"U.S. AND JAPAN SHOULD COOPERATE RATHER THAN COMPETE"
World Economic Crisis Simulation

Maintain Economic Growth
Avoid Protectionism by All Means

by
Professor Akira Onishi
Director
Institute of Applied Economic Research
Soka University
1-236, Tangicho
Hachioji-shi, Tokyo 192
JAPAN








Appeared in Nihon Keizai Shimbun
(August 8, 1986)









Translated
by
Takeshi Utsumi, Ph.D.
President
Global Information Services, Inc.
43-23 Colden Street
Flushing, NY 11355-3998
718-939-0928
(August 15, 1986)


Edited
by
Fred Campano
International Economist
United Nations

ABSTRACT

A sharp decline in the price of crude oil and a sharp depreciation of the U.S. dollar are the basis of the two crisis scenarios for the present world economy. Using the FUGI world model to simulate to the year 2000, the following results were obtained:

1. A sharp decline in the price of crude oil could cause a number of oil producing debtor countries to default. If the U.S. pursues expansionary policies which circumvent financial uncertainty, the world economy will plunge into a recession which will be characterized by an inflation and a radical rise in interest rates.
   
2. Continued large U.S. cumulative current account deficits will lead to a loss of confidence in the U.S. dollar. A collapse of the dollar would have an impact way beyond anyone's guess and the economy of the U.S. as well as the rest of the world will rapidly decelerated.
   
3. If the U.S. enacts comprehensive trade (protection) legislation in order to prevent a sharp depreciation of the U.S. dollar, the U.S. current account balance would substantially improve, but with the burden of the sacrifice by many other countries, including Japan, and subsequently world trade will significantly decline.

In order to avoid this protection-oriented trade war, cooperation among the U.S., Japan and Western Europe is absolutely necessary. The U.S. must adopt a tight fiscal policy and Japan must expand domestic demand. International cooperation on further reduction of interest rates is also vital.

Apprehensions of A Sharp Decline
in the Price if Crude Oil and in the Exchange Rate of the U.S. Dollar

From July 16 to 18, the World Future Society presented a U.S./Japan teleconference connecting New York and Tokyo. The FUGI world economic crises prediction simulation model of Soka University was used for the discussions. In this article, the world model was used to project the long-term response of the world economy to sharp declines in the price of oil and the exchange rate of the dollar vis-a-vis the yen. (A scenario designed by Professor Lester Thurow of M.I.T. and Mr. Fred Campano, an economist at the United Nations.)

The baseline scenario, i.e., what could be expected if the current trends in the world economy were to continue, indicted a balance of payments crisis for the U.S., however, other scenarios indicated that this could be averted if the proper policy mix was undertaken by the U.S. and Japan. (The percentages used in the scenario summaries below indicate the percentage point difference between the baseline and the scenario results.)

A Sharp Decline in Crude Oil Prices

If the recent rise of crude oil prices resulting from the latest agreements on oil production by the OPEC countries is not sustained, and the price of oil remains on an average of $10 per barrel until the year 1990, then developing crude oil producing countries, especially debtor countries such as Mexico, will experience a large negative impact on their economic development. The yearly growth rate for the 1987-1990 period will be 1.9% less then the baseline for Mexico, and 0.8% less for the oil-producing countries as a group. The cumulative deficit of current account of the former during this period will mount to 30 billion dollars and that of the latter to 370.7 billion dollars. Many debtor countries, such as Mexico, could default, and Middle Eastern oil-producing countries would probably be forced to liquidate their overseas assets and hence start a chain reaction of bankruptcies of a number of American banks. If the U.S. Government tries to increase its money supply to cope with the financial crisis, the U.S. dollar would encounter a sharp decline in its value and inflationary pressures will force the decline of interest rates to halt. Under this scenario, a 20% reduction in the value of the dollar is assumed. This results in the growth rate of the U.S. economy to be less than the baseline by 1.5% (yearly average) and Japan's by 0.8%, and for the world economy as a whole, a decrease of 1.0% from the baseline.

On account of decline in the growth rate, U.S. current account deficit should be reduced by 22.6 billion in 1990. However, in the case of Japan, since the reduction of surplus over the U.S. trade is offset by the gain in the balance against the OPEC, the overall surplus will remain. On the other hand, the U.S. economy would experience an economic recession due to a depressed oil sector in the U.S. Economy, since the U.S. itself is an oil-producing nation. This in turn would put recessionary pressures on the Japanese economy.

A Sharp Decline of the U.S. Dollar

In this scenario we assume that the U.S. current account deficit continues into the future and that there is a sharp decline of the U.S. dollar in 1987 due to a loss of confidence in the dollar, to about 40% of the baseline exchange rate against the yen, that is, to about 100 yen to the dollar.

Such a sharp depreciation of the dollar would have an impact on the world economy which is beyond what anyone could guess. From the FUGI model we estimate that for the period 1987 1990, the average growth rate in the U.S. would be 4.8% less than the baseline growth rate, in Canada 5.7% less, in Japan 2.0% less and in the Pan Pacific periphery countries as a whole, 3.8% less.

