Japan`s Trade Pattern and Policy

Contents

1 - INTRODUCTION
1.1 - Country Overview
1.2 - Economical Overview
1.3 - Japanese Political Standpoint

2 - COMPARATIVE ADVANTAGES OF JAPAN
2.1 - Definition and Explanations of Comparative Advantages
2.2 - Understanding Japan's comparative advantages
2.3 - Comparative Advantages from the Japanese point of view
2.4 - Domestic Comparative Advantages
2.5 - Conclusion - Outlook

3 - INTRA-INDUSTRY TRADE
3.1 - Definition
3.2 - Intra-Industry Trade of Japan
3.3 - Conclusions

4 - JAPAN'S TRADE POLICY
4.1 - The Trade Policy since the 80s
4.2 - Protecting and Industry Targeting
4.3 - FDI expand - strategic or not?
4.4 - Economic Ties
4.5 - Conclusion of Trade Policy

5 - FUTURE

6 - BIBLIOGRAPHY

1 - Introduction

1.1 - Country Overview

First, to get a small overview, here are some numbers of Japan:

Area: 377 801 qkm

Inhabitants: 125,9 millions (1996)

Inhabitants / qkm: 322 (1995)

Increase in population: 0,4%

GNP / per capita: 39640 Dollar (1995)

Inflation: 0,5% (1996)

Unemployment rate: 3,5% (1997)

1.2 - Economical Overview

Japan counts to the highest developed industrialized countries in the world. Beside London and New York is Tokyo the most important bank place in the world. Japan is the most industrialized country in Asia. After the second world - war there has been a change in the structure in favor to the primary and investment industry (i.e. iron-production, chemistry production, mechanical engineering, shipbuilding industry and the car-industry). The traditional light-industries (especially the textile-industry) were not anymore significant. High growth rates are especially in the fields of microelectronics and robot-technique, but also in the electrotechnical industry and in the precision engineering industry.

The Western press paints Japan often as an export monster and an import miser; an unfair trader that gains export market shares via predatory pricing and keeps foreign firms out of the home market by cartel-like behavior. This is reflected in a fundamental problem: the US- Japan trade imbalance. But Japan's aggregate trade surplus has almost nothing to do with unfair trade. Trade simply reflects national savings that are not all invested at home. Controlling for international price differences, Japan has the third highest per capita output among G7 countries but only the sixth highest per capita consumption. Since not all of this unconsummated production is invested in Japan, the country must necessarily export more than it imports or is active through Foreign Direct Investments. Another example is that Japanese imports just don't matter much to the American economy; total US exports to Japan account for only nine tenths of one percent of US output.

On the other side of the dateline, Japanese commentators view the trade surplus, especially the US-Japan bilateral deficit, as a manifestation of social, intellectual and more flabbiness in the West.

1.3 - Japanese Political Standpoint

Japan is going through its largest political changes in the postwar period. After thirty-eight years of relative stability under the domination of the Liberal Democratic Party (LDP), Japanese politics now faces a high degree of unpredictability and confusion. The political changes have raised expectations of western observers that Japan will become more like "us", i.e. a mature democracy where the government is both internationally responsible and internally accountable to its citizenry.

Japan was a passive follower of American leadership throughout the Cold War period. But with the end of the Cold War and the rise of Japan's economic and technological strength, Japan faces both internal and external pressure to have its own policy in order to take responsibility in maintaining global order.

However, there is an emerging awareness among policymakers - politicians and bureaucrats - that Japan needs to become a more open economy. Faced with increasing criticisms from abroad, Japan's policymakers are convinced that if Japan continues to record large annual trade surpluses, its trading partners will adopt retaliatory measures.

Once regulations are created, the bureaucracy has the largest role in their day - to - day application, and the most discretionary power in the expansion or withdrawal.

2 - Comparative Advantages of Japan

2.1 - Definition and Explanations of Comparative Advantages

The principle of comparative advantage: a nation, like a person, gains from trade by exporting the goods or services in which it has its greatest comparative advantage in productivity and importing those in which it has the least comparative advantage.¹

This expression of least comparative advantages includes those products, in which the country has a comparative disadvantage in producing it itself.

According to the comparative advantage theory, a nation could be more efficient at producing all products than an other nations and still benefit from trade. This might be true if you compare an industrialized nation with a country of the third world. However if you compare the comparative advantages of one country with those of the world you will easily find that there is not a single country which is best in producing everything but it could be theoretically. Therefore the comparative advantage theory is looking for products for which the country (Japan) has a comparative advantage over the rest of the world, and for which not.

