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• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00447R000200790001-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 10
• Document Creation Date: January 12, 2017
• Document Release Date: May 12, 2011
• Sequence Number: 1
• Publication Date: May 1, 1985
• Content Type: REPORT

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Directorate of _See, t-
Conflicting Pressures on
Japan's Economic Policy:
Trade and Growth
EA 85-10100
May 1985
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Directorate of Secret
Intelligence
Japan's Economic Policy:
Conflicting Pressures on
Trade and Growth
This paper was prepared b
Office of East Asian Analysis. Comments and queries
are welcome and may be directed to the Chief,
Northeast Asia Division, OEA,
Secret
EA 85-10100
May 1985
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Secret
Japan's Economic Policy:
Conflicting Pressures on
Trade and Growth
Key Judgments Prime Minister Nakasone faces a dilemma in pursuing his two main
Information available economic objectives in 1985-to continue to cut the government deficit and
as o!2 May 1985 to lessen the tensions created by Japan's huge trade surpluses. Nakasone's
was used in this report.
commitment to a tight fiscal policy is having an effect on the deficit, but it
is also producing a drag on Japan's demand for imports. Although we
believe the current account surplus probably will grow less rapidly this year
than in 1983-84, we expect it to reach $45 billion, producing discord
between Japan and its trading partners and providing a clear target for the
Prime Minister's critics at home.
Nakasone's approach to the trade problem is already under attack from his
rivals in the ruling party, who have been arguing for some time that the
Prime Minister should do more to stimulate the domestic economy as a
way of boosting imports. Party Vice President Nikaido, who mounted a
major challenge to Nakasone in last October's party presidential election,
has sided with the Prime Minister's critics.
The domestic economy should continue to grow in 1985, but here, too,
Nakasone and his senior policymakers face some potential problems:
? Japan's GNP should grow by 4.6 percent this year, but we expect a
slowdown in export growth to force the economy to depend more on
domestic demand.
? Except for the booming investment sector, however, the domestic econo-
my's performance has been lackluster. Consumer demand-which makes
up over half of GNP-has been slack, and the surge in investment may
slow later in the year as the need to add capacity to meet export demand
declines.
Thus far the Prime Minister has lined up with the fiscally conservative
Finance Ministry against any move to stimulate domestic growth with an
injection of new spending or lower taxes. Nonetheless, we believe he may
reconsider this approach later this year if there are signs of a downturn in
the economy-which would give more ammunition to his critics in the
LDP-or more pressure from abroad to boost growth as a way of cutting
Japan's massive trade surplus.
iii Secret
EA 85-10100
May 1985
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Secret
Japan's Economic Policy:
Conflicting Pressures on
Trade and Growth
A Slowdown in Trade ...
We do not expect Japan's trade surplus in 1985 to
show the explosive growth of the past two years.
Export letters of credit, a key indicator of future
trends in exports, fell below last year's level in
February and March, and import growth is picking up
as the economy's expansion strengthens demand for
foreign goods. Based on the yen's weakness and our
expectation that the world's demand for imports will
continue to expand, however, we do foresee some
growth in the surplus
In 1984, Japan's current account and trade surpluses
(see figure 1) were characterized by:
? Exports increasing 15.7 percent, led by office equip-
ment, videotape recorders, semiconductors, and
cars. Imports increased only 8.7 percent, largely
because of lower crude oil import prices.
? A trade surplus with the United States that hit
$33.1 billion (see figure 2). Exports grew 40 percent,
while Japanese purchases from the United States
increased only 8.9 percent
In JFY 1985 the current account surplus probably
will reach $45 billion, compared with $37 billion last
year, in part because of the earnings from Japan's
overseas financial investments. The Economic Plan-
ning Agency (EPA) has officially-and, in our view,
overoptimistically-forecast a current account surplus
in JFY 1985 of $34 billion
... And in Growth?
