# Understanding the Evolution of Japan's Exports

Author Name THORBECKE, Willem (Senior Fellow, RIETI) East Asian Production Networks, Trade, Exchange Rates, and Global Imbalances

This Non Technical Summary does not constitute part of the above-captioned Discussion Paper but has been prepared for the purpose of providing a bold outline of the paper, based on findings from the analysis for the paper and focusing primarily on their implications for policy. For details of the analysis, read the captioned Discussion Paper. Views expressed in this Non Technical Summary are solely those of the individual author(s), and do not necessarily represent the views of the Research Institute of Economy, Trade and Industry (RIETI).

International Macroeconomics (FY2011-FY2015)
East Asian Production Networks, Trade, Exchange Rates, and Global Imbalances

How have Japanese exports evolved? How exposed is Japan to a slowdown in China? What types of policies would make Japanese exports more stable? To shed light on these issues, I employ a gravity model. Gravity models are one of the most successful models in economics and useful for predicting bilateral export flows. These models are estimated using three specifications and two econometric techniques--panel ordinary least squares and Poisson pseudo-maximum-likelihood estimation--using data from 31 countries over the 1988-2013 period.

Several findings emerge:

1) In every year between 1988 and 2006, Japanese exports to the United States were the largest positive outlier (see Figure 1). Over this period, on average, they exceeded the gravity model's predicted value by $43 billion per year. The lion's share of these exports to the United States was finished goods. For instance, 41% were consumption goods and 29% were equipment and capital goods. The preponderance of these exports were in the automotive, electronic, and machinery sectors. Between 2009 and 2013, on the other hand, Japanese exports to the United States on average fell short by$9 billion per year from the predicted value.

2) Japan's exports to China grew rapidly relative to the predicted values between 2001 and 2005. Thereafter, they remained much greater than predicted. The evidence indicates that the increase in exports between 2001 and 2005 were driven entirely by changes in "imports for processing," which are parts and components sent to China to be used for producing goods for re-export to higher income countries. Japan's "ordinary exports," which are goods destined for the Chinese domestic market, were the largest negative outlier every year between 1992 and 2008. While ordinary exports from Japan to China increased between 2009 and 2011, they have since fallen by 20%.

3) Japan's exports to Taiwan and Thailand were much more than predicted, and exports to South Korea were much less than predicted.

4) Japan's exports to the European Union (EU) fell below the predicted value year after year. In 2013, they were $30 billion less than expected. The results indicate that Japan's exports to the Chinese domestic market, the EU, and South Korea are less than predicted. One implication of these findings is that Japan is less exposed to a slowdown in China that would reduce exports to the domestic market than it is to a slowdown in the predominantly high income countries that would reduce Chinese exports of tablet computers, office machinery, and other sophisticated goods that are produced using Japanese parts and components. Another implication is that Japan should seek to expand its exports to its Northeast Asian neighbors and to the EU. The more diversified the group of countries that Japanese companies export to, the lower the risk that they face from slowdowns in individual countries or regions. Would free trade agreements (FTAs) help to stimulate Japanese exports to China and South Korea? The results presented in this paper controlled for the fact that no FTA exists between these three countries. If this is not controlled for, the model would predict that Japanese exports to China after 2009 would be$35 billion higher per year and that to Korea would be \$36 billion higher per year. The results thus support the growing body of evidence that indicates that an FTA with Asian trading partners would be beneficial. The findings also indicate that an FTA with the EU would stimulate exports.

The results that Japan's exports to Taiwan are much more than predicted while those to South Korea and the Chinese markets are less than predicted also reflect the different perceptions of Japan in these markets. Taiwanese President Ma Ying-jeou said on the 70th anniversary of Taiwan's freedom from the rule of Japan that it is important to remember the good things such as irrigation projects and reservoirs that Japan did during its occupation. This contrasts with China and South Korea, where many retain negative perceptions of Japan. Anti-Japan riots flare up in these countries from time to time, which probably cause Japanese exports to them to fall.

From an economic point of view, it would be beneficial for Japanese companies to diversify their exports by shipping more to China, Europe, and South Korea. FTAs and improved relations with Northeast Asian neighbors thus should be high on the Japanese policy agenda.