Comparative advantage theory may apply for manufactured goods on the one hand. For raw materials on the other hand, absolute advantage may determine many world trade patterns; nations export or import these materials depending on whether or not they have a natural endowment of them. Therefore Japan imports a lot of raw materials such as coal and oil since it has an absolute disadvantage in the production of those goods. In addition Japan tends to import labor intensive products such as cotton textiles because it has a comparative disadvantage in such products.

We have to see whether the export and import pattern of Japan is clearly conform with their obvious comparative advantages.

2.2 - Understanding Japan's comparative advantages

From the tables shown on the following pages we can easily estimate the areas in which Japan has or might have a comparative advantage. From the import statement we see, that Japan imports mainly raw materials, food and clothing. These are all products Japan cannot produce (simply because there is no oil on Japanese territory) or does not want to produce (i.e. cotton) in the extend the country needs them, because its very limited space is considered to be more useful for the production of other goods.

The export table shows mainly 3 areas of strong exports: Automobiles, Transportation Equipment and Electrical Appliances. These are mainly generated through companies well known to western consumers like Sony, Panasonic, Honda, Toyota and Nissan, to name just a few. In these product categories Japan definitely has a comparative advantage, since these categories include products which are mostly technological and R&D intensive where Japan is traditionally strong. Japan's economy can be described as R&D strong, innovative and being able (at least until recently) to finance any development and expansion plans through their Keiretsu (a conglomerate of companies, normally including a heavy industry company, a bank, an insurance company etc.) networks. These networks are so strong that until recently there were only a few big companies we knew of which are or have been in economical difficulties (like Mazda was). This situation has changed over the last month, which we are not going to consider now. An additional comparative advantage is the huge amount of high skilled labor Japan has at its disposal. When analyzing the export pattern of Japan the question arises whether the comparative advantages of Japan are fully exploited or not. If we define Japan's comparative advantage in R&D, Technology oriented, easy access to financial resources etc. and compare this to mayor products exported like cars, computers, electrical equipment and transportation equipment we can say that these comparative advantages are exploited to quite a high extend. Due to the lack of natural resources Japan on the other hand has not a big choice than concentrating on those mentioned product categories. There is for our understanding an additional explanation for comparative advantages in Japan. Japanese companies are very good in creating a need for a revolutionary new product. Not only that the quality of the product is very good, but the company manages also to create a feeling that everybody needs to have this product. If you think of goods like the Walkman or the Tamagochi, these are products which were not imitated or build upon. A lot of products which are fancy in Japan become fancy around the world, which is a big marketing aid for Japanese companies.

By viewing the tables one should keep in mind, that some products are exported although one might believe that Japan has a comparative disadvantage in those products. Food stuff for example is mainly imported and is considered to be a comparative disadvantage of Japan. On the other hand food stuff is a group of products which includes Japanese specialties send to Japanese Stores and Restaurants world wide for consumption. For these products Japan has logically a comparative advantage. The data below show an additional interesting feature. Exports of the Japanese car industry have been declining over 5 years. This actually happened not only with automobiles but also with other products which might not become visible in these tables, i.e. assembly of computers. One of the reasons for the decline is the following. Many other mostly Asian countries have emerged offering cheap labor in a political stable surrounding. Suddenly Japan became less comparative advanced in producing cars etc. and production was partially moved from Japan to Thailand or elsewhere. In addition many Japanese car manufacturers have started to manufacture in the markets where they are going to sell their cars like the US and Europe, because of political requirements and cheaper production possibilities. Toshiba for examples assembles notebooks for the European Market in Germany and just receiving parts from Japan and other countries.

Considering the recent developments in East Asia some companies are already considering to move production quantities back home to Japan because they fear the political unstableness.

There is one additional point which should be kept in mind while analyzing the Japanese Trade behavior and their comparative advantages. Japanese Companies tend to form so called Keiretsu's. A lot of this trade mentioned is being done between the Keiretsu partners and their foreign subsidiaries, this is especially true for machinery and heavy equipment. This leads to an adjustment of the numbers following.

Note: As a help to understand the following figures form the Japanese Ministry of Finance please be aware that the Exchange Rate is currently: 100Yen = 6.27NOK

illustration not visible in this excerpt

2.3 - Comparative Advantages from the Japanese point of view

In Japan the view of comparative advantage is both extremely broad and very dynamic and forward looking. One can argue that the nation needs to build and maintain a comparative advantage in manufacturing to overcome the disadvantage in natural resources. The Japanese government works through the MITI (Ministry of International Trade and Industry) and MOF (Ministry of Finance) also for future comparative advantages in certain industries by encouraging the development at home and by trying to limit imports as part of the strategy to guarantee that their expectations come true. For Japanese officials Japan must be a processing nation to prosper without a large natural resource base, therefore it must import raw materials and export manufactured goods and therefore the nation has little demand for foreign manufactured goods. But the causative connections in this logic are untrue in the extreme form generally assumed in Japan; there is no reason why the need of importing raw materials means that the nation cannot import manufactures or participate in intra-industry trade to a greater extent than it has during recent years.

