US-China Trade Friction: What Direction will it take?(No. 201)[Summary]

◆Japan’s Economy Continues Zero Growth: In light of the 1st preliminary Jan-Mar 2019 GDP release we have revised our economic growth outlook. We now forecast real GDP growth of +0.5% in comparison with the previous year for FY19, and +0.5% in comparison with the previous year for FY20. Japan’s economy will most likely continue cruising at low altitude in the future, with a growth rate below that of the potential growth rate. With overseas demand lacking much movement, domestic demand has increased in importance, but this area has also been in the doldrums of late. The collapse of the price of crude oil since the autumn of 2018 brought some temporary leverage to household real income, but now that crude oil is on the way up again, that positive factor will fall by the wayside in the future. In this report we examine the following three issues.

◆(1) US-China Trade Friction – What Direction will it take?: Who has the advantage in the intensifying US-China trade friction? Judging from economic structure, the negative effects are larger for China. However, when we look at the boomerang effect that comes along with the raising of tariffs, it appears that the US, which has implemented much more extensive economic sanctions, may see the more serious economic effects. China has taken a fairly measured approach to the US sanctions, adopting the strategy of a war of attrition, and it is this contest of endurance that could be a disadvantage for the US. That said, the US still has a variety of cards to play, both in the area of policy and negotiation strategy. And it still has room to implement fiscal and monetary policy, such as infrastructure investment and monetary easing. All in all, the US has a fundamental advantage in trade friction with China. Meanwhile, the underlying struggle for supremacy between the two systems (Capitalism vs. Communism) may continue on for another ten or twenty years.

◆(2) Will Japan’s Exports Recover?: Japan’s exports are expected to continue marking time. As for the global economy, the main factors to watch for are China’s economy, and the effects of additional US and Chinese tariffs. The Chinese economy will take a bit more time to recover, but it may have already passed the negative phase. Demand is expected to increase in the future due to economic measures being implemented by the Chinese government, but the benefits for Japan in terms of exports to China will likely be limited, with the focus being public investment related. Taking into consideration the secondary effects on Japan of the US and Chinese additional tariffs, if there is no resulting government expenditure in the US or China, Japan’s real GDP could be forced downwards by -0.13% to -0.22%. On the other hand, if the two governments carry out fiscal expenditure, the negative effect on Japan’s economy will be much more limited. The question of whether or not the US and Chinese governments make use of increased tax revenues from the tariffs to carry out government spending is an important one for Japan’s economy.

◆(3) Current State of Investment in Labor-Saving, and its Challenges: Major corporations, mostly in the manufacturing industry, have been carrying out investment in labor-saving. However, at this point in time, the situation is not one likely to encourage a strengthening of that activity. Looking at the current situation of profit distribution, major corporations are not increasing distribution to employment related categories (increasing number of new employees + rewarding current employees). On the other hand, small and medium-sized businesses have a strong sense of shortage of employees, and gradually a tendency is appearing to use profits in the employment related area. We can therefore deduce that there is a strong motive for potential labor-saving investment. However, labor’s share is high for small and medium-sized companies, and capex tends to be highly influenced by cash flow, meaning that there is not much margin available for the carrying out of labor-saving investment. In order to encourage small and medium-sized businesses to carry out more labor-saving investment, there needs to be a policy that promotes mergers between smaller companies so that their businesses can expand. It is important to find a way to resolve the problems of limits on capex and restricted cash flow.

◆BOJ’s monetary policy: During the period covered by this outlook, the CPI is expected to hover midway between zero and 1% y/y. Hence we expect the BOJ to maintain its current monetary easing policy for the time being. Considering the current policy to fight deflation for the long-term, a more flexible inflation target will likely become an issue.

Our assumptions
◆Public works spending is expected to grow in FY19 at +4.6%, and +1.3% in FY20.
◆Average exchange rate of Y109.6/$ in FY19, and Y109.6/$ in FY20.
◆US real GDP growth of +2.6% in CY19, and +1.9% in CY20.