What Happened?

Japanese stock prices reached a recent peak in the summer of 2007 and, with the outbreak of the US subprime loan crisis, began a gradual but substantial decline through the fall of 2008. The decline in stock prices placed a strain on the balance sheet and capital adequacy ratios of commercial banks and, as a result, limited their willingness to lend by the summer of 2008. The Lehman Brothers shock in September 2008 further depressed the stock market and aggravated the strains on Japanese commercial banks. Bank of Japan data indicate that new loans for equipment funds declined by 9% (year-on-year) in the third quarter of 2008, followed by a 10% decline in the fourth quarter. This, coupled with the lagged impact of the negative terms of trade shock (arising from the sharp rise in oil and other commodity prices until the summer of 2008), may to some extent explain the sluggishness of industrial activity in some sectors starting from the summer of 2008 (see below).

Even so, overall manufacturing production held up through September and October 2008 (Figure 3 [ PDF 30.8KB | 1 page ]). Notable exceptions were electronic parts and devices as well as transportation equipment, the production of which had shown earlier signs of softening. In November, however, manufacturing production collapsed precipitously in all major sectors (from 100 in October to 93, seasonally adjusted). Overall manufacturing production continued to fall and reached 70 in February 2009 before recovering somewhat. The collapse was even more spectacular for transportation equipment (52 in February 2009 compared with 110 in September 2008) and general machinery (59 compared with 99). The production of general machinery remained depressed even after production began to pick up in other sectors from the spring of 2009.

The downward movement of industrial production closely followed the downward movement of exports. Although the major factor behind the collapse of Japanese exports was a world-wide shrinkage of demand and trade following the Lehman shock, the sharp appreciation of the yen was an additional blow to Japan's export-oriented firms.² The total value of exports, which stood at 7,360 billion yen (¥) in September 2008, declined moderately to ¥6,915 billion in October and collapsed thereafter. Exports in January 2009, at ¥3,480 billion, were less than 50% of the previous peak in September 2008. The decline was across the board, but most pronounced in the export of industrial supplies, capital equipment, and consumer durables, Japan's three main categories of export products (which together account for over 90% of Japan's total exports). The decline was also registered not only for exports to the US and Western Europe (which together account for over 40% of Japan's total exports), where the financial crisis originated, but also for exports to emerging and developing Asia, Japan's largest export market now accounting for over 50% of total exports (Figure 4 [ PDF 28.6KB | 1 page ], Figure 5 [ PDF 32.3KB | 1 page ], Figure 6 [ PDF 32.3KB | 1 page ]).

Of the decline in exports of ¥3,880 billion from September 2008 to January 2009, emerging (and developing) Asia accounted for over 51%, which is roughly the share of emerging Asia in Japan's total exports. This implies that Japanese exports collapsed almost uniformly across destination markets. The composition of export declines, however, differed across regions, reflecting the different content of trade. Within emerging Asia, 86% of the decline was in industrial supplies and capital goods, whereas this share for the US and Western Europe was smaller at 60%. On the other hand, only 6% of the export decline for emerging Asia was consumer durables, while the share for the advanced markets was larger at 36%.³ This is a reflection of the fact that, though emerging Asia is the largest export market, it is not the dominant market for consumer durables; more consumer durables are shipped to the advanced markets of the US and Western Europe.

Essentially, the export of industrial supplies and capital goods to emerging Asia was most severely affected as the region's demand for Japanese parts, components, and capital goods—all critical inputs for the production of final consumer products—declined steeply. Japan was affected by the shrinkage of “triangular trade” where Japan and the Asian newly industrialized economies (the Republic of Korea (hereafter Korea), Singapore, and Taipei,China) export parts and components to the PRC and other emerging Asian economies, which in turn assemble them to produce final products for the US and European markets. Thus, Japanese exports collapsed because both the export of consumer durables to the advanced markets and the export of industrial supplies and capital goods to emerging Asia fell sharply, as a consequence of the contraction of private consumption and the softening of investment spending in the US and Europe.

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