio in not only electric machinery but also general machinery and transport machinery served as a factor in companies withdrawing overseas operations. In the case of the collapse of the IT bubble, it is also possible that the growing debt ratio had a negative impact on industries other than electric machinery through the decline in exports to the North American region, since it was the epicenter of the IT bubble.

The second factor is the increase in capital costs and the ratio of personnel costs to sales. Companies that faced these conditions in addition to the deteriorating debt conditions in 2002 had a tendency to withdraw operations. This trend was salient in transport machinery and general machinery in the Asian region and presumably a reflection of the delay in financial restructuring and business restructuring after the Asian financial crisis.

The third factor is the relationship to the growth rate. The tendency both in 1999 and 2002 is that the higher the GDP growth rate per capita in a country or region, the higher the likelihood that companies continued operations. More specifically, this is a characteristic that is evident in the North American and European regions in 1999 after the Asian financial crisis and in Asia in 2002 after the collapse of the IT bubble. This proves that the growth rate, a basic macroeconomic factor, affects whether companies that have launched overseas operations continue or withdraw operations.

The fourth factor is the increase in the investment rate by the Japanese side. In many cases, regardless of industry, companies that did not withdraw but instead continued operations in 1999 had raised the investment rate by the Japanese side in the previous three-year period. This suggests the possibility that the degree of involvement by the head office influenced companies to decide whether to continue operations. On the other hand, no such trend was evident in 2002. The increase in the investment rate by the Japanese side was changed from a factor influencing the decision to continue operations to a factor influencing the decision to withdraw operations in industries except for general machinery in the Asian region. In all likelihood, this is the result of companies deciding to withdraw operations because of deteriorating debt conditions, among other factors, even if the investment rate by the Japanese side was growing. This is an indication of the changing business environment wherein companies are forced to make decisions more quickly amidst intensifying competition.

The fifth factor is the relationship to the number of local subsidiaries and sub-subsidiaries. One characteristic that is seen in both 1999 and 2002 is that companies with a growing number of local subsidiaries and sub-subsidiaries were more likely to withdraw operations. Of all the companies that had launched overseas operations, more than twice as many companies in 1999 as in 1998 withdrew operations. It is possible that the Asian financial crisis triggered companies to turn to an overseas business expansion strategy. On the other hand, since the number of mergers and acquisitions (M&A) cases in Japan has been rising in recent years, and considering the above-mentioned interpretation that companies are pressured to make decisions more quickly, companies that withdrew operations in 2002 may have been affected by corporate reorganization and integration of head offices in Japan as well as other circumstances. This means that an increasing number of affiliated companies, including companies that have launched overseas operations, have merged or have been eliminated based on the so-called idea of "selection and focus."

Establishing a specialization structure through export-import networks

The sixth factor is the export-import ratio with Japan. One characteristic is that in both 1999 and 2002, many companies with a high export-import ratio with Japan withdrew overseas operations. It is likely that this was influenced by the fact that Japan faced a period of economic stagnation in both 1998 and 2001.

Similarly, companies with high local sales rates and high local procurement rates in the countries and regions where they had established overseas branches also had a tendency to withdraw operations. High local sales rates and high local procurements appeared to have a stronger impact in 1999 than in 2002. In fact, with the exception of electric machinery, which has a high export ratio to third countries, local sales rates have been declining since the late 1990s for transport machinery and general machinery, which have high local sales rates. This trend is evident on a regional basis as well (Figure 3-2-12 (left, center)). This means that the number of companies that have high export ratios to Japan and of third countries is gradually increasing. In other words, there has been a shift from a structure typical until the mid-1990s in which Japanese companies went overseas, built production bases, and produced and sold finished products locally to a structure in which a specialized production has developed gradually after the Asian financial crisis and the collapse of the IT bubble through export-import networks among different countries.

At the same time, the regional sales rate in the Asian region fell during this period, unlike in the case of the North American and European regions. This is a sign that the export ratio to regions other than Asia is rising and suggests that the Asian region is strengthening its position as an export base (Figure 3-2-12 (right) cited above).

Figure 3-2-12 Downward Trends in Local Sales Rates

What emerges from this analysis is the following: 1） based on macroeconomic factors, the basic strategy of overseas business development defined, among other items, by the soundness of fiscal content, degree of involvement of the head office and speed of coordination, serves as the fundamental factor for companies deciding whether to continue or withdraw operations, 2） the 1990s model of establishing overseas production bases in the Asian region and specializing in local sales and exports to Japan became less effective due to the Asian financial crisis and Japan's economic stagnation, and instead an export-import network was built by dispersing overseas production bases within the Asian region, and 3） the Asian region became more competitive as a result of these developments and turned into a stronger export base for Japan, North America and Europe.

Needless to say, the overseas production development by Japanese companies described above should have influenced Japan's export and import structure. That is to say, based on the manufacturing stage, there should be a difference in added value between products made in Japan and overseas affiliated companies that are traded through export-import networks.

