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November 28, 2005

Japan and Northeast Asia -- Policy Simulations with an Integrated Model: An Abridged Version

Shuntaro SHISHIDO (Professor Emeritus, International University of Japan and University of Tsukuba), Akira KAWAKAMI (University of Tsukuba), Motohiro KUROKAWA (Takasaki City University of Economics), A. MOVSHUK (Toyama University) and Kiyoshi TAMASHIRO (System Craft)

This is an abridged version of the paper presented by Prof. Shishido at the IIOA Conference in Beijing on June 27-July 1, 2005.

1. Introduction

In view of the growing importance of Northeast Asia in the 21st century world economy, an empirical study was conducted in the Leontief-Keynesian framework under the support of the National Institute for Research Advancement (NIRA). The present study covers Japan, and seven Northeast Asian countries including China, Hong Kong, Taiwan, Republic of Korea (ROK), North Korea (PDRK), Mongolia, and Russia with two sub-regions for Northeast China and the Russian Far East. These submodels are attached to the above main system, because of their growing mutual interdependence with Japan. These country models are linked with each other by means of a trade matrix specifically designed for this region.

Regarding the specifications of the country models, Japan's model (DEMOIS) is exceptionally large in terms of sector divisions, with 81 sectors, and in the number of behavioral equations, covering detailed fiscal and monetary variables. For other countries, the specifications of each model are fairly standardized, having 5 common sectors for output, employment, capital stock, etc. and common aggregate expenditure variables such as private consumption, investment, exports, etc. The original version of these country models, with a trade linkage (NAMIOS), was developed by the Economic Research Institute of Northeast Asia (ERINA) in Niigata in 1998 and the present version is an extended version renewed on an updated data base.

2. Japan's Model (DEMIOS)

The original version of this multi-sector model was constructed in 1997 on a project which was carried out under the collaboration of the Project LINK of the University of Pennsylvania on a 64-sector basis, covering sector output, employment, investment, etc., with a market adjustment mechanism for prices and wage rates as well as ordinary macroeconomic variables related to fiscal and monetary policy.

The model is known as the NIRA-LINK Model because of its historical background. The present version is an extended one with a larger sectional breakdown, i.e. 81 sectors and more elaborate fiscal and monetary sectors such as public sectors including central, local and social insurance, and monetary sectors including security stock markets. The basic characteristics of the present model, the NIRA-LINK model with a system representing flexible input-output coefficients are retained and are further elaborated in DEMIOS.

3. Northeast Asian Country Models (NAMIOS)

The coverage of the NAMIOS has been extended to new members, i.e., Hong Kong and Taiwan, thus now numbering nine countries. As in the previous model, common specifications are applied in each country model. Production and employment are divided into five sectors, i.e., agriculture, mining, manufacturing, construction, and services. Exceptionally, however, some sectors are aggregated due to data limitations.

Regarding investment and capital stock, all countries have investment functions by sector, but capital stock by sector is only available for China, where production functions are also estimated by sector on the basis of labor and capital stock series. Capital output and the rate of utilization of total production at the aggregate level are also available for China, but not for other countries. The rate of unemployment, however, is available for all country models, and that is used as a proxy variable of supply side constraints.

4. Policy Simulation

We will present two types of policy simulations. The first one is related to long-term simulations for the period 2000-2020, by using NAMIOS, while the second one concentrates on medium-term simulations by using an integrated model of DEMIOS and NAMIOS for the period 2002-2010. In both cases, common policy assumptions are used: (a) base line, (b) China's growth acceleration, (c) Japan's growth acceleration, and (d) world chronic recession.

4-1. Long Term Simulation

Four alternative long-term scenarios are presented. (a) The first scenario relates to the result of forecasts based on the simple extrapolation of exogenous variables. The results of this base line scenario are indicated in terms of population, real GDP growth, foreign trade, price levels, etc. during the 20 years between 2000 and 2020. Indicating relatively faster growth of GDP and foreign trade, China continues to be ahead in terms of its annual rate of increase, while Japan still remains in a mild deflationary trend. The disparity ratios remain almost unchanged in terms of the growth rate of GDP among China, Japan, South Korea, and other countries in the region. China tends to gradually overtake Japan in terms of exports though in around 2015.

