Why appreciation of yen

Again, the estimation results do not change much with respect to both the magnitude and the sign of the estimated coefficients. All these results are available on request. Application of the DOLS procedure requires the time series to be non-stationary and to be cointegrated over time. We are able to show that both conditions are satisfied in our case. Evidence of non-stationarity has been delivered already by the results of our unit root tests in Section 3.

And empirical support of cointegration among the variables contained in our empirical models is conveyed by cointegration tests Table 4 for the fully specified model and Table 5 for the model without Chinese exports. Figures 4 and 5 display the residuals which form the basis for the Engle-Granger cointegration tests described in Tables 4 and 5 and the actual and fitted values according to the DOLS regression models described in Tables 2 and 3 , respectively.

It turns out that the residuals in Figs. Seen on the whole, thus, we feel legitimised to argue that the yen real effective exchange rate has had a long-run negative impact on the share of manufacturing in total number of employed persons in Japan since the s. We now turn to the second option mentioned above, that is to conduct ARDL estimations based on the first differences of the non-stationary variables.

ARDLs are standard least squares regressions that include lags of both the dependent variable and explanatory variables as regressors Greene Their application requires the data to be stationary. This leads us to employ only the first differences of the variables of our empirical model. This comes at the cost that we are not able to exploit level information as it is the case in our cointegration exercise. The ARDL model selection process employed by us uses the same sample for each estimation and selects the final model by maximising the empirical realisation of information criteria in our case, of the Akaike criterion.

The expression ARDL 1, 2, 0, 1, 1, 0, 0 in Table 6 indicates the model selected by our search algorithm according to the Akaike information criterion. The first entry in brackets denotes the lags of the endogenous lagged variable. The second entry corresponds with the lag number of the change of total factor productivity, the third entry indicates the lag number of the change in gross domestic fixed capital formation CAP. The sixth entry is related to the lag number of the outward direct investment variable OFDI.

And the seventh entry refers to the lag number of lags of the yen exchange rate EXR. Values in brackets in Table 6 denote the respective significance level probabilities. Once again, we find a positive and significant effect of the yen exchange rate on the share of manufacturing employment. Summing up, our annual data analysis based on DOLS and ARDL estimations provides robust results which indicate that increases in the real effective yen exchange rate, i.

This is despite the fact that the yen also experiences longer periods of real effective depreciation and is thus indicative of hysteresis effects Krugman and Baldwin ; Belke et al. Having investigated the long-term impact of real effective exchange movements on aggregate manufacturing employment with annual data spanning almost five decades, we now turn to an analysis using higher frequency and, importantly, sector specific data. If exchange rate changes are to have a long-term impact on manufacturing, there ought to be some short-term impacts too.

Using sector-specific data at higher frequency allows us to uncover such potential effects. Ideally, we would be using sector-specific employment to mirror the annual data analysis. However, since we were not able to obtain matching monthly sector-specific employment data, we chose to use sector-specific industrial production data as dependent variable as a second-best option, given that industrial production and industrial employment are highly correlated.

In order to exploit our new dataset on sector-specific yen exchange rates Fig. Footnote 9 Appendix Table 15 provides further details on the variables and sources used. Details of these sectors are provided in Appendix Table In this sense, we follow a mixed panel-time series modelling approach after having estimated sector-specific ARDL models. The two series tend to move in opposite direction, indicating that real effective exchange rates may indeed have a negative impact on industrial production.

Industrial production and industry-specific real effective exchange rates for selected industries. We now proceed with unit root tests of the variables listed below Eq. Hence, we proceed with the individual variables considering them as I 1 variables which have to be differenced once in order to become stationary. We first conduct sector-specific Autoregressive Distributed Lag ARDL estimations based on first differences of the non-pooled variables.

We rely on the same mechanics of ARDL model selection which have already been explained in Section 3. The first entry in brackets denotes the lags of the endogenous lagged variable , the second entry corresponds with the lag number of the change of the sector-specific exchange rate , the third entry indicates the lag number of the change in US industrial production and the fourth stands for the lag number of the change in Japanese industrial input prices.

Deviating from the specification of Eq. Column 2 in Table 7 containing the yen exchange rate effect denotes the significant estimated coefficients for the yen exchange rate in the selected ARDL model.