Overseas affiliated companies are increasing the added value of exports to Japan

Taking note of the above-mentioned point, the following features are evident regarding the added value of Japan's exports and imports, considering circumstances such as enhancing quality in exports and imports of transport machinery, electric machinery and general machinery (Figure 3-2-13).

Figure 3-2-13 State of Added Value of Exported and Imported Products

Firstly, with respect to transport machinery, there was a break in the growth in added value of exports from Japan after the overseas production ratio grew in 2001 as described above, but the added value of Japan's imports has been rising. It is likely that this trend is also related to the fact that overseas affiliated companies are exporting high value-added products to Japan.

Secondly, as for electric machinery, the added value of Japan's imports has been rising since 2000. This coincides with the period when the overseas production ratio was growing as explained above. It is also consistent with the diminishing sensitivity of corporate profits in electric machinery companies to exchange rate changes, as the previous discussion has mentioned. This recent trend of growing added value of exports is noticeable in exports to Asia including China and Asian newly industrializing economies (NIEs).

Thirdly, general machinery has a different feature from the other two industries, namely, the fact that imports to Japan are shifting to products with low added value. This suggests that the production of products with relatively low added value, which have been undertaken domestically thus far, have been substituted by imports from abroad.

By focusing on trends in the added value of Japan's exports and imports, it becomes clear that overseas production development in Japan's leading export industries have influenced Japan's export and import structure. The fluctuation in the added value of exports and imports suggests that international vertical specialization has occurred with each industry.

Advancement of vertical intra-industry trade in Asia

The discussion up to this point has examined overseas production development in Japan's leading export industries. The difference in added value in the exports and imports of similar goods suggests the possibility that the advancement of overseas production development by Japanese companies also has an impact on production and trade trends in places where companies have established overseas branches. In other words, these international production networks indicate that progress has been made not only in the traditional form of trade where labor-intensive products produced against a backdrop of relatively low wages are traded with technology-intensive products reflecting the achievements of research and development (R&D) (called intra-industry trade if the product is in the same industry), but also in vertical specialization of the manufacturing process of similar goods (vertical intra-industry trade). With vertical intra-industry trade, labor-intensive processes are shared by developing countries, while technology-intensive processes are allocated to advanced countries and others possessing technological capacity with trade taking place between them. As a result, a trade structure emerges wherein parts and intermediary goods are exported to a particular country, where they become finished products, which are then re-exported to other countries. This type of vertical intra-industry trade is believed to have been established in the Asian region.

Looking closely at how trade in Asia has changed to reflect developments in vertical intra-industry trade in the Asian region is observed for three products—electronic components, electric machinery and general machinery.

Assuming that the increasing share of exports held by countries and regions in the global market is determined by the number of items, which represents the diversity of exports, as well as the degree of the added value of exports, the following characteristics are evident when the status of each of the four top-ranked countries or regions in Asia (excluding Japan) concerning the "product diversification" and "added value of products" is examined (Figure 3-2-14).

Figure 3-2-14 Vertical Intra-Industry Trade in the Asian Region

Firstly, China has realized remarkable growth based on the increase in its share of exports in the world. The only product for which Asian NIEs fall in the top four is electric machinery, while China and ASEAN countries account for the rest of the products. The underlying factor for China's growing export share is perceived as the range of items it has among similar products, or the product diversification.

Secondly, regarding the product diversification, China and ASEAN countries overall have been expanding the range of items, but Asian NIEs such as the ROK and Singapore have not.

Thirdly, the relative unit value, which represents the added value of a product, does not necessarily correspond to the growth in export share in the global market or trends in product diversification. This indicates that Asian NIEs such as the ROK, Hong Kong and Singapore continue to wield a strong influence.

While China and ASEAN countries are expanding their market share on the one hand, production and trade trends in Asia are changing dramatically, as evidenced by the production of higher added value products by Asian NIEs. A factor behind this change is the possibility that vertical intra-industry trade within the same industry is taking place between Japan, China, ASEAN countries and Asian NIEs reflecting each country's factor conditions (such as labor force, capital and technology), overseas production development undertaken by Japanese companies, and other aspects.

The vertical intra-industry trade structure in the Asian region was developed when companies specializing in the production of high value-added products sub-divided their production processes in response to improved technological and management capacity, etc. and dispersed each process to a different country or region. These networks are being built through cross-border corporate activities, which have been taking place as a result of improvements in technological capacity.

Corporate activity networks and structural reform

The discussion above has explored how Japan's leading export industries have come to take part in corporate activity resulting from globalization. The content of the discussion is summarized below.