2.4 - Domestic Comparative Advantages

An other issue is how Japan can maintain a domestic comparative advantage in so many different product fields. Japanese firms can and will provide all the differentiated products that consumers want or need, so that foreign firms hardly find a segment of the market to enter. One might think that this is because the Japanese firms are able to offer the lowest prices through mass production of consumer durables (economies of scale) or because they are more or less well managed and innovative. However these characteristics including the possibility of economies of scale is not the real reason why Japan has a domestic comparative advantage on consumer durables. This pattern can be better explained with economies of scope. Japanese companies are offering such a huge variety of often similar products that it is difficult for foreign enterprises to enter this market. The problem most foreign firms face is to meet the true Japanese taste. This is the advantage of local manufacturers, even if they are only mid-sized. However the economies of scope approach to explain the lack of imports in Japan is also only partially true. If foreign companies do not meet the true taste, why do Japanese shop so much when they go abroad, and why are also industrial goods imported also in minor quantities only?

2.5 - Conclusion - Outlook

Japan has exhibited a strongly held dominant intellectual belief in creating a comparative advantage for domestic manufacturing that has permeated most of academic, government, business and consumer thinking and behavior. Over many years, the MITI has given out R&D targets to Japanese Companies to make sure that Japan keeps its technological comparative advantage. It will be difficult to maintain these advantages over the following years, especially with the current developments in the region. These easier financing capabilities of Japanese companies might be reduced due to the further "clean up" of the Japanese banking system. Japan is a high priced country, with high labor costs which will lead to a further move of production facilities out of Japan. Japan might only be able to focus on strong R&D facilities. However other countries like India or South Korea come up with very good R&D capabilities which might cause problems to the Japanese economy in future. Nevertheless the comparative advantage in R&D and Technology is in absolute terms still very strong compared to its American and European competitors.

3 - Intra-Industry Trade

3.1 - Definition

We understand in the following Intra-Industry Trade (IIT) as a two-way trade, i.e. exports and imports of the same or very similar goods in the same industry. In the following we use the standard statistic to measure the countries' Intra-Industry Trade as

IIT share 1 - [sum of | X - M| / sum of X + M]

X := Exports M := Imports

This version of the so-called Intra-Industry Trade Index equals 100 % if there is an exact matchup and equals 0 % if there is no overlap. The index will be zero (no IIT) for X or M equal to zero and it will be one for X equal to M.

3.2 - Intra-Industry Trade of Japan

Because Japan is short of natural resources they have to import oil, wood, iron and other raw material essential to an industrialized nation. To be able to pay for these raw materials Japan has to be a net exporter (the value of the difference between exports and imports must be positive) of manufactured goods. So Japan could never reach 100 % in the Intra-Industry Trade index in manufactured goods, because in this case there would be no net exports of manufactured goods.

If we have a look at the following table:

Japan's Shares of World Exports and Imports

illustration not visible in this excerpt

Sources: IMF, IFS Supplement on Trade Statistics, 1988, and Corker (1990)

we can see that exports and imports are mainly equal. So it is interesting to understand why Japan's reputation developed to be an "lean mean export machine".

Now if we are having a look at the export data in the next table, we cannot see anything unusual. In most industrialized countries manufactured goods are the main shares of the exports. So the shares of imports must uncommon.

Comparing Japan's Export Composition (% of exports)

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Comparing Japan's Import Composition (% of imports)

illustration not visible in this excerpt

Source: IMF, IFS Supplement of Trade Statistics

Here we can see that Japan has a lack on importing manufactured goods. They are approximately just one third of their whole imports, while in other countries the share is over two third of the imports.

As we have already seen Japan has to be a net exporter of manufactured goods to be able to pay for the natural resources.