The total exchange rate effect next column is indicated in the third column of Table 7 by the sum of the period-specific significant entries.

Values in brackets denote the respective significance level probabilities. To illustrate, Table 8 contains a detailed ARDL estimation example for manufacturing sector as a whole.

Its results are summarised in the first row of Table 7. The ordinary Pearson correlations conducted for the example of the Japanese manufacturing sector displayed in Table 9 demonstrate that exports of the Japanese manufacturing sector dominate any impact on the industrial production of the same sector. As a robustness check, we estimated sector-specific ARDL models, this time including Japanese exports. The results are surveyed in Table As a first step, we test for unit roots in the pooled sector-specific time series.

In order to make sure that we employ stationary variables in our panel estimations we conducted the following panel unit root tests for the pools of sector-specific variables: Levin, Lin and Chu Levin et al. All variables turned out to be I 1. As a second step, we conduct Pooled Least Squares estimations of a mixed time series-cross section model based on stationary time series with White cross-section standard errors to allow for general contemporaneous correlation between the branch-specific residuals and White covariance White ; MacKinnon and White Non-zero covariances are allowed across cross-sections degree-of-freedom corrected.

The estimator we employ in this study is thus robust to cross-equation contemporaneous correlation between the branch-specific residuals and heteroskedasticity. The estimation results for our final model are displayed in Table The results are summarised in Table The results of our fixed effects redundancy test at the beginning of Table 12 support our specific choice of fixed effects empirically.

Footnote 10 Also in this case, we rely on White cross-section standard errors and White covariance. Again, the tabulated results of the fixed effects redundancy test in the upper part of Table 13 empirically corroborate our specific choice of fixed effects.

In all three estimation variants applied here we allow not only for fixed effects in the constant but also for cross-section specific slope coefficients. The selection of the final model was conducted according to the same criteria applied throughout the article and described in detail beforehand. Overall, the estimation results displayed in Tables 11 , 12 and 13 again appear well-behaved with an eye on our main hypothesis.

Significant negative sector-specific impacts of the yen effective real exchange rate can be established for at least six and a maximum of all nine sectors, the exact number of sectors depending on the chosen estimation procedure.

This corroborates the empirical findings of Sato et al. According to our Pooled Least Squares estimations Table 11 significantly negative effects of the sector-specific yen exchange rate on Japanese industrial production emerge for the chemicals, the optical instruments, the paper, the rubber, the wood and the textiles sectors.

Our estimations based on Pooled EGLS cross-section weights, Table 12 reveal that the sector-specific yen exchange rate negatively impacts sectoral industrial production in the chemicals, the optical instruments, the paper, the rubber, the textiles and the wood sectors. The expected negative sectoral exchange rate effect emerges from our Pooled EGLS Cross-section SUR estimates for the chemicals, the optical instruments, the rubber, the textiles, the transport equipment and the wood sectors Table We would like to stress that the evidence of negative yen exchange rate impacts on Japanese sectoral industrial production is thus confirmed by the most sophisticated estimation method applied by us in this article: the feasible GLS specification correcting for both cross-section heteroskedasticity and contemporaneous correlation cross-section SUR.

In all cases, the sectoral yen exchange rate enters the final model consistently with a lag of three months time-to-build effect. What is more, the selected empirical models are rather parsimonious in terms of the number of variables included. However, the lagged endogenous variable change in Japanese industrial production turns out to be highly significant throughout. Hence, in accordance with, for instance, Belke and Gros , we feel legitimised to argue that our final empirical models can be interpreted as at least partly reduced forms against which we are able to separate the additional marginal impacts of the yen exchange rate and Japanese exports on industrial production.

Footnote 11 Finally, critics may argue that the empirical realisations of the R-squared are not overly high. However, this type of evidence is quite typical of regressions of changes on changes. Moreover, the R-squared in our estimations appears to be located in the upper possible range. Summing up, in our monthly data analysis with sector-specific data, both ARDL estimations and estimations of a mixed time series-cross section model suggest small but highly significant effects of the real yen effective exchange rate REER on industrial production for a broad range of industrial sectors.