The foreign sector-Japan's international trade and
financial flows-accounted for over a third of last
year's GNP growth of 5.8 percent, the highest rate
since 1973. Other indicators also reflected the econo-
my's overall strength:
? Inflation remained at 2.2 percent, the second lowest
rate in 25 years.
? The official unemployment rate, was only 2.7 per-
cent. The number of jobless has crept up in recent
years; but thus far there appears to be little public
concern.
Figure 1
Japan: Current Account and Trade
Balances, 1981-858
We think Tokyo's official forecast for GNP growth of
4.6 percent in JFY 1985 is about right. Compared
with JFY 1984, the 1985 estimate reflects some
slowdown in foreign demand. It also suggests that 25X1
domestic economic expansion in Japan will continue
to be driven by private business investment in plant
and equipment.
The Investment Question
In fact, judging the relative role and importance of
private business investment versus foreign demand in
keeping Japanese growth on track has given economic
forecasters-and may give Nakasone-a thorny prob-
lem. Private investment grew at an annual rate of
Current account 25X1
balance
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Figure 2
Japan: Trade With the.United States,
1981-848
I I I I I I I I I I I I I
0 1981 82 83 84
Imports from the
United States
more than 10 percent in 1984 because of higher
earnings and business expectations of continued ex-
pansion in foreign as well as domestic markets. But
EPA officials disagree over whether increasing Japa-
nese exports-of electronics and cars, for example-
are necessary to continue this investment flow or
whether it can be fueled mainly by ongoing techno-
logical upgrading at home. We believe investment
should continue to be strong in 1985 based on business
plans already in place. The incentive to invest proba-
bly will diminish later this year, however, as the
requirement for added capacity to meet export de-
mand declines.
Like the EPA officials, private Japanese forecasters
are uncertain about the outlook for growth in 1985.
Most expect GNP growth to be between 4 and 5
percent, but the range of forecasts is wider this year
than last. As cases in point, the Mitsubishi Research
Institute and the Tokai Bank expect consumption to
remain stagnant and investment slow, keeping the
GNP increase under 4 percent. The Research Insti-
tute of the National Economy, however, is more
upbeat about both and predicts a 6-percent growth
rate for GNP this year.
Exports to the
United States
Trade surplus
with the United
States
The Budget: No Potential Help in Time of Need
Nakasone's commitment to reduce the government
deficit limits the tools he can use to stimulate the
economy. Planners are counting on an increase in
domestic consumption demand-which makes up over
half of GNP-to aid the economy's growth:
? The official forecast calls for consumption to grow
by 4 percent, compared with the laggard 3-percent
pace of the past two years.
? Although we do not expect a boom, we believe
spending by the average Japanese will be somewhat
stronger this year, because higher wage and bonus
payments-reflecting companies' higher profits-
will boost disposable incomes.
Fiscal policy in 1985 will provide little stimulus to
offset any shortfall in the expected growth in con-
sumption and investment. The 1985 budget-which
took effect on 1 April-raises total spending only 3.7
percent over the initial 1984 budget, the tightest since
1955:
? General expenditures-less debt service and reve-
nue sharing with local governments-decline for the
third year in a row.
? The Fiscal Loan and Investment Program, which
includes expenditures on roads, water supply, and
sewers, drops by 1.2 percent.
? Defense and foreign aid spending are exceptions
again this year. Defense spending will be up by 6.9
percent, bringing it near the 1-percent-of-GNP lim-
it, and foreign aid will rise by 10 percent.
The Ministry of Finance pushed hard for spending
controls and steps to increase revenue. As a result, the
1985 budget also includes additional taxes to cut new
bond issues by $4 billion from last year's level. The
net effect of the budget lowers the central govern-
ment's deficit in 1985 to 22 percent of total spending,
or about 4 percent of GNP.
The Political and Economic Dilemma
Beyond the difficulties a tight budget poses for the
Prime Minister should Japan's domestic growth tail
off more dramatically than expected later this year,
Nakasone's-fiscal policy, in our view, is already
adding to the problem of Japan's trade surplus.
