Japan's rise to the status of economic superpower, technical giant and financial juggernaut over the past 25 years has created a lot of uneasy feelings in Europe. On the one hand there is admiration and respect for the country's miraculous achievements; on the other hand, there is envy and rancour stemming from its trading practices. The relationship in recent years has been characterised by an increasing anxiety in Europe about the level of Japan's trade surplus with the European Union. This essay seeks to cast light on the extent, causes and implications of the EU's trade deficit with Japan.
The Extent
Since 1970, Japan achieved the longest period of consistently high economic growth ever achieved by any nation. It overcame two oil shocks, modernised its structures and developed new industries. It pursued a strategy of minimising its reliance on imports while developing a powerful export machine. It is this combination which led to the Japanese trade surplus with almost all its trading partners, most prominently with the United States and the European Union.
The magnitude and composition of the trade surplus
While the American deficit is higher than that of the European Union, theirs is rapidly shrinking whilst the EU trade loss is dramatically rising. In April and May of 1991, Japan's trade surplus with the European Community was, for the first time ever, even larger than its surplus with the US over the same months. The European Community began to develop consistent trade deficits with Japan in the late 1960's. Europe's deficit has increased ever since with the exception of only two years (1981 and 1982), rising from $659 million in 1970 to $37.2 billion in 1992.
What is in fact the major worry for the Europeans is not so much the existence of a deficit or its size - Japanese goods account for just about 11% of total imports into the EU - but rather its composition as shown in table 1.
Table 1
EU Exports to EU Imports from
Japan Japan
Food 655.1 63.0
Beverages/Tobacco 375.1 5.5
Crude Materials 206.0 103.2
Fuel Products 20.7 12.7
Chemicals 1775.6 1210.9
Manufactured 1901.7 3033.7
Goods
Machinery & 3829.1 19250.8
Transport
Source : Basic Statistics of the Community, Foreign Trade, 1992
Japan sells high value-added goods, especially machinery and transport, to Europe while the Europeans tend to sell to Japan a wider range of low value-added items. Japan's overall trade surplus is a result of its exports in the rubric machinery, scientific and optical equipment, telecommunications equipment, and semiconductors and electronic parts.
Foreign Direct Investment. (FDI)
The counterpart to Japan's surplus in merchandise trade has been the country's massive increase in overseas investment, in Europe in particular. At first glance, the Foreign Direst Investment picture looks alarming. The total amount of Japanese direct investment in the European Union is 14.5 times larger than vice versa. The reason for this is not an overwhelming amount of Japanese investments in Europe, but rather very low European investments in Japan. In 1992, Japanese direct investments in the European Union totalled some $42 billion, just about one quarter of the direct investments from the US. In the same year, total foreign investment in Japan represented only about one per cent of Japan's GDP.
The attention given to the European Union's trade deficit with Japan seems disproportionate when one considers that it comprises only 7% of total extra-EU trade. The main problem is the Japanese pressure on specific sectors of the European industry as shown in table 1. Over 80% of Japanese exports to the EU consist of engineering products (mostly machinery and transport equipment).
The Causes
The imbalance of trade was caused in part by the success of Japanese exports and in part by relatively low Japanese imports of consumer and industrial goods. Japan's success in exports is related to its focus on a few selected products. Concerning Japan's imports, European economists and policy makers claim that the Japanese market is closed for imports of manufactured goods, whereas Japanese representatives stress the difference of their culture and the lack of willingness and capacity of the Europeans to take this into consideration. This section is subdivided into separate analysis of the export and the import sides of the Japanese trade surplus with the European Union.
The Export Side
The successful Japanese export strategy is based on three characteristic industrial and financial strategies and on the country's exact analysis of European needs. Japanese manufactures have established and maintained a direct cost advantage as a result of three inter-related industrial and financial practices, namely : 'laser-beaming', 'dumping' and 'preferential financing.' These practices are sanctioned by government and sustained by Japanese banks, trading houses and manufacturing firms, designed to maximise Japan's share on export markets, establish long production lines based on deferred profits, and increase prices once market dominance has been secured. 'Laser-beaming' describes the very rapid increase in exports of particular products or groups of products to selected target countries or regions. Based on building up excessive production capacity, products may even be priced below their costs of production ('dumping'). Extensions of preferential loans to major businesses, which help to finance both 'laser-beaming' and dumping, together with repeated efforts of the Japanese authorities to systematically undervalue the Yen, result in a structural price advantage in foreign trade for Japanese manufacturers.
