The Japanese Trade Surplus with the European Union: Extent, Causes and Implications.

Olaf Gersemann



This essay examines the European Union's trade deficit with Japan. It argues that this deficit, a cause of concern to the EU, could be even larger if trade barriers were removed. Firstly, I discuss, using data from the EU's Statistical Office, the magnitude of the deficit, then the reasons for it on the Japanese side, and finally the welfare implications for the EU. Examples are taken from the car market, as cars are the most visible product of Japan's economic success.



Trade with Japan accounts for a large proportion (almost three fifths in 1992) of the EU's overall trade deficit. The Japanese surplus with the EU rose from 0.7 billion ECU in 1970 to 31.0 billion ECU in 1992.

Even when the yen was strong, the import-export ratio increased from 1.3 in 1960 to 2.9 in 1986. In 1992, the value of EU imports from Japan was 2.5 times higher than the value of the Union's exports to Japan. The penetration of Japanese markets by European products, on the other hand, was even lower in 1992 (0.72 %) than in 1960 (0.74 %).

Japanese products, however, still account for not more than 10.6% of EU total imports, less than the imports from Austria and Switzerland together. Hence, the attention focused on the Japanese trade surplus is "scarcely proportionate to its relative significance"[1] for the EU.


Japan has few raw materials or energy sources of its own. As a consequence, it has an enormous demand for these primary products and is forced to produce goods and services for export. Japan's economy has specialised in sophisticated products like machinery and transport equipment. In 1992, three such sectors (road vehicles, office machinery, telecommunications and sound equipment) contributed

* 51.7% of total imports from Japan and

* 74.2% to the EU's total trade deficit with Japan.

Thus, it is obvious that Japanese pressure is felt particularly in specific sectors and in the countries where these sectors are located.

Voluntary Export Restraints and Direct Investments

Given free trade, the Japanese exports to the European Union would be likely to be even bigger, since this would imply that tariffs and non-tariff barriers (NTBs) would be removed.

In addition, for example, to the Union's common external tariff of 10.3%, five EU member states restrict car imports from Japan by Voluntary Export Restraints (VERs). From the exporters' point of view, a VER is the lesser of two evils, since it not only raises the price to consumers, in the same way as a tariff, but also "allows the exporters to obtain the rents associated with the artificially high prices"[2] by letting them do the restricting.

However, Japanese car manufacturers should look forward to the removal, by the year 2000, of the VERs on car imports from Japan, as agreed by the EU in 1991. Smith and Venables (1991) showed in a model based on the world car market in 1988 that a removal of Europe's VERs would push the Japanese market share from 8.8% to 16.5%. This increase in volume will, according to Smith and Venables, outweigh the reduction in price (which in general cannot be taken as given, as Greenaway and Hindley (1985) point out). The profits of Japanese car manufacturers are expected to rise by one billion ECUs per year.

In 1977, Japanese firms began significantly to export not only goods but also industries. Japanese-owned car factories in the Union, for instance, produced some 500,000 cars in 1993 and are expected to make about 2 million cars annually by the year 2000.

Japan's Foreign Direct Investments (FDIs) in Europe can be considered "an effective counter to the accusation that Japanese imports are `destroying' jobs"[3]. Circumventing barriers might not be the only reason for the FDIs in the EU, but the investments tend to be concentrated in industries which face protectionism. However, the FDIs, at least, reduce the EU's trade deficit if the Japanese factories use, as do the car manufacturers, a high proportion of locally made parts. Toyota, for example, expect the European content of its cars to reach 80% by value this year.


Europe's manufacturers are clearly failing to penetrate Japan's markets: Thurow (1992) says that Japanese imports from Europe are 25% to 45% less than would be expected given Japan's circumstances. This might be due partly to the preferences of Japan's consumers. However, given roughly similar preferences of consumers in Japan and Europe, there are two possible reasons for the European lack of success: firstly, Japan might be more protectionist than Europe and secondly, Europe's economy, when compared with its counterpart, might suffer from a lack of competitiveness.

