Tue, Dec 25, 2001 page21

• Yen debate sheds light on China tussle

  • By Alan Wheatley / REUTERS
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  Japan's decision not to impose long-term import curbs on cheap Chinese farm produce can be read as a positive sign that Prime Minister Junichiro Koizumi means what he says about pushing through head-to-toe reforms of the ailing economy.

  For many economists, though, the true litmus test of Koizumi's resolve will come next year.

  With its economy deep in recession and in the grip of deflation, will Japan wholeheartedly embrace China's economic dynamism to accelerate a shift away from manufacturing? Or will it try instead to protect inefficient producers by engineering a big drop in the yen?

  The political and economic consequences of that strategic choice will be huge for Japan and for the rest of Asia.

  A steep depreciation of the yen could trigger beggar-thy-neighbor devaluations across Asia that would lead to higher debt-servicing costs, inflation and interest rates and a massive transfer of purchasing power to Western consumers.

  "All told, a sharply weaker yen is unambiguously bad for the economies in Asia ex-Japan," Lehman Brothers said in a recent report. "In the worst case, it could lead some Asian governments to shy away from the movement toward free trade and investment."

  As for Japan, some economists are convinced that the only way to crush deflation is to push the yen lower, thus raising import prices and changing people's expectations.

  But others are dismissive of the longer-term restorative powers of a weaker yen, which they say will do nothing for Japan's deep-seated problems of weak demand and woeful returns on investment, to say nothing of adverse demographic trends.

  Andy Xie of Morgan Stanley in Hong Kong said it was difficult to imagine that Japan, in the transition to a services-led economy, could achieve robust economic growth without the help of a cheaper currency -- along with a large dose of deregulation.

  But rather than using excessive depreciation to protect the least efficient producer, Xie said the government should emulate the US, which made use of a cheap dollar in the 1980s to induce a massive shift out of manufacturing.

  Manufacturing now accounts for just 12 percent of total US employment, down from 21 percent two decades ago.

  "If the Japanese government doesn't interfere in the market, the same will happen in Japan," he said in a note to clients.

  Japanese manufacturing rose from the ashes of World War II to become the envy of the world so it is no surprise that China's emergence as the workshop of the world is discomfiting Tokyo.

  Fears abound of a "hollowing out" of Japanese industry and, more broadly, that China is starting to eclipse Japan politically as well as economically.

  "China is developing rapidly in its coastal areas, it has joined the WTO and will host the Olympics," Foreign Minister Makiko Tanaka said last week. "It is rapidly joining the capitalist economy. Japan is being left out."

  Seen in that light, the eight-month row over surging imports of cheap shiitake mushrooms, Chinese leeks and rushes for tatami mats was more significant than it might have appeared. The showdown ended on Friday when Japan dropped its threat to impose import safeguards against the three products.

  Koizumi said Japan had acted "from the long-term perspective of promoting friendly ties between Japan and China."

  With beleaguered producers of everything from seaweed to towels also clamoring for protection, CH Kwan, a senior fellow at the Research Institute of Economy, Trade and Industry (RIETI), a Japanese government-affiliated think tank, said slapping on safeguards would have discouraged innovation in Japan and obstructed domestic structural reform.

  Japan, moreover, is China's largest trading partner and sanctions would have had a serious impact on industries in both countries, Kwan said in a column posted recently on RIETI's Web site (www.rieti.go.jp).

  He said building barriers to prevent the relocation of sunset industries overseas would merely hamper industrial upgrading.

  "There are in fact no examples of sinking industries in developed countries that have recovered their competitiveness through government-instituted protection policies," Kwan said.

  Instead of using import curbs and subsidies to lock labor and capital and into uncompetitive sectors, the government should focus on eliminating barriers to productivity growth and the creation of new manufacturing and service industries, he said.

  By keeping unviable companies afloat, economists say Japan is not only building up a mountain of non-performing loans on the books of the nation's banks but also stunting the creation of wealth needed to provide pensions for its greying population.

  According to Kathy Matsui, equity strategist at Goldman Sachs, major Japanese firms will make a return on equity this year of just 2 percent -- less than one third of the levels of German companies and one eighth that of US firms.

  The temptation to resort to a cheaper yen instead of painful restructuring has grown in tandem with an exodus of Japanese companies to China in the past year, lured not only by cheap labour but by soaring quality and efficiency levels. Xie said an adjustment of the yen could not possibly close the cost chasm between China and Japan. Not only are China's wages just 3 percent of Japan's but its labour productivity is already virtually identical in areas such as light manufacturing and consumer electronics. Steel, petrochemicals and the auto industry are not far behind.
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