After World War II, Japan learned much from Europe. Many young Japanese studied in Europe, and Japan sent many study teams and task forces to Europe. Japan has long been trying hard to know Europe, adopt its strong points, and study European needs in detail. The success of Japanese efforts to make products which sell well in Europe is remarkable. However, why should Europeans not be able to acquire the same knowledge about the Japanese market? This is one of the questions which will be addressed in the following reflections about the import side of the Japanese trade surplus.
The Import Side
Many Japanese economists, such as Ryutaro Komiya (1993) in his 'Some Thoughts on the Future Development of Japan-Europe Economic Relations', take the view that the Japanese market is very open and that today's difficulties are stemming rather from the differences in life-style and taste of the Japanese and the Europeans. Despite official Japanese statements, however, Japan remains the most import-impervious advanced economy in the free world, blocking potential importers with trade barriers of different kinds.
The Japanese Culture
Japanese customs, tastes and business practices are different from their European counterparts. Japanese economists and policy makers frequently state that Europeans have never shown much interest in Japan. If Europeans want to enhance their trade balance, they have to learn more about Japan, and develop high quality products catering to Japanese needs and explore Japanese markets. Or, as Komiya puts it: 'Most of the complaints by ... Europeans are like saying 'Why do Japanese have black hair? We want them to have blond hair.'' However, also in those sectors in the Japanese economy which are inefficient, such as households appliances, furniture, food, footwear, and clothing, and where Western countries would be happy to sell their high quality products, imports do not really manage to come through. To say, therefore that foreign imports will be successful if the importing firms consider the Japanese tastes and offer high quality products, is over-simplistic.
Formal and Informal Barriers
The general resistance of the Japanese economy to imports is reflected by a complex series of formal and informal obstacles tailored to limit the entry of foreign goods. Formal barriers, sanctioned by the government, include tariffs, quotas, taxes, customs procedures and technical standards of various kinds. Tariffs, quotas and taxes are the most obvious, although probably the least important, of the barriers that have to be overcome by importing firms. They apply most of all for traditional products where Japanese manufacturers are less efficient than competitors abroad, such as cigarettes, footwear, textiles, wood, rubber and most processed agricultural goods. Concerning these formal barriers, the Japanese market is at least as open as other industrialised countries.
Highly effective non-tariff barriers to trade, however, are created through obscure and discriminatory standards and certification procedures together with strict public health and environmental regulations which help to exclude, obstruct or delay the entry of competitive foreign products in a number of sectors such as foodstuff, pharmaceuticals, chemicals, medical equipment and household appliances. James Moorhouse gives the example of a British biscuit shipment. The British exporter made a mistake in spelling 'sodium metabisulphite' which describes an additive listed on the label. Japanese customs officials banned the import, claiming that it contained and unknown substance which is inconsistent with health standards.
The Japanese industrial culture is frequently described by the subordination of self to employer, flexibility towards change, no class feeling or significant industrial discontent, the commitment of the worker to excellence and his understanding of the commercial needs of the firm in which he works. This reflects the Japanese tendency to emphasize the 'vertical' aspect of social relations rather than the 'horizontal'. The uniqueness of Japanese economic institutions and the comparative advantage they confer upon Japan in international markets and in its own domestic market are very much related to this industrial structure. Once a foreign product has officially entered Japan and overcome the various formal tariff and non-tariff barriers imposed by the government, the importing firm will realise that the highest barrier lies in the vertical industrial network of closed linkages. The following two issues illustrate the point. People in Japan have always been grouping together in hierarchies of dependence, the so-called Oyabunkobun relationship; whether traditionally between patron and client, landowner and tenant, master and disciple, or today between company and employee. Companies group together in exclusive business families, the so-called keiretsus, each having its own bank, insurance company, heavy industrial firm, trading company and perhaps chain store, so that they do not require the services of others. These conglomerates represent a network of interlocking directorates and, additionally, create significant opportunities for lateral membership across industry keiretsus. Such conglomerates are able to engage in very far sighted strategic planning, because of the readily available capital and because of comparatively lower costs. This enables them to withstand the vagaries of business cycles far better their competitors. They are able to launch strategic alliances with ease to penetrate overseas markets. Nothing is comparable to keiretsus in the West, and the concept is clearly not compatible with the anti-trust practices in the West. Keiretsus are certainly not attractive to imports and are especially helpful in order to protect their domestic market.
