A Few thoughts on External Accounts and Growth Model

By Ichiro Suzuki

In recent years, trade and current accounts have become poor indicators of a country’s economic success, as far as developed countries are concerned. Japan has been posting current account surpluses at 2-3% of GDP throughout the decades of its economic stagnation that followed the burst of the bubble at the beginning of the 1990s. Since the last decade Japan’s trade account is essentially balanced as some industries, especially electronics, became also-ran in the digital age. Despite lost competitiveness, interest and dividend income from investments in overseas assets, be they U.S. Treasury securities or Corporate Japan’s foreign subsidiaries, continue to flow in. As population ages, households draw down their savings and lower savings are supposed to exert downward pressure on trade and current accounts, but they have not turned out that way. Stark current account surpluses represent a failure to deliver what the Japan’s policy makers tried to achieve in the last few decades, that is domestic demand-driven growth. Germany has been registering even greater current account surpluses at 7-8% of GDP and the country is often criticized for its insufficient policy measures to boost domestic demand. Germany has stubborn aversion to run budget deficits to create demand, always beholden to fears of rising prices that are attributed to the Weimar Republic’s nightmarish experiences of hyper inflation. Exporting industrial goods is always considered as virtue for the economy, and Germany AG excels in it, pushing for greater market shares in the global economy. Though EU and Germany try to project themselves as guardians of human rights, German manufacturers never try to conceal their zeal of exporting their goods into the Chinese market. Exporting manufactured goods has become a very tough game to keep playing over the last few decades. There are always developing countries behind, who are trying to eat forerunners’ lunches, not only with low cost but also with nearly equally well-made goods. Forerunners are always under pressure to move up a value chain ladder. Half way through the 20th century, Japan took off as a low cost competitor in textile and lightly manufactured goods. The country then moved onto home electric appliances, shipbuilding, cars, electronics, semiconductors, etc. Japan has been always chased by Asian Tigers that included South Korea, Taiwan, Hong Kong, Singapore, etc. As these Tigers grew richer, China captured their market shares in many of these industries, and the Tigers moved on. On a sharp rise of China’s income, factories are now moving out of China to lower cost countries such as Vietnam, Indonesia, India, Bangladesh, etc. Forerunners alway do not succeed in moving up a ladder. A case in point was Japan’s electronics and semiconductor industries. Until the early 1990s, Japan was leading the world in these two industries, and then stumbled in a rather spectacular fashion. The advent of the internet and digital revolution left the management of Japanese electronics industry totally puzzled. Unable to understand the paradigm shift in the industry, Japanese electronics makers lost its luster. In the semiconductor industry, Japanese corporation’s management teams without strong leadership found it hard to make big decisions on capital investments that increasingly became larger in response to greater sophistication of newer chips. Such developments made Japanese companies unable to keep up with competitions, and dropped out. One notable adverse effect caused by holding onto an export-driven growth model could be persistent deflationary pressure. In response to low cost competitors, forerunners are always forced to keep their prices in check, sometimes unable to pass increased costs onto consumers and customers/ end-users. Low prices brought by international competition were initially received positively by consumers. As China broke into the global trade system upon its entry into the WTO, with its massive number of low wage workers the country has distorted the Philips curve that defines the interaction between the inflation rate and unemployment rate. The lower the unemployment rate, the higher the inflation rate, or vice versa, as the theory says. In the face of fierce competition with Chinese manufactures, wages could not be raised easily at factories in the developed world, even if they are producing higher value-added products. For Japanese manufactures, pressure from an ever-appreciating currency added extra pressure to cut costs on top of pressure from low cost competitors, China or else. Such pressure exacerbated mild deflation that Japan had already been afflicted with, from a series of banking crises. Corporate Japan turned out to be very successful in containing costs, and hence in generating external account surpluses that in turn adds extra pressure on the yen. This is catch 22. An export-driven growth model may have gone as far as it could, and has outlived its usefulness. Perhaps, the best defense could be getting out of this vicious loop of competition, costs and external account surpluses. Intentionally or not, the United States has dropped out of this game of going up a ladder in manufacturing at the height of Corporate Japan’s might. The U.S. appeared to be drifting at that time but was laying groundwork for what would come toward the end of the 21st century. Apple Computer went public in 1980 and Steve Jobs almost became Time Magazine’s 1981 Man of the Year. Microsoft became a public company in 1986. These two still relatively young companies are dominant two largest public corporations on earth today, and are essentially minting money. Intel went public in 1971. Designing and producing microprocessors became America’s answer to Corporate Japan’s onslaught in the semiconductor sector in the 1970s, especially in the space of DRAMs (dynamic random access memories). Manufacturing was abandoned slowly by U.S. corporations, as contract manufacturers took up the job of assembling gadgets. On the back of every iPhone, it was engraved “ Designed by Apple in California. Assembled in China”. Designing became what mattered and manufacturing was relegated to a secondary consideration. Semiconductor production slowly disappeared from Silicon Valley as chip makers increasingly focused on designing, leaving manufacturing to ‘foundries’ that essentially means Taiwan Semiconductor Manufacturing Company (TSMC). Intellectual property stayed in the U.S., making Corporate America prosper with stunning earnings growth. NVIDIA, which only designs circuits, overtook Intel years ago in terms of equity market capitalization. However, TSMC that manufactures chips for NVIDIA and other design houses holds the title of the largest chip maker. TSMC represents the value that Corporate America chose not to retain within themselves. This is acceptable, as far as equity markets are concerned. Other flourishing tech giants don’t make things, represented by Microsoft, Amazon, Alphabet (Google) and Facebook. As the rise of TSMC represents, efficient manufacturers for U.S. corporations, be they shirt, shoe or chip makers, enjoy value transferred from the American soil. It also keeps pressure on U.S. trade and current accounts through greater imports. This still sounds tolerable up to a certain point. By focusing on intellectual properties and platforms, the U.S. has set itself apart from those who are still playing the game of moving up a manufacturing ladder. In the U.S. economy, downward pressure on prices are much milder than it is in Japan or Europe. Since the greenback is the world’s reserve currency, the U.S. keeps providing liquidity to the global economy through current account deficits. Current account surpluses for the U.S. would have detrimental effects to the world through tightened monetary conditions. Trade and current account deficits are good, in fact. Everything is going well, right? Here’s a catch, of course. Factory closures led to losses of well-paid manufacturing jobs that have long underpinned America’s middle class, while tech people became richer, especially in the coastal states. Disgruntled workers drove a movement that have pushed democracy to test its limits. In the last few years, there have been attempts to bring some factories back to the U.S., or close to home at least, through restructuring of Corporate America’s supply chain that was overly dependent on China. Nevertheless, it does not seem likely that exporting manufactured goods regain its luster in America, as export-driven economic growth is beginning to look outdated. The global economy is in search of a right balance between exporting manufactured goods and earnings from much less visible intellectual properties.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.