Firstly, the appreciation of the yen from the late 1980s to the early 1990s forced exporting companies to raise their overseas production ratio and yen-denominated export ratio to avoid experiencing negative impacts on corporate profits. As a result, Japan's exporting companies expanded their overseas business development mainly in Asia. However, many of these companies also withdrew their overseas business operations because of the Asian financial crisis in 1998 and collapse of the IT bubble in 2001, as well as Japan's economic stagnation and trend toward corporate reorganization and integration.

On the other hand, some companies have also expanded overseas business operations. In advancing overseas business development, companies face the issue of where to establish their production and sales bases, the quality of their products and where to sell and export their products. Each company responded to these issues at the microeconomic level, resulting in structural changes in the added value of Japan's exports and imports and vertical intra-industry trade with the Asian region.

The current vertical specialization in the Asian region was made possible by the building of such networks. This means that given these international corporate activity networks, the impact on Japan of activities conducted by cross-border companies appears to be a good precursor of what happens to "Japan, which has been relatively insulated by national borders from the rest of the world."

Therefore, it is clear how important it is to tackle structural reform in a manner consistent with the promotion of economic partnerships as well as the international economy in considering Japan's future path from a global perspective. This issue will be closely examined after the following sub-section.

3. Impact on the Household Sector

The impact of globalization eventually manifests itself as various benefits and setbacks to the household sector. From the standpoint of the household sector, the benefits of globalization are shared by a broad spectrum of households, while setbacks are concentrated on a limited group of households. These benefits and setbacks will be studied in close detail below.

Benefits are shared by a broad spectrum of households, while setbacks are concentrated on a limited group of households

The household sector has two aspects: consumers and employees.

From the consumers' standpoint, they enjoy the benefit of being able to buy low-priced goods from abroad. This is a result of the improved terms of trade and has the same economic effects as an increase in disposable income for households. The effects are especially prominent if there is a wide price gap between domestic and overseas markets (Appended Note 3-4). Furthermore, imports of low-priced goods from abroad are expected to trigger intensive domestic competition and enhance the cost-cutting effect.

What kind of impact does globalization have from the employees' viewpoint? Due to intensified global corporate activities, companies are becoming more exposed to price competition with both domestic and foreign companies. It goes without saying that since domestic wage costs are higher than in Asian countries, Japanese companies will lose their cost competitiveness should they continue domestic production. Furthermore, if domestic rival companies shift to overseas production, then Japanese companies will be at a disadvantage in terms of competition with these rival companies as well. In order for companies to survive competition, they may be pressed to consider wage cuts and closing down factories in Japan and have no other choice but to transfer their production bases overseas where production costs are low. If this happens, workers who were employed at domestic production bases will be faced with wage cuts or loss of employment opportunities. In particular, the loss of employment is sometimes called "industrial hollowing-out." These effects are likely to be profound in industries lacking export competitiveness due to their labor intensity. In contrast to these developments, employment will grow as a result of the expansion of imports, and employment will be created in non-manufacturing, among other effects, but in some cases, these impacts are not fully recognized compared to concerns about hollowing-out.

In this light, it can be said that the impact of globalization on the household sector is that the benefits of globalization are shared by a broad spectrum of households, while setbacks are concentrated on a limited group of households.

Prices declined due to the rising import penetration ratio

Firstly, let us look at the benefits of globalization on the household sector. Imports from Asia, especially China, have increased since the 1990s (Figure 3-2-15). The household sector, which is the mainstay of consumption, has been able to obtain goods at reasonable prices and keep down the cost of living.

How has growth of imports of low-priced food and clothing affected the prices of these goods in Japan? Although the consumer price index fell after 2000, they were nearly flat or rising moderately in the 1990s and no downward trend was apparent. Thus it is difficult to illustrate the price effect in the 1990s looking at the consumer price index.

For this reason, data from the Family Income and Expenditure Survey (Ministry of Internal Affairs and Communications) were used to calculate the price index for food and clothing (Figure 3-2-16). The purchase price index was determined by dividing the paid price index by the purchase volume index for each item (Appended Note 3-5). Since the 1990s, the import penetration ratio has increased while prices have fallen for each good. There is also a strong correlation between items with significant growth in the import penetration ratio and a large decline in the price index.

Figure 3-2-15 Rise in Import of Clothing and Decline in Prices

Figure 3-2-16 Import Penetration and Purchase Price Index

The consumer price index is calculated for the items selected for the survey every five years. In contrast, since the Family Income and Expenditure Survey measures the price and volume of actual purchases by households every month, it is quicker to reflect the changes in consumers' buying behavior. A growing number of imported goods, which are less expensive than domestic goods, is becoming available in stores, and consumers are beginning to buy more imported goods than domestic goods as a result of the wider choice. Seizing on consumers' tendencies to opt for low-priced goods, retailers have embarked on "price destruction." The Family Income and Expenditure Survey suggests that this interaction between the demand side and supply side has led to the price decline.