The second issue is Japan's antiquated and inefficient distribution system. It is extremely difficult for foreign firms to break into the vertical network of closed ties between wholesalers and retailers all being members of the keiretsus. Newcomers looking for just one retail outlet may have to negotiate with up to four layers of intermediaries before. This type of distribution system promotes what many Europeans consider price-fixing and denies market access to outsiders. It is said that with the step by step removal of tariffs, it is the distribution system which has taken the functional task of excluding non-Japanese sellers from the home market. In other words, products not produced and distributed by members of a keiretsus are essentially barred from the regular Japanese market.
The following section seeks to describe the implications resulting from this identification of causes thereby presenting possible reactions of the European Union.
The Implications
Policy makers in Washington and Brussels see that massive Japanese bilateral and multilateral trading imbalances are having a destabilizing effect on the world economy as a whole. Although there is a generally accepted policy to keep the market open, there is a danger of a declining confidence in the free trade system as it has developed over the last decade or so.
There is, in fact, no inherent reason why Japan should run a large, ever rising trade surplus with the European Union. Without it, Japan would still have the highest overall trade surplus in the world. Representing less than one per cent of Japan's GNP, its surplus with the EU is marginal to Japan's overall economic well-being, so that this bilateral imbalance could shrink to nothing without major repercussions on the domestic economy. As shown in the previous section and supported by the data presented in section one, the European Union's trade deficit with Japan results from the combined effects of the strategic targeting by Japanese firms of specific markets and by Japan's unwillingness to open its market to European products. This section identifies three major fields of action for policy makers in the European Union: (i) increasing European exports to Japan, (ii) tailoring Japanese investment in the European Union to meet European needs and (iii) restricting Japanese products entering the European market.
Increasing European Exports to Japan
The European Union must exert strong pressure on Japan to open its market. In addition it is crucial both to improve and expand export promotion schemes.
The first objective must be to remove the remaining formal and informal barriers to trade which were identified in section two, especially its discriminatory standards, its time-consuming customs and certification procedures and its unwieldy, inefficient and impenetrable distribution system. Beside all European efforts, most of all, this necessitates a commitment to free trade on the Japanese side. Conscious government policy is needed in order to increase Japan's actual propensity to import targets and the major purchase of European civil and military hardware on the basis of open public-purchasing arrangements (including the use of 'administrative guidance' in order to induce major corporations to do so.) A major opening of the Japanese market, matched by a significant increase in import propensity, underpinned by continued appreciation of the Yen should be in the centre of Europe's set of demands towards Japan.
Assistance for European firms aiming to export to the Japanese market could be expanded. Export-promotion schemes have been developed in order to guarantee that European firms are in a position to make maximum use of improved access to the Japanese market. For example, market research surveys have been designed to provide basic information to potential exporters. In addition, young Europeans are sent out to Japan to learn Japanese and gain some practical business experience in Japanese firms. Finally, Foreign Direct Investment (FDI) by European firms in Japan has to be supported. It is commonly argued that Western firms need to be in Japan in order to integrate Japan into the operations of a fully open and free trading system. However, given the current operation of cultural, governmental and market barriers to imports, the task to penetrate the Japanese market on any major scale seems to be virtually impossible.
