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Japan: Running out of Steam

One of the world's greatest export engines is running out of steam. 

For decades, Japan used the combination of manufacturing might and shower markets  around the world with its cars and consumer electronics and semiconductors. This is for the first time since 1980 that the Japanese government has announced that the country recorded its first annual trade deficit. If the yen re- mains strong and global demand weak, economists warn that Japan could run trade deficits for years to come.
The startling change is partly a result of one-time factors like the disastrous earthquake and tsunami last year, which destroyed factories, crippled supply chains and idled many of the country's nuclear reactors. But the quake seems to have accelerated trends—like a decline in corporate competitiveness—that have been bubbling under the surface for years as the export superpower slowly transforms into a nation of pensioners. More and more Japanese companies are moving production offshore. “This is a turning point for us,“ says industrialist, which this year is opening its first factory overseas, since the company was founded in 1948.  Whereas Japan once forced the rest of the world to march to its drumbeat, now the island nation is being swept up by big global forces outside its control.
The torrid growth of emerging economies like China and Brazil has pushed up the cost of what Japan pays for everything from oil and gas to the rare earths it imports for the manufacture of cameras, mobile phones or cars. The high rare-earth material prices have doubled the cost of magnets used in the motors his company needs. 
Japan's domestic manufacturing malaise is being reflected in its trade numbers. For the first 11 months of 2011, it re- ported a trade deficit of ¥2.3 trillion ($30 billion), compared with a surplus of ¥6.6 trillion for all of 2010. Analysts say it is all but impossible for the country to report a big enough surplus in Wednesday's December report to overcome the deficit for the rest of the year.
A former Bank of Japan official who heads economic research, expects Japan to log a trade deficit this year as well as last year. He says there is no chance of returning to surplus as long as the yen remains near historic highs against the dollar, energy prices high and global demand relatively weak. Underscoring the country's struggle, the Bank of Japan had said that it expected the economy to contract by 0.4% for this fiscal year, revising a previ- ous projection for a 0.3% gain.
The central bank said slowing overseas economies and the appreciation of the yen continued to hamper growth. It is an ominous development for Japan. If the trade deficits continue, Japan could change from a steady provider of capital to a net borrower. The country could eventually struggle to finance a debt burden that is already bigger than Italy's as a percentage of its economy. While the yen is sky-high now, it will eventually plunge if Japan keeps running trade deficits. A weak yen would help Japanese manufacturers but would take a toll on an economy increasingly dependent on imports.
In the decades after World War II, Japan practically invented export-led growth, propelling a remarkable creation of wealth touted as the “Japanese miracle“ by the country's leaders. Japanese cars proved so popular in America that in 1981, the US government start- ed pressuring Japan's auto makers to “voluntarily“ limit their exports. Shortly after, the US accused Japan of dumping cheap semiconductors on world markets.
As part of a global effort to rein in Japan's export juggernaut, the US, the leading European economies and Japan signed the Plaza Accord in 1985—named after New York's Plaza Hotel, where the pact was set—to strengthen the yen against the world's major currencies, thus pushing up the cost of Japanese-made goods in world markets. The agreement had a dramatic effect on ex- change rates: The yen soared from about ¥239 to the dollar in 1985 to ¥128 in 1988.
But the change didn't end up having the desired effect of shrinking Japan's mammoth trade surpluses, in part because Japanese authorities tried to mitigate the economic impact by flooding the economy with cheap money. The resulting asset bubble created major distortions in Japan's economy and financial markets, and its burst set the stage for two decades of stagnation. The widely perceived trauma from the Plaza Accord has been cited by Chinese officials as a major reason for their hesitance to respond to similar pressure from the US now to appreciate the yuan.
Japanese manufacturers have in recent years been losing out to rivals from countries like China or are often just as good and whose costs are much lower. A 2010 survey of global manufacturing executives projected Japan would continue to slip behind developing countries but also the US in manufacturing competitiveness during the next few years, as the population ages and the costs of making goods at home rises.
Intense competition abroad has been pushing down the prices that Japanese manufacturing heavy- weights like Toyota Motor Co. or Sony Corp. can get for their wares overseas, while the strong yen has been making it harder to eke out profits.
The nuclear accident at Fukushima Daiichi, which has effectively halted the use of nuclear power in Japan for now, is also forcing up energy costs. Plant operator Tokyo Electric Power Co. had announced an average 17% hike in its base electric rates for corporate customers—its first since 1980—citing a higher de- pendence on expensive oil in the face of public resistance to restarting idled reactors. Other Japanese utilities are also finding it tough to restart reactors. And the government is warning that all the country's nuclear power plants—which accounted for about 30% of Japan's energy a year ago—could be down during the high-demand summer season, threatening forced conservation or possibly even rolling blackouts.
Some say the disasters only sped up a much broader shift in Japan's economy over many years. “This is part of the process of becoming a mature economy,“ a trade official during the 1980s, who now heads the Japan External Trade Organization. The organization itself started in 1951 as a body to promote Japanese exports, and has since switched to encouraging investment in Japan, as well as counselling small businesses that want to move overseas, he points out.
Japan is still a rich country with a stable of manufacturers that hold big shares of global markets from automobiles to endoscopes. Some of the factors driving the country's decline in exports are temporary, like lower overseas demand for prod- ucts in the face of weakness in Europe and the US Japan's yen is at historic highs versus the dollar and euro. A weakening of the country's currency would change the equation in Japanese manufacturers' favour. And Japan still has ¥251 trillion more in foreign reserves and investment assets—like US Treasury bonds—than other countries hold in Japanese investments, according to the Ministry of Finance. “It's true that the trend is toward trade deficits, but as long as Japan keeps a current-account surplus, it doesn't matter,“ says Eisuke Sakakibara, a former finance official. The current account tracks the difference between what a nation saves and what it invests. It balances imports of goods and services, plus the return on investments abroad, versus exports. When the current account goes negative, it means domestic investments are being financed with foreigners' money.
The weakening in Japan's trade balance comes as an aging population and decades of next-to-zero growth erode the stockpiles of cash that thrifty Japanese socked away when its economy was booming. That, in turn, is stoking fears that Japan will sooner or later have trouble financing its roughly ¥1,000 trillion in public debt.