In the world economy as a whole, excluding the Centrally Planned Economies which should be minimally affected, the average growth rate would be 3.1% less than the baseline. The developing countries would have a decrease of only 1.0%, but the newly industrialized countries (NICS) in Asia would experience a substantial decline of 2.4% less than the baseline.

After an initial increase to $221.1 billion in 1987 from $134.3 billion in 1986, the U.S. current account deficit should begin to decrease in 1988 down to 90.2 billion in 1990. The Japanese current account surplus should also decrease from 79.6 billion in 1986 to 45.6 billion in 1990. Compared with the baseline figures, the U.S. deficit would be 73.4 billion less in 1990 and the Japanese surplus would be reduced by 42.5 billion. On the average for the 1987-1990 period, U.S. consumer prices would increase by 5% and interest rates by 3.2%. This and the reduction in world trade should impact severely upon debtor developing countries and the sharp decline of the U.S. dollar may trigger a world economic depression.

Enactment of U.S. Trade Legislation

If the U.S. enacts trade legislation designed to limit imports as a means of avoiding a crisis stemming from a dollar depreciation, a number of (dollar) surplus countries against the U.S. such as Japan will cooperate with each other and retaliate against the U.S.

In such a case, world trade would be $291.4 billion in nominal terms (76.8 billion in constant 1975 dollars) less than the baseline level for 1990. For the 1987-1990 period, the growth rate in the U.S. would increase on the average of 1.1% per year, while Japan's would decrease by 1.4%. The Asian NICS would also decrease by 1.6%, with Taiwan experiencing a 2.5% decrease and Hong Kong 3.0%. The EC as a whole would remain relatively unaffected with a marginal decrease of 0.12% (Federal Republic of Germany with a decrease of 0.38%).

The developed marked economy countries as a whole would see a slight increase of 0.19% because of the good U.S. economy, but the developing countries as a group would see a slight decrease of 0.16%. In general, the impact on the Asian countries would be large, but the impact on the Central and Latin American countries as well as the African countries would be minimal. Albeit small, the Middle Eastern and Centrally Planned Economies would have a positive effect.

The U.S. current account deficit would be $52.4 billion less than the baseline in 1990 and Japan's current account surplus would be $38.8 billion less than the baseline estimate. The improvement of the U.S. economy and the decline of the Japanese economy would accelerate the cheaper yen/higher dollar parity, thereby reversing the rate of increase of U.S. consumer prices by 0.27% and eventually stabilizes. Consumer prices in Japan, however, would have an average yearly increase of 0.94%.

A Scenario to Avoid Crisis

This scenario is designed to correct the structural imbalance between current accounts of the U.S. And Japan and aims to avert a world economic crisis through cooperative U.S./Japan policies starting in 1987. The assumptions are:

1. The Gramm-Rudman legislation forces the U.S. to tighten its fiscal spending and bring its budget into balance by 1991.
   
2. The U.S. and Japan cooperate in reducing the interest rate in the U.S. by 2% and in Japan by 0.5%. Other major OECD countries would follow suit. Japan would also lower the mortgage interest rate and consumer credit rates by 2%.
   
3. Private investment would be stimulated in the U.S. and Japan through research and development expenditures amounting to 0.5% of GDP. Moreover, Japan would stimulate consumption by cutting personal income taxes by about 2 trillion yen and cutting corporate taxes 1 trillion yen. Public investment would also increase by 1 trillion yen. Japan would take steps to further open its markets by 1990 through a gradual elimination of tariff and non-tariff barriers. Japanese ODA (Official Development Assistance) of developing countries would achieve its goal of 0.7% of GDP by 1995. Japanese private overseas direct investment would also increase by an additional 0.5% of GDP.

An Escape from the Reverse Oil Shock

If the above U.S./Japan cooperative scenario could be realized, world trade would expand by 197.7 billion dollars in 1990, and by 783.4 billion dollars in the year 2000 (nominal dollars) as compared with the baseline. The crude oil price would rise $3/bbl above the baseline in 1990, to $13/bbl more than baseline in 2000, and subsequently a "reverse oil shock" would be avoided.

For the period 1987-1990, the yearly average growth rate of the Japanese economy would be 3.2% more than under the baseline scenario, and 1.9% more during the 1990-2000 period, in other words, the real growth rate would be 7.1% for the former period and for the latter it would average 6.5%. The world economy yearly average growth rate would be 0.6% above the baseline, while non-oil producing developing countries 0.7% above, and the NICs 1% above.

For the U.S., the average yearly growth rate would be 0.9% above the baseline in the 1987-1990 period and 0.6% in the 1990-2000 period. However, the U.S. current account deficit would be 45.8 billion dollars less than the baseline deficit in the year 1990 and 131 billion dollars less than the baseline in 2000; furthermore, the U.S. would avert a crisis resulting from a sharp depreciation of the U.S. dollar.

Moreover, because the U.S. is able to balance its budget by 1991 it can ease the debt servicing burden of debtor developing countries by decreasing interest rates and expanding world trade.

The above simulation indicates that a new era is approaching in which it is absolutely necessary that the U.S. and Japan cooperate rather than confront one another.