Tailoring Japanese investment in the European Union
The priority should be on getting import substituting and employment-generating Japanese investments that, so far as possible, involve fully integrated research, development, and manufacturing operations, with high levels of local value-added and sourcing from components with significant local content. Europe must avoid investments that have the counter productive effects of both job destruction and rising of imports. Even seemingly beneficial investment, however, is not undisputed. Many observers see the competition from Japanese subsidiaries as a danger for the established local industry rather than an appropriate answer to the accusation that Japanese imports are destroying jobs in Europe.
Restricting Japanese products entering the European market
How should the European Union react in cases where imports have negative consequences for its markets? Should it close its markets to outsiders in such cases, hence becoming a 'Fortress Europe', or should it remain open even at the risk of losing some of its markets to non-member countries or their companies? Although there is a generally accepted policy to keep the market open, there are still those who think that in the case of threat to whole branches of industry and the respective jobs, the community should have the option of protecting its economy against such massive disruptions. Such measures include voluntary export restrictions (VERs), tariffs and anti-dumping duties in specific sectors.
In recent years various models in International Trade Theory have expressed a new view concerning the case of protection. These theories show that there can be a justified case for protection and that government action can improve on market outcomes. As Paul R. Krugman (1987) puts it : ' There is still a case for free trade as a good policy, and as a useful target in the practical world of politics, but it can never again be asserted as the policy that economic theory tells us is always right.'
It is the essence of the Strategic Trade Policy concept that by intervention a government can raise national welfare at another country's expense. Following this concept, protection works like an export subsidy, deterring foreign entry and allowing the domestic firms to capture the excess returns. The second basic idea which is important in these circumstances states that it may be desirable to deviate from free trade in order to encourage activities that yield positive external economies. This argument is well known and based on the inability of innovative firms to appropriate fully the knowledge they create.
However, it is generally accepted that those strategies aiming to raise European exports to Japan are far superior to protection (on economic grounds). The gains to European consumers stemming from their access to Japanese cars and the related jump in overall automobile quality serve as an impressive example.
Conclusion
As the analysis of the Japanese trade surplus shows, many criticisms brought forward by European policy makers and economists concerning Japanese trade practices are well justified. However, the fingerpointing at Japan's unfairness should not blindfold the Europeans to their own deficiencies. Structural adjustments in Europe are badly needed to keep pace with, or to catch up with Japan's technological innovation and industrial flexibility. There are many voices in Europe, as well as in the USA, pushing for protectionist measures as a reaction to the Japanese 'threat'. As shown in section three, however, there exist other, non-protectionist strategies, which may reach the desired result, i.e. a well-balanced trade relationship with Japan, which does not threaten the benefits of free trade in Europe.
Bibliography
Hager, W. (1992) EC 1992 and Japan, in T. Leuenberger and M.E. Weinnstein (eds.) Europe, Japan and America in the 1990s, Springer, Berlin
Komiya, R. (1993) Some Thoughts on the Future Development of Japan-Europe Economic Relations, in T. Andersson (ed.) Japan: A European Perspective, St. Martin's Press, New York
Krugman, P.R. (1987) Is Free Trade Passé? in Economic Perspectives, Vol. 1, No. 2, Fall 1987, pp. 131-144
McAleese, D. (1994) EC External Trade Policy, in A.M. El-Agraa (ed.) The Economics of the European Community, Harvester Wheatsheaf, New York
McIntyre, J.R. (1987) 'Europe 1992' and Japan's Relations with Western Europe, in T.D. Mason and A.M. Turay (eds.) Japan, NAFTA and Europe, St. Martin's Press, New York
Moorhouse, J. (1987) Righting the Balance : A New Agenda for Euro-Japanese Trade, Conservative Political Centre, London
van Agt, A. (1993) Europe-Japan : Conflict of Cooperation?, in T. Andersson (ed.) Japan: A European Perspective, St. Martin's Press, New York
von Brockdorff, T. (1992) The Japanese Challenge to Europe: Ambiguous Relations, in T. Leuenberger and M.E. Weinstein (eds.) Europe, Japan and America in the 1990s, Springer, Berlin