Footnote In this article we have investigated the role of the yen exchange rate in the de-industrialisation that has taken place in Japan over recent decades. There are certainly multiple factors that have played a role in this process, and we do not seek to evoke the impression that the exchange rate has been the single most important factor.

Yet our results suggest that a strong yen had more than just transitory effects on Japanese manufacturing employment and output. In our annual data analysis, the DOLS and ARDL estimations provide robust results which indicate that appreciations of the real effective yen exchange rate did have significant negative effects on the share of manufacturing in total employment in Japan.

This is despite the fact that the yen also experienced longer periods of real effective depreciation, which is indicative of hysteresis effects on manufacturing. Our findings are consistent with recent research on the hollowing out of the U.

But we should also highlight that the magnitude of the exchange rate effects in our annual data analysis are much smaller than of those variables that have the biggest effect on manufacturing employment, namely TFP and fixed capital formation. We also find significant negative effects of the real effective yen exchange rate on industrial output when using monthly and industry-specific data. Our ARDL estimations find significant negative effects for chemicals, electrical equipment, transport equipment, rubber, optical instruments and paper.

Our panel analysis with sector-specific monthly data suggests that movements of the sector-specific real effective yen exchange rate had significant impact on up to seven industrial sectors chemicals, optical instruments, rubber, wood, textiles, paper and transport equipment.

Still, we should also mention that our ARDL and panel estimations did not uncover significant exchange rate effects for several industrial sectors, including general machinery, one of the most important industrial sectors for Japan.

From a policy perspective, our findings suggest that central banks should try to avoid rapid, large-scale appreciations of the type Japan has seen a number of times over recent decades as negative effects on the manufacturing sector cannot be easily reversed at a later stage.

In fact, Japan followed such an exchange rate policy at times e. Foreign exchange interventions therefore became politicised and difficult to follow through. Since ending its dollar peg, China has been cautious to allow only gradual appreciation of its currency. Given the importance of the manufacturing sector for growth, development and employment, policy makers ought to consider potential adverse effects of rapid, large-scale exchange rate appreciations.

As pointed out by Frankel , no single exchange rate regime is right for all countries or at all times. There can be therefore no general recommendations regarding the most appropriate exchange rate regime. But our findings suggest that the exchange rate is too important to be ignored by policy makers. A recent study by Alfaro et al. There are also a number of studies investigating exchange rate effects on European economies.

For instance, using firm-level data, Moser et al. Ekholm et al. Thorbecke and Kato examine the effect of changes to the Swiss franc exchange rate on the Swiss economy and find differences related to the sophistication of exports. A further factor that appears to have played a role in the falling share of manufacturing is the outsourcing of various services that historically were conducted in-house and hence counted as manufacturing, whereas they are now counted as services. Evidence for this development in Japan is presented in Uemura and Tahara Bleaney looks at the pricing of Japanese manufacturing exports and finds a significant role of the yen real exchange rate.

See Belke et al. But none of these studies controls for exchange rate effects. Unfortunately, no data was available for Chinese manufacturing exports for this period. This is why we selected total exports from China. The hysteresis argument is mainly related to the irreversibility of investment-type decisions, due to high fixed costs which cannot be recovered ex post sunk costs.

Industrial manufacturing production, the focus of the second part of this paper, is a very good example because it is dependent on investment-type decisions related to, among others, fixed investment, hiring and firing decisions and establishing distribution networks.

The time series of industrial production have been seasonally adjusted, using the Census X procedure. Cross-section SUR allows for contemporaneous correlation between cross-sections clustering by period.

It is sometimes referred to as the Parks estimator. This interpretation is valid for all finally selected model specifications in this paper which do not include the full set of variables proposed by theory, i. In Section 3. Note that using quarterly data Section 3. National Bureau of Economic Research, Cambridge. Google Scholar. Int Econ J 14 3 — East Econ J 33 1 — Baldwin RE Hysteresis in trade.

Empir Econ 15 2 — Baldwin RE Globalisation: the great unbundling s. At the same time, if a significant disequilibrium of the rate of the yen actually exists, drastic depreciation of the yen could occur at some point, irrespective of policies.

