Is Japan losing its competitiveness?

Author: Richard Katz, The Oriental Economist

Although Japan’s merchandise trade deficit in 2011 — the first since 1963 — is a product of the natural disasters of 2011, it is a harbinger of things to come. Sometime within this decade, Japan is likely to start running chronic trade deficits.

While some economists see this happening within three years, it will probably take somewhat longer.

A number of countries run trade deficits because of macroeconomic conditions at home, rather than a loss of competitiveness. The US, for example, runs a trade deficit because it continuously consumes more than it can produce. But in Japan’s case, the anticipated switch from a trade surplus to a trade deficit does appear to reflect declining competitiveness. Japan’s share of OECD-country exports has fallen from a peak of 12 per cent in 1984 to 7.6 per cent in 2010. By contrast, the US share was 17 percent in 2010, just one point below its share way back in 1972. And when it comes to high-tech goods, Japan’s share of OECD exports has halved from 22 per cent in 1989 to 10.6 per cent in 2009. Conversely, South Korea’s share of OECD high-tech exports has steadily risen from less than 4 per cent in 1989 to 11 per cent by 2009. This rise took place whether the Korean won was strong or weak.

Competitiveness is, of course, a relative term — just take a look at cars. Toyota’s Camry and Honda’s Accord used to be America’s best-selling mid-size cars because they had fewer defects than Detroit models, and they could charge a price premium of a few thousand dollars. Not any longer. Today, the Ford Fusion has passed the Accord in sales. Moreover, Honda and Toyota now have to hold prices down to Detroit levels in order to maintain their market share. The same is true of Japan’s big electronics firms. Sony — a company once known for being first in developing new products, from walkmans to VCRs — is no longer the innovator it used to be. When it comes to new products like mobile phones, Japanese brands are a rarity in international markets, and are losing market share at home.

While Japanese firms are losing competitiveness, Japan as a base of production is losing competitiveness even faster. With every passing day, Japan’s top exporters are deciding it is better to reach their overseas customers via overseas production rather than exporting from Japan. The Japanese auto industry now sells 2.5 times as many vehicles made in its overseas plants as it exports from home. Reportedly, Nissan intends to halve the number of cars it currently exports from Japan by 2016. The same trend is evident throughout other major sectors which have historically contributed to Japan’s trade surplus, including consumer electronics and machinery.

There are some who deny that the trade deficit is an indicator of declining competitiveness. They argue that the trade balance reflects nothing more than the domestic balance of savings and investment. A nation that saves more than it invests (or produces more than it consumes) will run a trade surplus. According to this school of thought, if Japan is turning toward a trade deficit, it is just a reflection of declining household savings rates and big budget deficits.

But this logic is deeply flawed. No matter what is going on with Japan’s own savings and investment rates, it can only run a trade surplus of, say, US$300 billion if the rest of the world combined runs a trade deficit with Japan of US$300 billion. What if the rest of the world decides to switch from Japanese to Korean cars and electronics goods? Or just buys fewer cars and TVs? Or if the rest of the world reduces budget deficits, which reduces its savings-investment gap and so causes its combined trade deficit with Japan to fall by US$100 billion? In that case, Japan’s trade surplus has to fall by US$100 billion, forcing its domestic savings surplus to also fall by US$100 billion. This will happen because, as Japan exports less, corporate profits (a big part of its national savings) will decline. So will employment and tax revenue. This, in turn, will increase the government budget deficit.

It is possible to tell whether Japan’s trend toward trade deficits reflects its domestic savings trends or else declining competitiveness by looking at the price Japan charges for its products. As with a company, a country that has to charge less for its products and still loses market share has a fundamental competitiveness problem. Consider the value of the yen. In nominal terms, the yen seems to be at a record high. But to measure the true price competitiveness of Japanese exports, we have to take into account deflation in Japan compared to inflation everywhere else. According to the Bank of Japan, the real, price-adjusted value of the yen is 10 per cent below its quarter-century average since 1986. When Japanese firms complain that the yen is too high, what they are really complaining about is that the yen is no longer as cheap as it was in the mid-2000s, when it was as much as 25 per cent below its long-term average.

So, despite arguments to the contrary, Japan’s is definitely suffering from declining competitiveness. And that is the main reason it is likely to turn from chronic trade surpluses to chronic trade deficits sometime during this decade

Richard Katz is Editor at The Oriental Economist.