Daily necessities are less of a burden on households

It is now clear that the import penetration rate is rising and the price of food and clothing purchased by consumers is falling. How have these trends ultimately influenced consumer spending? A look at changes in spending by goods and services in the Family Income and Expenditure Survey reveals that as the entire economy places greater importance on services than goods year by year, the share of services spending is rising while the share of goods spending is declining according to consumer behavior (Figure 3-2-17). Nonetheless, although called goods spending in a nutshell, the breakdown shows that spending on durables (automobiles, household electrical appliances, etc.) has not contracted that much, while spending on semi-durables (clothes and footwear, etc.) and non-durables (food, etc.) has been falling gradually since the 1990s. An item-by-item examination reveals that expenditures in items such as food, clothes and footwear, furniture and household utensils have declined considerably.

Figure 3-2-17 Share of Nominal Household Consumer Spending

Since all of these goods are similar in nature to daily necessities, consumers were able to reduce their spending on daily necessities as a result of the decline in prices. In turn, consumers should have been able to spend spare disposable income on other spending on goods and services, such as reading and recreation, transportation and communication, medical care, and education. Of course, such spending on goods and services is not only determined by demand side factors, but also influenced by supply side factors. For instance, supply side innovations, such as the emergence and spread of cellular phones and the Internet as well as improvements in medical and nursing care services, have also stimulated new demand. Nonetheless, it appears that an underlying factor that enabled spending on newly emerged goods and services was the spare disposable income, generated as a result of being able to cut spending on daily necessity-type goods with the influx of low-priced imported goods.

Measuring the price gap between the domestic and overseas markets for food and clothing

Next, the size of the price gap between the domestic and overseas markets for food and clothing will be measured.

Based on the Japan Exports and Imports and Input-Output Tables for 2000, statistics were collected, as far as possible, for identical food and clothing items among imported and domestic products (84 items for food including milled rice and beer, 59 items for clothing such as suits). After that, the import value, domestic production output and difference in unit price (price gap between domestic and overseas markets) were calculated (Appended Note 3-6).(17)

According to the results, the share of imported and of domestic clothing products is almost equal. In particular, items with significant differences in unit price tend to have a high share of imports (Figure 3-2-18). Meanwhile, the share of imports of food remains at a low level. Moreover, the difference in unit price for some items is over 700% and their share of domestic products is quite substantial. Therefore, it is apparent that there is a difference between clothing and food, since imports are increasing for clothing items with a large price gap between the domestic and overseas markets, while imports remain low for food even if there is a large price gap between the domestic and overseas markets

The difference in unit price and volume of demand (domestic production and imports) in 2000 was multiplied in order to measure the size of these price gaps (Appended Note 3-4 cited above). The size of the price gap was 6.5 trillion yen for clothing (1.3% as a share of nominal GDP in 2000) and 10.8 trillion yen for food (2.1% as a share of nominal GDP in 2000).(18) It is important to bear in mind that these price gaps between the domestic and overseas markets persist.

Figure 3-2-18 Calculation of Price Gap between Domestic and Overseas Markets

Concerns about "industrial hollowing-out"

Next, the setbacks experienced by the household sector through employment are examined.

Japan's trade surplus increased beginning in the 1980s, prompting trade friction with developed countries in North America and Europe. As a result, industrial circles initiated full-scale measures to transfer production bases to North America and Europe. Meanwhile, outward direct investment led to concerns that domestic employment opportunities would be lost as a result of the outflow of domestic production bases overseas. These are the so-called concerns about "industrial hollowing-out." In the 1990s, the destination of outward direct investment noticeably shifted from North America and Europe to Asian countries including ASEAN and China. At the same time, in terms of import, the inflow of low-priced imports from these Asian countries increased and intensified concerns about "hollowing-out." The difference between concerns about hollowing out in the 1980s and 1990s is that in the 1980s, the concern was about the loss of employment caused by Japan's leading industries transferring overseas, while in the 1990s it was about an increase in unemployment caused by domestic companies going bankrupt.

How has the trade impacted on employment? Firstly, employment of Japanese manufacturing industries in Japan and overseas is examined by the growth rate of domestic employees (according to the Census of Manufactures) and the growth rate of overseas employees (according to the Basic Survey of Overseas Business Activity) between 1985 and 2001 in each industry. In most industries, it is clear that the number of domestic employees has fallen while the number of overseas employees has increased. Such a trend apparently accelerated especially in the early 1990s (Figure 3-2-19).