On the other hand, in order to improve the terms of trade, an approach from the import side could be to lower the prices of import commodities, taking advantage of the strong yen, or lower the weight of import of energy and raw materials through conservation of energy and natural resources.

Another approach could be to raise the relative prices of exports by increasing the weight of export goods whose income elasticity of world demand is high. Either approach requires structural responses that relate to economic fundamentals. This page uses Javascript.

Please enable Javascript in your browser. Skip to Content. Home Articles Column FY Tweet Print. Note 1 Assessment of international competitiveness of industries and companies should be made based on the real exchange rate rather than the nominal exchange rate. Note 6 Intervention in the foreign exchange market for significant correction of the exchange rate would face international criticism and would not sustainably change the level of the exchange rate on a long or medium term basis.

However, even with different reference years, recent figures still indicate that the recent rates of the yen are relatively higher than ever. However, this approach is an issue of measurement of the real exchange rate rather than a policy to improve the international competitiveness of the manufacturing industry. Reference s Driver, Rebecca L. Of course, the reverse will be true when the exchange rate trend reverses.

Both will be better off in yen terms, but Company A will be more so. These scenarios show the substantial impact exchange rates have on Company A. Because Company A has a mismatch between its currency at production and its currency at sale, profits will be affected in both currencies.

But Company B only faces a translation effect because its profitability in dollar terms is unaffected - only when it reports earnings in yen or tries to repatriate cash to Japan will anyone notice a difference. The sharp appreciation of the yen during the 10 years after the Plaza Accord, and the exchange rate volatility that followed forced many Japanese manufacturers to reconsider their export model of building in Japan and selling abroad.

This had an impact on profitability. Japan had rapidly gone from a position as a low-cost producer to one where labor was relatively expensive.

Even without the impact of the effects discussed above, it had simply become cheaper to produce goods overseas. In addition, it had also become politically challenging to export products to the United States where there was local competition. Americans witnesses companies such as Sony SNE , Panasonic, and Sharp devour their television manufacturing industry, and they were reluctant to let the same thing happen to other strategic industries such as automobiles.

Hence, a period of political tension surrounding trade emerged, where new barriers to Japanese exports arose, such as voluntary quotas on automobiles and limits on exports to the United States for sale. Japanese companies now had two good reasons to build factories overseas.

It would it lead to more stable profitability in the face of an unstable exchange rate, and relieve the increasing cost of labor. Toyota is a classic example. The slide below is from Toyota's FY annual results presentation. It details the split between a how many cars the company produces in Japan and overseas, and b how much revenue it generates in Japan and overseas.

First, the data show that the vast majority of the company's revenues now come from outside of Japan. But we also note that the majority of cars it builds are manufactured overseas.

While the company may still be a net exporter , and while the evolution may have happened over an extended period, the graduation to a focus on overseas production is clear. Source: Toyota, Not all manufacturers in Japan are large exporters, and not all exporters in Japan have been as aggressive as Toyota and the auto industry in moving production overseas.

However, it has been a trend for most of the last three decades. The chart below combines data from two government agencies to illustrate this point. It looks at the revenues from overseas subsidiaries of Japanese manufacturers and divides it by total revenues of those same companies for the years to In other words, more and more Japanese manufacturers were seeing the merit of expanding their businesses overseas and making products where they sold them.

The problem with this model, however, was that it hollowed out the Japanese economy. As factories moved abroad, fewer jobs were available domestically in Japan, which placed downward pressure on wages and damaged the domestic economy.

Even non-manufacturers felt the impact as consumers reined in spending. The exchange rate factors heavily into discussions on energy security because the country is devoid of natural resources such as oil.

Anything that the country cannot produce through renewable sources such as hydro, solar, and nuclear energy must be imported. Even after the triple disaster of the massive earthquake, tsunami and nuclear meltdown that occurred in March , the country's government and manufacturers were keen to have the nuclear reactors back in operation. While the government's quantitative easing program has been successful at weakening the yen since , the flip side is that imports cost more as a result of that weakening.

The strengthening of the yen against the dollar after the Plaza Accord and the exchange rate volatility that followed has encouraged a rebalancing of Japan's manufacturing industry from one focused on domestic production and export to one where production has shifted overseas on a large scale.