The March 2011 earthquake and tsunami damaged supply chains, causing a decline in exports, and the Fukushima nuclear disaster shut down a number of nuclear power plants, increasing Japanese imports of energy. Many have speculated that the trade deficit is emblematic of Japan’s declining competitiveness, but a closer inspection reveals this is not the case.
If we consider the trade balance and per capita GDP for selected countries in 2009, China shows a huge trade surplus while the US shows a large trade deficit. Given this data, one could conclude that China became more competitive than the US over this period. Using the same logic, France — with a trade deficit running into the billions — would also appear to have become less competitive than Nigeria, despite the fact that French income levels are more than 30 times higher than Nigeria’s.
To understand the nature of Japan’s trade balance, it is important to recall that a country’s GDP is measured by adding together its consumption spending, private investment, government expenditure and exports, before then subtracting its imports. GDP can also be measured by adding together a country’s consumption spending, private savings and its government revenue. This in turn signifies that a country’s trade balance (exports minus imports) is equal to net private savings (private savings minus private investment) plus net government expenditure (government revenue minus government expenditure).
This shows that if a country’s investments exceed savings, or government expenditure exceeds its revenue, the country will face a trade deficit. So, at the country level, trade balances are not attributable to the competitiveness of the country but to the balance between net private savings and net government expenditure.
As Paul Krugman said, ‘Trade between countries is so much unlike competition between business that many economists regard the word “competitiveness”, when applied to countries, as so misleading as to be essentially meaningless’.
Put differently, even if countries lose their competitiveness in the sense that they lag behind in productivity growth, they are still able to balance their trade. This is because what drives trade is comparative advantage rather than absolute advantage. So, Japan’s recent trade deficit does not mean the country is losing its competitiveness.
In fact, Japan’s aging population is more likely to worsen its trade balance. As the number of retirees and the elderly dependency ratio increases savings rates are likely to significantly decrease. Holding other domestic factors constant, such as private investment and net government expenditure, the decline in savings could in turn aggravate Japan’s trade balance. Similarly, irrespective of a country’s competitiveness, if its government deficit becomes large, its trade balance also tends to be in deficit.
Because Japan is facing an aging population, together with a rapid expansion of social security expenditure, it may have experienced a trade deficit in the near future even without the earthquake and tsunami last year. A country’s trade balance is important not because it reflects competitiveness but because it reflects domestic private and sovereign balance sheets. Changes to the trade balance, then, need not elicit nervous responses about competitiveness. But given Japan’s huge public debt, a more important question is whether or not the country’s net private savings can finance government deficit, and how Japan can reduce the government deficit itself.
Kozo Kiyota is Associate Professor of Economics at Yokohama National University.