Impact of exports and imports on employment

How have exports and imports affected domestic employment? Firstly, in order to look at the changes in Japan's trade structure, the ratio of the export amount to the gross value added in the manufacturing industry and the ratio of the import amount to the gross value added in manufacturing were examined using the Linked Input-Output Tables 1985-1990-1995 of the Ministry of Internal Affairs and Communications. The comparison shows that there was a turning point around 1985. More specifically, 1） the export ratio, which had been rising consistently until then, hit a peak around 1985, and 2） the import ratio has risen more with time since 1985. Using 1985—the turning point for trade structure—as a benchmark, the impact of subsequent changes in the export and import structure on Japan's employment in manufacturing are estimated.(19)

Figure 3-2-19 Rates of Change in Domestic/Overseas Employees by Industry (Cumulative change from 1985)

In this analysis, the number of employed persons in 2000 was projected on the assumption that the trade ratios have not changed since 1985.

To be specific, the number of employed persons in 2000 was estimated, assuming that the export ratio (export amount/(domestic final demand + intermediate demand)) and import ratio (import amount/(domestic final demand + intermediate demand)) in 1985 were fixed. This number was compared to the actual number of employed persons in 2000, and its difference could be attributed to the decline in the export ratio or growth in the import ratio. For instance, chances are high that both domestic production and employment were sluggish since exports from Japan to overseas declined in industries with lower export ratios than in 1985. It is also highly likely that both domestic production and employment stagnated since imports from overseas to Japan rose in industries whose import ratios increased.

The estimate was 1.96 million persons according to the results of the calculation (Table 3-2-20, Appended Note 3-7). This figure indicates the possibility that the number of employed persons in 2000 may have increased by 1.96 million persons more than it actually did if the export-import ratio in 1985 had been maintained in 2000.

Table 3-2-20 Fluctuations in the Number of Employed Persons (1985-2000)

A look at the impact of trade on employment by industry shows that it was concentrated on certain industries. The following industries were estimated to have experienced job losses over 100,000 persons as a result of a decline in the export ratio and the growing import ratio: foods and tobacco (-220,000 persons), textile industry products (-100,000 persons), clothing and other textile products (-320,000 persons), processed metals (-100,000 persons), electrical machinery (-360,000 persons) and transportation machinery (-230,000 persons). The impact on other industries was limited compared to these industries. Consequently, it is likely that the effect of trade on employment was concentrated on several industries.

Impact on exports and imports is eased due to the growth in new domestic demand

Even if exports and imports truly had an impact on employment in manufacturing, it does not mean that the impact immediately led to a decline in the actual number of employed persons.

Firstly, with respect to the foods and tobacco industry, which was estimated to have experienced a significant negative effect from export and import, the actual number of employed persons rose by 160,000, implying that employment expanded in response to the growth in domestic demand. Imported food not only replaced domestic food but made domestic production and employment decrease. The needs of food are diversifying due to changes in consumers' lifestyles and tastes, and sales are rising in the food service industry and for convenience stores, etc. In order to respond to these needs, imported food were sold as ingredients and prepared dishes, which in turn also triggered the competition in the manufacturing and processing industries of domestically-produced food. It is believed that these synergistic effects have increased production and employment in the food industry, which led to the increase in the actual number of employed persons

Secondly, the actual number of employed persons is growing in the chemical and plastic industries. This is because the impact of exports and imports was alleviated and cancelled out as a result of increased domestic demand. In particular, in terms of the chemical industry, the number of employed persons in pharmaceutical manufacturing and other industries is rising and this is believed to reflect the growing sophistication of medical care and rising health-consciousness.(20)

New employment expanded substantially in non-manufacturing industries

Meanwhile, the number of employed persons in non-manufacturing industries rose by 6.33 million persons between 1985 and 2000 (Figure 3-2-21). There is a noticeable expansion in the service industry (4.98 million persons) and wholesale and retail industry (1.06 million persons). The weight of non-manufacturing in the overall economy is growing compared to manufacturing and the percentage of the number of persons employed in non-manufacturing is 80% (2000). In terms of manufacturing, employment was affected by export and import, but it was more than offset by the job growth in non-manufacturing.

Table 3-2-21 Rise in Number of Employed Persons in Non-Manufacturing Industries

There are some non-manufacturing sectors in which employment was created due to the impact of globalization, such as tourism (overseas travel) and foods and beverage retailing (fast food, family restaurants, etc.).

Moreover, employment is expanding substantially in sectors that are indirectly related to globalization. These sectors include medical care, social insurance and welfare, road freight transport (delivery service, etc.), other retailing (pharmaceutical retailing, etc.), sports facilities; parks; amusement parks, software, and worker dispatch service. The new consumer needs generated by these sectors are creating new employment.

In light of the advancement of globalization, what is important is to smoothly facilitate the absorption of lost employment and to nurture new industries that will be creating employment. Therefore, a major task is to tackle domestic structural reform concurrently with these measures.

Impact of exports and imports on wages

Next, the way in which changes in exports and imports affected the wages of workers in Japan is examined.