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Nakasone is continuing government tax and spending
policies that since 1979 have reduced the deficit as a
share of GNP. But the private sector's savings rate
has remained high-well above the domestic invest-
ment rate-producing a surplus of private domestic
savings. Because the central government's budget
deficit financing needs have been too small to absorb
the domestic savings surplus, funds have moved
abroad. Last year's record $50 billion net long-term
capital outflow kept the yen's value low, in turn
supporting the export boom already under way
because of strong foreign demand for Japanese prod-
ucts. Strong foreign demand has made up for the lack
of stimulus from the government and kept growth
healthy enough to mute criticism of the government's
deficit-trimming fiscal policy.
Tokyo's austerity has not been the only reason for the
trade surpluses, but our econometric modeling sug-
gests that a 10-percent increase in the level of govern-
ment spending in 1982-84 would have cut $10 billion
from Japan's current account surplus in 1984. A 10-
percent cut in the level of taxes over the same period
would have reduced the surplus by $4 billion.
Nakasone's tight fiscal policy in any case is still
supported within the government, but there are con-
cerns about how the United States views its effects, as
well as signs of simmering political opposition at
home. On the one hand, some officials in Tokyo are
concerned about a US perception that Japan is using
exports to keep the government's tight fiscal policy
from slowing the economy. In meetings with foreign-
ers, the Japanese have attempted to portray their
recovery and expansion as based on domestic demand.
For example, in the EPA's official forecasts, coordi-
nated with the Ministries of Trade, Finance, and
Foreign Affairs, Tokyo has consistently underestimat-
ed the strength and importance of foreign demand, as
well as the size of the trade and current account
surpluses. According to the US Embassy in Tokyo,
the Ministry of International Trade and Industry
(MITI), the EPA, and the Ministry of Foreign Affairs
fought hard for a JFY 1985 forecast that depicted
strong growth based on domestic demand, which
would suggest increased Japanese imports
The Finance Ministry has also been concerned this
year that Washington will push Tokyo to stimulate
the economy in order to boost Japanese demand for
imports.
On the other hand, some opposition to Nakasone's
fiscal austerity is surfacing again in his own party.
Before Nakasone's reelection as president of the
Liberal Democratic Party (LDP), some of his chief
rivals argued for a spending increase. In the last
month or so, versions of their ideas have reappeared:
? Kiichi Miyazawa, the heir of the Suzuki faction,
proposed an "asset-doubling" plan, reminiscent of
the official "income doubling" theme associated
with Japan's spectacular growth in the 1960s, that
would increase public works spending.
? State Minister Toshio Komoto, head of a competing
LDP faction, has continued to push his long-favored
fiscal stimulus ideas to boost growth and imports.
? LDP Secretary General Shin Kanemaru, who was
critical of the Finance Ministry's austere 1985
budget proposal, has advocated more spending and
other measures to boost domestic demand.
? More recently, the issue was raised by LDP Vice
President Nikaido, who suggested pump priming
may be in order to reduce trade friction.
The opposition parties, while considerably less influ-
ential politically, have maintained a similar chorus.
The Japan Socialist Party has led the way by propos-
ing a 1.1 trillion yen ($4 billion) tax cut and boycott-
ing Diet sessions to protest this year's tight budget.
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The Chances for Change: The Consensus Position
At this point, Prime Minister Nakasone is not being
driven by a political groundswell to consider new
fiscal initiatives. Economic policy is not seen in Tokyo
as one of his strengths, and he would be certain to be
attacked if he undertook new policies that would
widen the budget gap and undercut the five-year
effort to cut back the bureaucracy. For example, both
Keidanren and Nikkeiren-Japan's two most presti-
gious business umbrella groups-recently have at-
tacked the idea of government economic stimulation.
Nakasone's tight fiscal policy has stronger backing
from the LDP's supporters in the business and finan-
cial worlds than does a stimulatory approach.