(b) The second scenario is related to the case of China's accelerated rate of growth with more active fiscal policy and foreign direct investment in China. The actual performance over recent years seems to be closer to this scenario, since the growth rate of real GDP in China has further accelerated by nearly 1% and a similar trend is observed in foreign trade, overtaking Japan significantly. The expansionary impact on South Korea, Taiwan, Russia and other neighboring countries is also noticeable. Regarding the trend of prices in China, its inflationary impact still remains modest without any indication of further acceleration. Similarly, no indication of excessiveness is observed in terms of the GDP gap and foreign trade balance despite the acceleration of growth. The impact on Japan is also noticeable in terms of its exports, rising to 3.1% from 2.9% in the base line scenario.

(c) The third scenario indicates a case where the Japanese economy accelerates in growth of about 4%, recovering from the chronic deflationary trend which has continued for more than ten years. Real imports are also assumed to rise by 5.5%. The impact is significant, though not as high as in the second case, having a strong effect on every region of Northeast Asia. Particularly noteworthy is the impact on two regions, Northeast China and the Russian Far East, the effects being greater than in the second scenario. It is also noteworthy that China tends to accelerate in growth due to financial and technical collaboration from Japan, which is assumed in this scenario.

(d) The last scenario is less optimistic, assuming a reduction in world trade caused by chronic stagnation in the United States, Japan, and the rest of the world. A deceleration in terms of growth in the Unites States is assumed to continue due to twin-deficits in fiscal and trade balances. Negative economic impact is widely observed in this scenario in almost all of the regions in the Northeast. Population also tends to decrease in many regions. This is mostly accounted for by the fact that China's dependence on foreign trade is relatively modest.

4-2. Medium Term Simulation

Now we turn to more detailed annual changes up to 2010 by using our integrated model in which Japan is completely endogenized to analyze the mutual interdependence between Northeast Asia and Japan. Particularly important is the feedback effect from Northeast Asia to Japan, which is not fully endogenized in the long-term simulation. A similar pattern of sensitivity to the long-term simulation for the period between 2002 and 2010 is generally observed. However, a remarkable difference becomes noticeable. As compared with the base line simulation, imports under Japan's growth acceleration indicate significantly higher values than in China's growth acceleration case.

The results of the DEMIOS simulation for Japan's growth acceleration are obtained. As against the base line simulation of about 0.7% of GDP growth, the acceleration simulation assumes about a 10-15% growth rate in public investment, strong financial support to business investment, and housing investment of about 2% of GDP. The unemployment rate declines significantly from about 5% to 3.8%, while the rate of capacity utilization rises from 92% to 100%, that is 15% higher than the base line scenario in 2010. Total imports also keep rising, reaching a level 13% higher than the base line. This indicates a significant increase in tax revenue, and the ratio of net government debt against nominal GDP also improves from 1.32 to 1.14.

In conclusion, from the above scenario of Japan's growth acceleration, it is suggested that there is no more horizontal trade linkage as observed during the 1980s, but a more hybrid relationship of horizontal and vertical division of labor becoming dominant, and this new trend has been strengthened by global capital movement, especially foreign direct investment since the 1990s, the post cold war period.

5. Concluding Remarks

As suggested in the above scenario, growing interdependence in Northeast Asia indicates relative advantages of mutual collaboration in terms of the promotion of infrastructure, environmental protection, energy saving technology by foreign direct investment, FTA agreements and trade liberalization, etc., and while these suggested areas for collaboration seem to be rapidly expanding, it should also be emphasized that the Northeast Asian contribution to the world economy is steadily growing as one of the engines for global development. This fact should not be under-emphasized, as well as the growing need for international collaboration within and outside of Northeast Asia.

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