The changes in the wage gap between industries were analyzed based on data from the Basic Survey on Wage Structure.(21) The explanatory variable used in this analysis was the hourly scheduled wages of full-time employees (all workers excluding civil servants, employees working in establishments with nine employees or less, and part-time workers). The transport machinery industry, one of Japan's leading export industries, was selected as the benchmark. The analysis used a dummy variable to express the wage gap between industries, in other words, whether wages were higher or lower compared to transport machinery. Since gaps in wages may also result from factors other than wage differences between industries, dummy variables for the size of establishment, age, gender and academic background of workers were also incorporated in this analysis. Figure 3-2-22 and Appended Note 3-8 illustrate the gap in wages between industries estimated for four points in time—1985, 1990, 1995 and 2002.

Figure 3-2-22 Gap in Wages by Industry

Growing pressure for fending off a wage increase in the food and clothing industries

There is a significant negative gap in wages for textiles and clothing (-20%) and foods (-12%) and the difference is widening with time. It has already been demonstrated that the impact of trade on employment was substantial on food and clothing. Here it is evident that there was also an obvious negative gap in wages for food and clothing.

It has been pointed out that the reason for growing pressure for fending off a wage increase in the food and clothing industries is that the factor price equalization effect is at work. Factor price equalization occurs when developed countries with many skilled workers trade with developing countries with many unskilled workers and when developed countries export skilled labor-intensive goods while importing unskilled labor-intensive goods from developing countries. Consequently, wages in developed countries for skilled labor rise and those for unskilled labor fall because the demand for skilled labor increases while demand for unskilled labor decreases. As a result of these wage fluctuations, employment in skilled labor, which is expensive, will be relatively curbed in all industries in developed countries (thereby lowering the ratio of skilled labor to unskilled labor).

Since no statistical data exists for skilled labor and unskilled labor, an analysis of factor price equalization has been conducted using proxy variables (such as the ratio of production workers to management, administrative and technical workers). This analysis has shown that employment in skilled labor has not been curbed. Furthermore, it has been pointed out that technological progress, in addition to exports and imports, has a substantial impact on wages and employment. More specifically, it is believed that there is a growing need for highly qualified workers due to the advancement of IT, etc., which may be widening the wage gap as against other workers. Thus it cannot be determined that factor price equalization has been realized.

Japanese people are wary of globalization

One distinctive feature of the Japanese people is that they are wary of globalization due to factors including the impact of exports and imports on employment and wages. To explain this phenomenon using international comparisons, a survey by the World Economic Forum (conducted in autumn 2001, covering 25 countries) revealed that there are considerable differences in the way that countries view the impacts of globalization on the economy.

Developed countries such as the Netherlands, US and UK and developing countries in Asia including China and India have high expectations that globalization will enhance their economies. Meanwhile, such expectations are relatively low in developed countries such as Japan, Spain and France. Why do these different opinions exist and what are the factors associated with them?

The first aspect to consider is the impact of globalization on employment. There is a strong correlation between expectations for increase in employment and expectations for improvement in the economy (Figure 3-2-23). In short, countries with high expectations for an increase in employment have high expectations for improvement in their economies. Japan's expectations for an increase in employment were the lowest among the countries surveyed. In terms of its expectations about economic improvement, it was also second-lowest after France among the developed countries. The fact that the Japanese economy in autumn 2001 was in recession and faced with a severe economic environment including a rising unemployment rate is believed to have contributed to this response. Japan's wary response is presumably also attributed to the impact of exports and imports on employment and wages, as previously clarified.

Figure 3-2-23 International Comparison of Awareness with Regard to Impact of Globalization

However, the growth in employment is merely an expectation. A look at the correlation between the rate of change of the actual number of employees and the expectation for an increase in employment proves that there is hardly any correlation (Figure 3-2-24). In other words, there is almost no relation between the number of employees actually rising and growing expectations for an increase in employment.

Figure 3-2-24 Correlation between Expectations for Increase in Employment and Number of Employed Persons as well as Exports/Imports

Japan's export-import ratio is low, with low expectations for an increase in employment

The second aspect is the relationship between expectations for increase in employment and the export-import ratio. The correlation between these factors is that countries with high export-import ratios have higher expectations for an increase in employment. This indicates that there is a tendency that countries with a high degree of economic openness expect to see desirable effects on employment, which is a rather surprising result. Countries with high export ratios will certainly have high expectations for an increase in production and employment, since they can expect exports from their country to others to rise. Nevertheless, it was predicted that countries with high import ratios would be pessimistic about globalization because of the possibility that domestic production and employment would decrease due to competition from imports. This prediction was refuted in terms of the import ratio. The growth in imports stimulated import-related industries, which in turn led to strong expectations for increase in employment.

Japan's export-import ratio is on the low side among the countries surveyed and it also has extremely low expectations for an increase in employment. This result suggests that there is room for Japan to derive further benefits from globalization by advancing its structural reform measures.