The Finance Ministry, which has the upper hand on
macroeconomic policy, is also ready with a counter-
attack if it faces a political campaign for more
In our judgment, massive fiscal stimulus would be
needed to significantly affect growth and the current
account surplus in the short term. A $4 billion
increase in government spending in JFY 1985, for
example, would boost growth by only 0.3 percent and
cut only $1 billion from Japan's current account
surplus, according to our model.
What Could Move Nakasone?
The attractiveness to Nakasone of new policy depar-
tures will depend, in our view, on his judgment of the
cost of inaction abroad as well as at home. US
Congressional action because of a perceived Japanese
unwillingness to deal with the current trade imbal-
ance-even if the rate of growth in Japan's surplus
declines-could well force Nakasone to consider new
steps. For Japan-and for Nakasone-the interna-
tional economic environment in 1985 will be less
predictable than in 1984. In our view, it could present
conditions that reverse the slowdown we now expect in
growth of the trade surplus and bring about a corre-
sponding upswing in international pressure on Japan:
? Continued weakening of the yen compared with the
dollar-a situation that already has contributed
greatly to Tokyo's trade problems-would make the
surpluses difficult to contain.
? An increase in the rate of growth of world import
volume, which began to stagnate last year and limit
Japan's exports, would induce further growth in
Japan's export markets. So, too, could better-than-
expected economic performance in the United
States that fueled rapid growth in world trade and
boosted the surpluses even more than we project.
At home, Nakasone must address fiscal policy deci-
sions driven by his deficit reduction goals that could
complicate both trade and growth problems. The
Finance Ministry is pushing for another tax increase
in JFY 1986 to further reduce issuance of deficit
bonds. Large amounts of older bonds that come due
this year and next will push up debt servicing ex-
penses. We expect refinancing will not have as strong
an impact on credit markets and interest rates as .
some have feared, because redemption of the old
bonds will provide investors with sufficient capital to
buy the new issues. Nevertheless, refinancing provides
more ammunition for the Ministry in pushing its tax
increase plan.
The Ministry argues that only new revenues will
enable the government to meet its goal of eliminating
deficit financing bonds by 1990. The Ministry pro
poses the introduction of a European-style value-
added tax, coupled with cuts in the income tax and
packaged as "tax reform." Finance Minister Take-
shita has hinted he wants to see the reform effective
as soon as JFY 1986. The LDP's Tax Research
Council, which has dominated decisionmaking on
taxes in the past, has come out in favor of the Finance
Ministry's proposal.
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If Prime Minister Nakasone chooses to attack the
budget deficit with new taxes, he risks slowing growth
and-by cutting future demand for imports-worsen-
ing trade frictions. Our analysis indicates the short-
run effect of the taxes would be small. A $4 billion
increase in indirect taxes, for example, would add only
$76 million to Japan's trade surplus by the end of the
first year, according to CIA's econometric model. If
other voices-either abroad or at home-are quiet on
trade issues, we believe Nakasone will follow the
Finance Ministry's lead. In recent statements, for
example, he has left open the possibility of a value-
added tax, even though he has publicly opposed tax
increases in the past.
There are signs that Japanese concern with US
retaliation for perceived inaction on trade has reinvig-
orated Komoto, Miyazawa, and others who are again
publicly suggesting fiscal stimulus to deal with the
current account surplus. Political crosscurrents in the
LDP stimulated by the incapacitation of former
Prime Minister Tanaka-Nakasone's main backer in
the party-also appear to be a factor behind the use
Nakasone's rivals have made of the issue. As a case in
point, the two main contenders for leadership of the
Tanaka faction, which comprises one-third of the
ruling party's membership, have squared off on the
fiscal stimulus question. Both men are aspirants for
prime minister. Finance Minister Takeshita has con-
tinued to champion the current conservative approach
to budget cutting, but senior faction leader Susumu
Nikaido, echoing the views of Komoto and Miyazawa,
now publicly advocates more spending to solve the
import problem. The issue is politically sensitive and
could prompt Nakasone to rethink his own policy-
particularly if further friction with the United States
leads contenders for the prime-ministership to blame
him for failure to resolve the problem.
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