Investigating Japan’s Machinery and Equipment Exports after the Global Financial Crisis

The Japanese real effective exchange rate is now at its lowest level in the 44-year period for which that the Bank of Japan provides data (see Figure 1). How does this affect Japanese exports?

Source: Bank of Japan

Japanese exports are sophisticated. This can be seen using the method of Hidalgo and Hausmann (2009). They observed that producing complex goods require advanced capabilities. These products are more likely to be made by countries with diverse export baskets. They defined an economy’s complexity based on its ability to export varied and advanced products. They defined a product’s sophistication based on its non-ubiquity. Using these definitions, they calculated country complexity indices (CCI) for over 130 countries and product complexity indices (PCIs) for more than 1,200 products.

Japan’s CCI was rated as the most advanced in every year between 2000 and 2021. Taking a weighted average of the PCIs for Japan’s machinery exports, its machinery exports are more complex than the machinery exports of the other three leading machinery exporters (the U.S., China, and Germany).

Abiad et al. (2018) argued that more complex goods are harder to produce and thus have fewer substitutes. Because of this, they noted that the price elasticity of demand should be lower for more complex products as measured by the Hidalgo and Hausmann (2009) measure. Therefore, they reasoned that exports of these goods should be less sensitive to exchange rates. This paper investigates how responsive Japanese machinery exports are to exchange rates.

Japan produces and exports high-quality machinery and capital goods. These include excavators, machine tools, turbines, robots, machinery to manufacture semiconductors and textiles, and other capital goods. Japan has traditionally played an important role in exporting these goods to downstream Asian countries. Kwan (2004) noted that, if Asian firms are unable to obtain capital goods from Japan, they are frequently unable to obtain them at all.

Historically, Japanese firms relocated factories to Asian countries when the yen appreciated. In 1985, to reduce the U.S. trade deficit, Japan, France, West Germany, and the U.K. agreed in the Plaza Accord to let their currencies appreciate against the U.S. dollar. From the time the accord was signed in September 1985 until the middle of 1995, the yen appreciated from 240 to the U.S. dollar to below 88 to the dollar.

Japanese exporters lost price competitiveness. To cut costs, they relocated labor-intensive tasks to factories in ASEAN and China. Bayoumi and Lipworth (1998) found that the motive for Japanese FDI at this time was vertical integration, where subsidiaries in other countries became part of the production process. Yoshitomi (2007) described the trade that accompanies this vertical FDI as vertical intra-industry trade (VIIT). Under VIIT, firms slice the value chain across developed, emerging, and developing countries based on comparative advantage. Each region’s comparative advantage is determined by its endowment of capital and skilled and unskilled labor and by its physical and institutional infrastructure.

Sasaki et al. (2022) observed that when the yen appreciated during the 2008-2009 Global Financial Crisis (GFC), Japanese multinational corporations (MNCs) continued to relocate manufacturing overseas. This helped to offset the loss of price competitiveness from the appreciating yen. Then, as the yen began depreciating in 2012, Japanese firms refrained from reshoring production and continued to produce abroad. Sato and Shimizu (2015) noted that for several decades Japanese firms had increased overseas production and their production networks were centered in Asian countries. As the yen appreciated during the GFC, these firms accelerated the division of labor by relocating more production to Asia. Sato and Shimizu noted that because of this, a weaker yen no longer stimulates machinery exports as much because an increase in exports increases imports of parts and components from overseas subsidiaries in Asia.

If production of parts and components has been relocated to Asian countries, then the yen exchange rate would naturally have less of an impact on Japanese exports to these countries. A depreciation of the yen against the currency of an Asian country that is providing parts and components to Japan would increase the yen costs of these imported inputs. This increase in costs would mitigate the increase in price competitiveness arising from the impact of a weaker yen on Japanese value-added exported back to this country. Thus, if Japan has offshored more production to Asian countries after the GFC, a yen depreciation against an Asian country’s currency would have less of a stimulative effect on exports to that country since then.

This discussion paper investigates whether the influence of exchange rates on Japan’s machinery exports has in fact declined since the GFC. The results indicate that for the 1990-2000 and 2000-2010 sample periods, a 10%-yen appreciation reduces total machinery exports by 6%. Many individual subcategories of machinery and equipment exports also see reductions in response to appreciations. However, over the 2010-2020 sample period, appreciations no longer decrease exports of total machinery exports in most of the important subcategories.

Among individual categories, specialized machinery and commercial vehicle exports are not affected by exchange rates during the 2010-2020 period but telecommunications equipment exports are. The fact that exchange rates do not impact specialized machinery exports after 2000 is consistent with Baek’s (2013) observation that downstream countries such as South Korea depend on machinery exports from Japan. It is also consistent with the Abiad et al. (2018) observation that price elasticities for advanced goods such as robots and semiconductor manufacturing machines should be small.

The finding that commercial vehicle exports ceased responding to exchange rate changes after 2010 reflects Nguyen and Sato’s (2019) finding that Japanese transportation equipment exporters responded to a weaker yen during the yen depreciation period that began in 2012 by pricing-to-market. This meant that rather than lowering prices in the importing country’s currency, they chose to keep foreign prices close to constant. Thus, they chose not to increase export volumes as the yen depreciated, but rather to increase profit margins.

Telecommunications equipment exports were very sensitive to exchange rates over the 2010-2020 period. Before the GFC Japan was a leading producer of cellphones. However, as Sato et al. (2013) discussed, the sharp appreciation of the yen that started with the GFC combined with the sharp depreciation of the Korean won caused Japan’s communication equipment exports to plummet and Korean communications exports to soar. Thorbecke (2023) reported that, by 2012, Korea’s Samsung had become the largest phone manufacturer by sales. It continued to hold this position over the next ten years.

When Japanese exports are separated into those to Asian countries and those to non-Asian countries, exchange rate depreciations after the GFC fail to stimulate exports to Asia for all machinery exports and for most subcategories. Depreciations do, however, increase exports to non-Asian countries. For total machinery exports, a 10% depreciation increases exports to non-Asian countries by almost 6%. There is also a statistically significant relationship between exchange rate depreciations and rising exports for several subcategories. These findings are consistent with Sato and Shimizu’s (2015) hypothesis that the relocation of production to Asian countries has weakened the link between exchange rate depreciations and Japanese machinery exports to Asia.

The research discussed here investigates the changing impact of exchange rates on Japanese capital goods exports. Future research should investigate how exchange rates impact Japanese exports of parts and components. It should also investigate whether the knowledge spillovers from Japanese exports to downstream firms outside of Asia is comparable to the knowledge diffusion from Japanese trade with downstream Asian firms that authors such as Hirano (2016) and Ito et al. (2023) documented.