Abenomics, Yen Depreciation, Trade Deficit, and Export Competitiveness

Prime Minister Shinzo Abe's economic stimulus package, Abenomics, depreciated the yen sharply from the end of 2012, which was expected to have a positive impact on Japan's trade balance. Contrary to the J-curve effect, however, Japan's trade balance has not shown any signs of improvement, even though two years have passed. There is a growing concern that Japanese firms might lose their export competitiveness in the global market. This paper shows that Japanese firms conducted a strategic relocation of their production bases by expanding their overseas production of low-end products, while domestic production is concentrated more on high-end products. This new phase of international division of labor is likely to impede the positive effect of the yen depreciation on Japan's trade balance, which is empirically supported by the auto-regressive distributed lag (ARDL) model. In addition, Japanese manufacturing export prices in terms of the contract (invoice) currency have not changed in response to the large depreciation of the yen, which is empirically confirmed by the time-varying parameter estimation of the exchange rate pass-through analysis. Thus, the slow recovery of Japan's trade balance in response to the yen depreciation can be explained by the Japanese firms' pricing behavior as well as the changes in their production and trade structure.