Japan Engages in Little Intra-Industry Trade:

illustration not visible in this excerpt

Source: OECD Economic Review, Japan 1990/1991

But is this lack of resources the only explanation for such a low Intra-Industry Index? We can add several points:

1. Japan has a geographically disadvantage. Empirical studies about Intra-Industry Trade have shown that we can find a higher Intra-Industry Index where trade barriers and transport costs are low. An example for this is the European Union. Having a look at the table above we can see that Germany, France and the United Kingdom have reached an extremely high level of Intra-Industry Trade.
2. Another reason given by R. E. Baldwin, is that Japan has a big economy and that big
economies tend to be more closed than small ones. "This trade-reducing effect of bigness is especially relevant to Intra-Industry Trade." We can explain this with the economies of scale, e.g. unit cost that fall with scale of output. Small economies often cannot use the economies of scale if they do not export their products because the domestic market is too small. So they are forced to trade with other nations to sell their products if they want to use the economies of scale. Big economies can close their markets. Very often the excess to foreign market is not necessary to use the economies of scale. Than the domestic market is big enough to consume the whole production of an industry.
3. E. J. Lincoln is speaking about "greater dispersion of behavior". Japan has a high concentrated trade, much more than other countries. So most of the exports can be found in those industries with a low level of Intra-Industry Trade. In the same time Japan decides to export more of a product, it will import less the same product.
4. As a last point we have naturally to speak about trade barriers. R. Lawrence believes that the "Keiretsu" is the main responsible for this highly developed phenomena. Foreign firms have to fight hard to break into new markets in Japan. But Baldwin believes that this antitrade aspect of "Keiretsu" has much less effect on markets where the clients are private consumers rather than other manufacturers.

3.3 - Conclusions

All in all there are several reason for Japan's low Intra-Industry Index. The prejudice that Japan just works with trade barriers to avoid Intra-Industry Trade is just a part of a bigger story. We have to see more aspects and during the tendency of globalization Japan opens it markets more and more but in our opinion it will always have less Intra-Industry Trade than other industrialized nations.

4 - JAPAN'S TRADE POLICY

4.1 - The Trade Policy since the 80s

Historically the dominant explanation of Japan's trade policy is mercantilism, which tells us that a government will not liberalize markets for non-competitive home products. Until the early 1980s, the Ministry of International Trade and Industry (MITI) has been the central actor in international trade negotiations following this policy and the industries under MITI's jurisdiction, like steel and automobiles highly protected at home, increased their exports especially into the USA.

The responding attempts of the USA to control Japan's exports, as the voluntary export restraint agreements (first negotiated in 1977 and 1980) indicate, were not very successful. Hence a sudden change came in 1985-86 with the Marked-Oriented Sector-Selective (MOSS) talks between Japan and the USA. The USA shifted its policy from protecting its home market towards securing overseas markets for its exports.

Other bilateral trade negotiations followed, the Structural Impediments Initiative (SII) in 1989 and 1990 and the Framework talks in 1993, in which the USA tried to expand American exports to Japan.

But these talks were also a turning point in Japan's strategy. In the MOSS talks Japan first accepted the principle of open markets through removal of all trade barriers (It did not remove all barriers in the negotiated sectors, but at least accepted the principle). Concerned Industries (telecommunications, pharmaceuticals, forest products, electronics) tried to adapt to the new situation. To help these and other exporting industries, also against the strong rise of the YEN in 1985-87, the Japanese government provided an easy monetary policy and low interest rates. Despite the acknowledgment of the free trade principle, Japan's policy is still to react on foreign Countries' pressure, rather then to open markets freely.

But there is an emerging awareness among Japan's policymakers that Japan needs to become a more open economy.

4.2 - Protecting and Industry Targeting

In Japan very few products are protected by high tariffs and import quotas (except for some agricultural products). However, regulations and private sector commercial practices pose the major obstacles for foreign businesses. These obstacles to protect home markets from competition are even more important for the development of Japanese companies, than the socalled Japanese Industry Targeting.

As the following table for 4 industries shows, it is a mistake to assume that Japan's has a general active state policy to push exports by providing subsidies or other governmental help. And there might be also other (and better) explanations for industry success:

illustration not visible in this excerpt

Source: Lindert, Peter H. and Thomas A. Pugel, International Economics, 1996, Irwin

The fact that in Japan there is no coherent pattern of industry targeting observable, in the sense that infant industries with a high future growth potential are favored by Japan's government, contradicts also the industry targeting fairy-tale. Greatest help is received by the most-in-trouble sectors, such as agriculture, mining textiles and nowadays steel. Far from favoring fast growth sectors, the Japanese government was trying to check the decline of Japan's relatively declining, and less exporting, sectors.

And targeted cutting-edge industries, such as aerospace and computer software (not mentioned in the table above) have failed to gain sustainable growth. So even if there is active, substantially state involvement in high growth sectors, this does not always lead to success.

4.3 - FDI expand - strategic or not?

The importance of Foreign Direct Investment (FDI) for Japan grows, and it grows even faster than trade. Japanese FDI outflow by 1989 was USD 156 billion (receiving only USD 28 billion).

