The Deficit in the U.S. Balance of Trade with Japan:
Introduction
If balance of trade between two countries is indeed a key indicator of their economic relations, than the relations between the U.S. and Japan can be very briefly summarized in terms of the latter’s predominance. This is not to say that the U.S. economy is essentially inferior to that of Japan, but the data and the view this paper discusses may teach some important lessons about the two economies’ strengths and weaknesses. This paper does not aim to construct a critique on U.S. international trade policies. Instead, it reviews the underlying reasons for the current situation and uses them to make some recommendations regarding the future of international trade.
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A Brief History of the Trade Between the U.S. and Japan
Throughout the last 65 years the U.S. and Japan went through considerable trade friction, whose main underpinning was the increasing Japanese export to the U.S. Van Sant, Mauch and Sugita (2007) summarize the emergence of the post-war trade relations between the two countries:
After WorldWar II, under tutelage of the United States, Japan made great efforts toward economic recovery. The U.S. market was the lifeblood for Japan’s postwar recovery. Japan’s exports of textiles, silverware, and other miscellaneous good rapidly increased. In this period, textiles were Japan’s largest-volume export item, and a flood of cheap Japanese cotton goods did great damage to the American textile industry, precipitating a Japanese voluntary export restraint in January 1956. The United States had a favorable trade balance with Japan until 1964, but since then, it has generally run a trade deficit. In the late 1960s, Japan’s exports of cotton, wool, and synthetic fiber products to the United States rose to the surface as the first instance of trade friction.
Further improvement in the Japanese industries’ efficiency brought about superior performance (mainly in terms of price and quality) among American consumers compared to home manufacturers in various fields. The scale and scope of Japanese imports expanded from textiles in the 1960s to automobiles and consumer electronics (most notably color televisions) in the 1970s and to semiconductors in the 1980s. Similar trends also appeared in the agricultural sector, where demand for some Japanese products brought about lower prices and excess capacities among American farmers.
By that time, Japanese capital was used not only to export manufactured goods into the U.S. but also as means of foreign direct investments (FDIs), with a clear preference to retailing and real estate over investments in American industries. During the 1980s, the Japanese FDI in the U.S. was second only to the U.K. However, although the latter are still the biggest foreign direct investors in the U.S., Japan is now ranked only as the 7th major source for foreign capital. In fact, its current FDI in the U.S. is less than half of that of the U.K. and Switzerland (Bureau of Economic Analysis, 2010).
The Economics of the U.S. Trade Deficit with Japan
An economy’s balance of trade is the difference between its exports and imports in a given period. The higher the imports, the lower the balance; if exports exceed imports, the economy has a trade surplus, whereas economies that import more than they export have a trade deficit. Furthermore, since the balance of trade and its components are expressed in monitory terms, it is clear that changes in foreign exchange (i.e. currency fluctuations) may significantly influence the balance regardless of the actual volume of the goods and services being traded with other economies.
The U.S. is traditionally in a state of trade deficit, which stood at USD375 billion in FY 2009. On the other hand, Japan’s long-established trade surplus tended to decrease in recent years, but with a surplus of JPY2,671 billion (or about USD32 billion) in 2009, Japan is still a largely export economy. This holds true even more when we examine the Japan’s balance of trade with the U.S. (Japan’s largest trading partner), which favors the by about USD44.7 billion – much higher than its total balance (ibid.; Statistics Bureau of Japan, 2010). It should be noted, however, that the services component of the balance of trade between the two countries shows the opposite trade, i.e. Japan has a deficit in trade of service with the U.S.
In a comprehensive analysis of the U.S. trade relations with Japan, Bergsten, It? and Noland (2001) find several underlying reasons for this constant trade gap:
First, as a larger country with many more natural resources, the U.S. tends to export a broader line of products, while Japan seems to show a higher degree of specialization, thus exporting much more manufactured goods and importing food, oil and resource-based products. This implies that Japan will tend to have a trade deficit with resource-rich economies (e.g. Saudi Arabia), whereas focusing on selling manufactured goods to the U.S. to compensate for its lack of resources.
Second, Japan has a relatively weak intra-industry trade. That is, Japanese hardly buy goods and services that they produce themselves. For example, whereas the U.S. economy both sells its manufactured automobiles and buys automobiles from foreign manufactures, Japanese car imports are weak, especially in regard to American cars. This tendency may be due to several reasons, including extraordinary competitiveness and higher preference towards local products.
Third, the positive (from the U.S. point of view) balance of trade in services is mostly driven by tourism and education, and explained in the context of the relative inefficiencies of these heavy regulated industries in Japan.
Finally, there is a considerable gap between every economy’s FDI inflows into the other, as Japanese FDI into the U.S. is incrementally higher than the other way around in both relative and absolute terms. Major differences in the investment atmospheres (particularly the rather ‘unfair’ treatment of foreign investors by Japanese regulators) and historical returns of FDI are among the major reasons for the fact that Japanese investors get more opportunities to make strategic FDIs (e.g. mergers, acquisitions and integrations) in the U.S. compared to their American peers’ opportunities in Japan.
The Future of Bilateral Trade
The history of post-war trade friction between the two countries entails a repeating pattern of protective measurements from Washington, which included price dumpling lawsuits and other sanctions and usually led to voluntary (or semi-voluntary) export restrains of Tokyo. As time went by, however, and due to the central role of the World Trade Organization in ensuring freer flow of goods and capital between nations, such measurements were no longer effective. Today it is clear that ‘old fashion’ protectionism (mainly in the form of tariffs and quotas) is no longer valid, and that the only way to control healthy trade is through cooperation and further specialization.
Today, both economies face major difficulties, such as their volatile currencies, emerging competition from Asia and the European Union and diminishing returns in almost every sectors of the economy. From a U.S. perspective, its relative advantages over Japan, especially in high-end and knowledge-intensive services, rapidly diminish as knowledge gaps erode in the natural flow of globalization and information technology. Similarly, Japan’s competitive advantages are diminishing inasmuch as other Asian nation (particularly China and India) retain their enormous growth and relatively qualified and cheap labor force.
A brief look at current data shows that Japan is far from being a burden on the U.S. balance of trade. In an age when China’s trade surplus with the U.S. is about five times higher than that of Japan (Bureau of Economic Analysis, 2010), the future of trade between the two countries must rely on cooperation and further specialization rather than on mutual efforts to hinder one economy’s stake of trade with the other. In other words, it is very unlikely that the two economies will make any material gains from pursuing a course of mutual ‘distraction’ of trade in the bilateral and international arenas.
Instead, both governments should consider the very large extent to which their interests intertwine. Both fighting enormous public debts and high unemployment rates, it is doubtful if the two countries’ monetary policies (which bring about weakness of both the yen and the dollar) will indeed protect national manufacturing. Their economic prospects, however, seem to be based more on high-end and knowledge-intensive production and innovation rather than on traditional means of manufacturing.
Therefore, it would be advisable to forgo the historical tension between the countries and focus on cooperation in spheres such as education, science and security. However, such cooperation must also be accommodated with serious intentions to ease investments and abolish many of the unnecessary policies, which hinder the private and public sectors of both countries from further collaboration, open trade and specialization.
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