How have Japanese exports evolved? How exposed is Japan to a slowdown in China? What types of policies would make Japanese exports more stable? To shed light on these issues, I employ a gravity model, which is one of the most successful models in economics and useful for predicting bilateral export flows (see Anderson, 2011).
Traditional gravity models assume that trade between two countries is directly proportional to GDP in the two countries and inversely proportional to the distance between them. These models are analogous to Newton's law of gravitation that states that the force of attraction between two bodies is directly proportional to the product of their masses and inversely proportional to the square of the distance between them. When explaining trade flows, gravity models also typically include other factors affecting bilateral trade costs such as whether trading partners share a common language or a free trade agreement (FTA).
Anderson and Van Wincoop (2003) recommend modifying traditional gravity models to capture the fact that exports and imports between two countries depend not only on trade costs between the two countries, but also on changing trade costs between third countries. For instance, exports from country i to country j can be affected if country i enters into an FTA with a third country k.
To predict Japan’s exports, I use both traditional gravity models and modified gravity models as recommended by Anderson and Van Wincoop (2003). These models are estimated with two econometric techniques—panel ordinary least squares and Poisson pseudo-maximum-likelihood estimation—using data from 31 countries over the period 1988-2013 (Thorbecke, 2015).
Several findings emerge:
- In every year between 1988 and 2006, Japanese exports to the US were the largest positive outlier. Over this period, on average, they exceeded the gravity model’s predicted value by $43 billion per year. The lion’s share of these exports was finished goods. For instance, 41% were consumption goods and 29% were equipment and capital goods. The preponderance of these exports was in the automotive, electronic, and machinery sectors. Between 2009 and 2013, on the other hand, Japanese exports to the US on average fell short by $9 billion per year from the predicted value.
- Japan’s exports to China grew rapidly relative to the predicted values between 2001 and 2005. Thereafter, they remained much greater than predicted. The evidence indicates that the increase in exports between 2001 and 2005 was driven entirely by changes in ‘imports for processing,’ which are parts and components sent to China to be used for producing goods for re-export to higher income countries. Japan’s ‘ordinary exports,’ which are goods destined for the Chinese domestic market, were the largest negative outlier every year between 1992 and 2008. While ordinary exports from Japan to China increased between 2009 and 2011, they have since fallen by 20%.
- Japan’s exports to Taiwan and Thailand were much more than predicted and its exports to South Korea were much less than predicted.
- Japan’s exports to the EU fell below the predicted value year after year. In 2013, they were $30 billion less than expected.
The results indicate that Japan’s exports to the Chinese domestic market, the EU, and South Korea are less than predicted. One implication of these findings is that Japan is less exposed to a slowdown in China that would reduce exports to the domestic market than it is to a slowdown in the predominantly high income countries that would reduce Chinese exports of tablet computers, office machinery, and other sophisticated goods that are produced using Japanese parts and components. Another implication is that Japan should seek to expand its exports to its Northeast Asian neighbours and to the EU. The more diversified the group of countries that Japanese companies export to, the lower the risk that they face from slowdowns in individual countries or regions.
Would FTAs help to stimulate Japanese exports to China and South Korea? The results presented in this paper controlled for the fact that no FTA exists between these three countries. If this is not controlled for, the model would predict that Japanese exports to China after 2009 would be $35 billion higher per year and that to Korea would be $36 billion higher per year. The results thus support the growing body of evidence indicating that an FTA with Asian trading partners would be beneficial (e.g. Kawasaki 2014). The findings also indicate that an FTA with the EU would stimulate exports.
Global liberalisation of course would produce the greatest gains for Japan and other countries. However, trade liberalisation produces losers in certain sectors. It is thus necessary to facilitate labour mobility and the movement of firms from losing to gaining sectors by providing retraining and upgrading for displaced workers and reducing entry barriers to new firms and facilitating exit through structural reform.
The findings that Japan’s exports to Taiwan are much more than predicted while those to South Korea and the Chinese market are less than predicted also reflects the different perceptions of Japan in these markets. Taiwanese President Ma Ying-jeou said on the 70th anniversary of Taiwan’s freedom from the rule of Japan that it is important to remember the good things such as irrigation projects and reservoirs that Japan did during its occupation. This contrasts with China and South Korea, where many retain negative perceptions of Japan. Anti-Japan riots flare up in these countries from time to time, thereafter Japanese exports to them tumble.
From an economic point of view, it would be beneficial for Japanese companies to diversify their exports by shipping more to China, Europe, and South Korea. FTAs and improved relations with Northeast Asian neighbours thus should be high on the Japanese policy agenda.
Editor’s note: This column was reproduced with permission from the Research Institute of Economy, Trade and Industry (RIETI).
Anderson, J., 2011, “The Gravity Model,” Annual Review of Economics, 3, 133-160.
Anderson, J., and E. van Wincoop, 2003, “Gravity with Gravitas: A Solution to the Border Puzzle,” American Economic Review, 93, 170-192.
Kawasaki, K., 2014, “The Relative Significance of EPAs in Asia-Pacific,” RIETI Discussion Paper No. 14-E-009, Research Institute of Economy, Trade and Industry, Tokyo.
Thorbecke, W., 2015, "Understanding the Evolution of Japan's Exports," RIETI Discussion Paper No. 15-E-131, Research Institute of Economy, Trade and Industry, Tokyo.