Domestic income disparities are widening according to studies of the OECD

As any economics textbook would say, expansion of exports and imports brings about the following effects: 1） developed countries will export products manufactured by skilled labor and developed countries will export products created by unskilled labor, allowing both parties to enjoy the benefits of trade, and 2） as a result, wages will behave in the way described above, and there will be a relative increase in wages for skilled labor in developed countries as well as a relative increase in wages for unskilled labor in developing countries.

If everything happens according to theory, it can be suggested that these effects will widen domestic income disparities in developed countries (domestic income disparities will narrow in developing countries). On the topic of domestic income disparities resulting from the advancement of globalization, a great deal of research has been conducted by the OECD, World Bank and other agencies on this topic. Some of the results of the study differ from what is suggested by the theory.

Firstly, studies by the OECD show that income disparities widened in many member countries (i.e. developed countries) from the 1980s to 1990s (Table 3-2-25). According to the degree of equality of income distribution (Gini coefficient), income inequality was increasing in about half of the 20 countries surveyed, or 11 countries. Japan also experienced a widening disparity during this period. On the other hand, disparities are narrowing in four countries such as Australia and Ireland.

Table 3-2-25 Trends in Income Disparities of Developed Countries

The factors that have brought about such differences were examined. 1） To begin with, there was no association between the export-import ratio, the leading indicator of globalization, and disparity trends. 2） The advancement of the aging society was identified as a major factor causing the growing income disparity in Japan, yet no correlation was confirmed between income disparity trends and advancement of the aging society in the 20 countries covered by the survey. 3） A positive association was evident in the variation in the unemployment rate, albeit weak. Put another way, the higher the increase in the unemployment rate, the more the increase in income disparity.

Therefore, income disparities are growing in developed countries, but it is more likely that they are brought about by domestic factors such as unemployment rather than global factors.

Moreover, a report by the International Monetary Fund (IMF)(22) concludes that globalization has had only a minimal impact on employment, wages and income disparities in developed countries. Labor markets in developed countries have experienced a shift in demand from unskilled labor to skilled labor. Labor migration occurred relatively smoothly in countries with elastic labor markets (such as the US and UK), but unemployment rose in countries with rigid labor markets (European countries). Nonetheless, the major underlying factor behind these developments was the growth in demand for skilled labor as a result of technological innovation, and exports and imports are presumed to have had a minor impact.

Studies by the World Bank refute theories about income disparities

Meanwhile, studies by the World Bank(23) illustrate the relationship between income disparities (share of average income by income decile group, until the early 1990s) and globalization in developed countries (approximately 20 countries). According to the results of this study, disparity trends were opposite of what theories suggested, and income disparities narrowed more in countries with a higher degree of openness (total exports and imports as a share of GDP). One major reason this occurred was that income disparities were relatively improved in low- to middle-income groups. It is believed that the background of this trend is that in cases where the quality of labor improves through education, the higher degree of openness stimulates new labor demand, thereby narrowing income disparities.

The results of some of the experimental studies on income disparities in developed countries suggest that 1） the verdict on growing disparities differs according to the indicators used to measure disparities, 2） although a definite conclusion cannot be drawn on the impact of globalization on income disparities, it is impossible to say that it was a major factor in widening income disparities at the very least, and 3） there is a good chance that domestic factors, including the labor market, have had a great impact on growing income disparities, and given these circumstances, improving human capacity building geared to technological innovation is a vital policy challenge.

Need for structural reform

The impact of globalization on the household sector consists of both benefits and drawbacks. The benefits include increased disposable incomes as a result of low-priced imports and the drawbacks in employment and wages have been concentrated on some industries. In terms of benefits, looking at the representative example of food alone has suggested that there are still many potentially available benefits. Meanwhile, increasing private demand while dealing with industrial restructuring and labor turnover, etc. remains an issue regarding drawbacks. Since the benefits to the household sector are shared by a broad spectrum of economic entities, there is a tendency for Japanese people to be wary of globalization, but it is expected that advancing structural reform measures will enable them to feel the benefits of globalization more keenly.

4. Regional Economy and Globalization

The advancement of globalization has generated changes in regional economies as well. As discussed earlier, the decline in exports and growth in imports has caused employment to fall sharply in some industries. Faced with these circumstances, some people may feel that globalization has dealt a severe blow to regional economies. However, competitive advantage is something that is always changing and advancing structural measures to counteract the negative effects is necessary in order to create new employment and enable people to take on new positions in new fields. This discussion will summarize the key points on the benefits that regional economies can extract from globalization and the new trends and new measures to this end.

Economic impact of foreign companies

Foreign direct investment into Japan is believed to revitalize regional economies.

The head offices of foreign companies are concentrated in major cities such as Tokyo and Osaka (the top three prefectures where head offices are located are Tokyo (69%), Kanagawa (10%) and Osaka (7%)).(24) Therefore, it is often considered that nothing can be done about the fact that few connections exist between foreign companies and regional areas.