This height of FDI is just partly a strategic behavior. On the one hand it is a reaction on trade policies of importing countries with high tariffs. These tariffs have induced direct investments as substitutes for exports. But on the other hand, there is an area where Japan behaves strategically in deed.

Japan follows two policies: Commercial support, i.e. reducing the private costs to firms of locating production abroad, and Geographic Targeting through its Official Development Assistance (ODA), i.e. developing other countries infrastructure. These efforts are predominantly concentrated in East Asia. Hence Japan increases its influence in the region. So it is no wonder that FDI has grown more rapidly years than the trade within this region in the recent years.

The new AID (Asian Industrial Development) plan introduced in 1989, established aid criteria like possibilities for horizontal industrial diversification or possibilities of infrastructure developments such as roads and power plants (do not forget the importance of the Japanese construction sector).

East Asia has been a historic recipient of Japanese ODA. In 1990 the 2.3 billion USD flow from Japan to the region, the main part in YEN loans. While Japanese public policy of ODA is increasingly neutral towards export promotion, it continues to encourage outward FDI. This unlikely to diminish in the future, for despite the current crisis, the future incomes will rise in the long run the East Asian economies and there is also a shortage in cheap labor supplies in Japan itself. Although there is a lot of encourage of Japan's government to increase their FDI, it is also a development that is accelerated by prohibitive trade policy of the recipient countries.

4.4 - Economic Ties

The Political initiatives of the ODA to promote closer regional economic ties and to rationalize and coordinate economic development in the East Asian region, have evoked concerns that growing Japanese trade and investment implies the formation of a self-sufficient bloc.

Measures like Export Processing Zones (EPZ) and Free Trade Zones (FTZ) have already been introduced in Malaysia, Thailand, Taiwan and the Philippines. Further Liberalization of the regional economies can be expected in the future.

We could see this development towards a YEN block, led by Japan, even if it there is no official institution, also as a response towards other regional integration, such as EC and NAFTA. Japan will enforce this block building anxiously at the same time preserving access for its manufacturing exports into rich countries.

4.5 - Conclusion of Trade Policy

Faced with increasing foreign pressure "gaiatsu", policymakers in Japan are convinced that if Japan continues to have large annual trade surpluses, the trading partners will set measures. Now Japan is beginning to take an active role in achieving a global free trade system. By opening its home market, Japan also tries to face its internal problems. Regional integration in East Asia will likely accelerate, to provide a weight against the trade blocks NAFTA and EC, even if such a development can cause `trade-divertive' effects by setting inter regional trade barriers. But new trade barriers are in fact not very likely, since Japan's politicians do not consider raising protection as a legitimate trade policy and have also a large stake in keeping the EU and NAFTA markets open.

Another sign towards market liberalization is Japans membership in the Asia-Pacific Economic Cooperation (APEC). At the conference in November 1996 the members set up a program to create a free trade area until the year 2020.

5 - Future

Future will bring the challenge against the long protected, inefficient companies, who could only survive with best regards to the Japanese financial system, that allowed unprofitable companies to burn shareholders money.

One way to enforce competition is to remove protection. But is that enough?

Because of the cross-shareholder-culture between Japanese firms, that make also takeovers by foreign firms impossible, the crisis spreads all over the country. A way to survive for endangered Japanese companies could be mergers with foreign companies (maybe we will soon see VW buying Nissan), but before this happens, the Japanese economy has to be restructured to provide access to foreign capital.

6 - Bibliography

- Baldwin, Richard E., "Japan's Trade", SIS-Rapport Nr. 13, Bergen, 1992
- Bliss, Christopher, Economic Theory and policy for trading blocks, 1994, Manchester University
- Deutsches Jahrbuch, 1992
- Dobson, Wendy, Japan in East Asia, 1993, Institute of Southeast Asian Studies, Singapore
- Lawrence, Robert, "The Changing Structure of Japanese Trade Flows", IMF Working Paper, November 1990
- Lincoln, Edward J., "Japan's Unequal Trade", The Brookings Institution, Washington, 1990
- Lindert, Peter H. and Thomas A. Pugel, International Economics, 1996, Irwin, Chicago
- Mikanagi, Yumiko, Japan's Trade Policy, 1996, Routledge, London and New York
- Steven, Rob, "Japan and the new world order", Macmillan Press Ltd, London, 1996
- The Economist, April 11th 1998
- Webpages:
- www.stat.go.jp
- www.ihk.de

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¹ Source: International Economics, Peter H. Lindert & Thomas A. Pugel, 10th edition, page 33