Despite the tendency to think that employment in foreign companies is only growing in major cities, employment in foreign companies in regional areas has been steadily rising. This is because foreign companies' branches and their affiliated companies have widely expanded in regional areas. Forty-six percent of employees working in offices of foreign companies in Japan work in prefectures other than Tokyo, Osaka and Kanagawa.(25)

In addition to the fact that foreign companies in regional areas are generating employment, it is expected for the spread of technology and know-how by these foreign companies to revitalize regional economies. To be specific, one experimental study shows that labor productivity in foreign companies is about twice as high as domestic companies.(26) High labor productivity will improve the standard of living. A look at the relationship between the proportion of workers employed at foreign companies and labor productivity demonstrates that prefectures with a high percentage of workers employed in foreign companies have a tendency to have high labor productivity.(27)

New opportunities: foreign consumers

Foreign consumers have focused on Japan's resources including tourism and agricultural products. Regional economies will be able to derive the benefits of globalization if foreign consumers recognize the value of these resources.

Firstly, with regard to tourism, the influx of tourists has been growing in response to rising income levels in the Asian region, as examined in Chapter 2. This is because foreigners have acknowledged the charms of each region as something of value. For instance, the snow in Hokkaido and Tohoku are effective tourism resources from the point of view of subtropical Asian countries and the Southern Hemisphere whose seasons are opposite of those of Japan. In addition, hot springs (onsen) are also becoming popular among foreigners. Due to such reasons, the number of foreign tourists visiting Hokkaido has more than doubled in the five-year period from FY1997 to FY2002.(28) Of this figure, tourists from Asia have nearly tripled.

Secondly, as for agricultural products, Japan's exports have increased in the Asian region where the standard of living has been improving. Section 4 of this chapter will examine this topic in more detail. As demonstrated by the examples of rice, apples, pears and Japanese yam in particular, there is a growing demand abroad for Japanese agricultural products that are relatively expensive by international standards. This is a sign that there is growing interest in Japanese cuisine, which has been recognized as healthy, and that quality products with high added value have been appreciated. In addition, the growing demand for Japanese agricultural products is also an indication that foreign consumers have acknowledged the value of safety, reliability and other factors in quality management through the appropriate use of production materials such as agricultural chemicals.

Promoting Special Zones for Structural Reform

The system of Special Zones for Structural Reform was established in December 2002 as a measure aimed at regional revitalization. To date, a total of 386 special zones (including those designated in the fifth round in June 2004) have been established in a wide range of areas including education, agriculture and medical care. Among these, there are 26 special zones in the field of international economy that explicitly refer to accepting foreigners and measures concerning Asia and international distribution.

Measures aimed at accepting foreigners include the following: extending the maximum duration of stay (Fukuoka City, Fukuoka Prefecture, etc.) to promote the acceptance of outstanding foreign researchers and others, providing Japanese language instruction for foreign children in order to support foreign workers permanently residing in Japan (Ota City, Gunma Prefecture), and teaching trainees from developing countries and other places about traditional fish processing technologies with a view to realizing international contribution and regional revitalization (Sarufutsu-mura, Hokkaido).

Moreover, measures concerning Asia include: simplifying the process of obtaining short-term visas and inviting tourists from the ROK (Kagawa Prefecture) and revitalizing local regions with a focus on harbors that serve as intersections of sea routes of Asia and as international distribution centers (Okayama Prefecture).

Efforts led by regions are important

In addition to the special zones, local regions have undertaken unique measures in coordination with the national government to promote the acceptance of direct investment. Given that the national government's Program for the Promotion of Foreign Direct Investment into Japan (2003) stated that the government and other entities will support local governments in attracting foreign capital, the Ministry of Economy, Trade and Industry called for applications for the Program for the Promotion of Advanced Direct Inward Investment and five projects were designated in FY2003. These projects include "cooperating with Finland, a leading country in IT and welfare, and invite health- and welfare-related companies, among others, from the Nordic countries and EU countries such as Finland with the Finnish Well-Being Center at the core" (Sendai City, Miyagi Prefecture) and "inviting medical care-related companies based on the Kobe Medical Industry Development Project and Shanghai-Chang Jiang Trade Project and others" (Kobe City, Hyogo Prefecture). In addition, an increasing number of local governments are vigorously promoting partnerships with cities in China, and they have opened 35 local offices in China.(29) This sheds light on the intensified economic exchange that is taking place with an emphasis on the economic benefits at the regional level.

Thus regional economies are proactively tackling globalization, giving rise to a stance of deriving benefits from globalization. It is necessary to fully assess the fields in which each region has a comparative advantage since regional economies possess diverse resources. Therefore, nationally uniform policies are not necessarily effective in bringing out the various advantages of regional economies. It appears that it is important for regional areas to tackle structural reform based on their own initiative according to their special features in order for regional areas to enjoy the benefits of globalization.

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