The Openness of Japanese Markets

Undoubtedly, the Japanese built a protective wall in post-war years in order to develop certain industries. However, in the last few decades Japan has cut her tariffs and quotas down significantly. Hence, according to Hanabusa (1979) the discriminatory effects on imports to Japan today have to be considered dubious. Nevertheless, Laura D'Andrea Tyson (1992), Chief Economic Adviser to President Clinton, considers that despite the tariff reductions, the country "remains significantly more closed to foreign trade and investment" than other advanced industrial nations. The closure, argues Tyson, is a consequence of structural market barriers created by the integration of large firms with one another. Many Japanese companies are members of keiretsu, groups consisting of companies with cross-shareholdings in one another. The members of these business groups give preferential treatment to each other as preferred suppliers and customers, i.e. by co-ordination and economies of scale. Further co-ordination is provided by the Ministry for International Trade and Industry (MITI). However, to argue that this is protectionist is subjective and difficult to prove.

The Competitiveness of Japan's Economy

A country's competitiveness is reflected by its ability to increase its share of export markets, given free trade (or an equal level of protectionism) and depends upon the productivity and costs of its factors of production.

In the 1960s Japanese productivity was significantly below that of the USA and Germany. The gap had been nearly closed by 1970 and had turned into an advantage by the end of the 1970s. Today Japanese manufacturers can, for instance, assemble a luxury car with only one quarter of the labour that is required in Europe[4].

Japan's competitiveness can also be seen by comparing the performance in third markets. In the US car market, for instance, Japanese producers proved to be far more competitive than the Europeans. While Volkswagen, the last European mass manufacturer left in the US market, "is in the process of being driven out", Japan's market share declined in recent years but is still higher than one fifth. (Although one must be cautious about comparing a single sector since it is possible that Japan has competitive disadvantages in other areas.)

The Japanese cost advantage is due to several characteristics of Japan's economy and society. Three of them will be presented in more detail in the following section.

System of Values

"The Japanese secret is to be found in the fact that they have tapped a universal human desire... to belong to an empire". The goal of Japanese firms is not profit maximisation, but market share maximisation. Accordingly, "a big part of the Japanese success in coping with the rising value of the yen"[5] is found in their willingness to accept lower rates of return than their competitors.

Moreover, the identification of Japanese employees with their companies is far stronger than elsewhere. This is because firms offer life-time job security (which would in the view of European managers undercut motivation). Even in recessions Japanese companies tend to accept `in-house unemployment' rather than dismissals).

Savings, Investments, and Consumption

In the Japanese economy, savings and investments are systematically promoted. Compared to European countries

* the work force gets a low share of national income,

* rates of personal income and commodity taxation are low

* dividends are low relative to after-tax profits.

The outcome is a traditionally high savings ratio which in turn leads to a low price of capital. Hence, the required rates of return are far below the corresponding rates in the EU. As a result, Japan invests relatively more money which in turn improves productivity and thereby supports economic growth. High savings ratios, on the other hand, are synonymous with low consumption ratios. This means that Japan's domestic demand is traditionally weak. Therefore market penetration by imports is impeded.

Research and Development

Japan traditionally has a high level of research and development (R&D), encouraged by MITI, the existence of keiretsu, and the low price of capital. Another advantage is that it has concentrated its R&D since the 1950s not on new products but on new production processes. Therefore Japanese firms are often, as is the case of the CD player, not the inventors of a new product but the cheapest producers.



European consumers gained enormously from the increase of Japanese imports. Access to Japanese goods offers additional choice through product differentiation. It provides, as Winters (1992) expresses, `life-enhancing variety'.

Furthermore, the penetration of EU markets by Japanese products stimulated competition. This led, for example, to "vast improvements in the quality of automobiles which have been pioneered by Japan and then imitated and developed"[6] in the Union.

However, the gains for consumers would be far bigger if the EU stopped protecting its industries from Japanese competitors. According to Smith and Venables (1991), a removal of the VERs in the European car market would imply a consumer surplus in the order of 6 billion ECU per year, an amount that clearly outweighs the predicted losses to European producers of approximately 3 billion ECUs per annum.

Employees, Producers and Taxpayers

If exports and imports increase in a balanced way, it is not likely that the expansion of trade between the European Union and Japan would create major (net) employment problems. In the case of trade between developed countries (or trading blocks, respectively) it can under certain conditions be assumed that job losses which emerge from additional imports are roughly compensated by job gains through additional exports.

If, however, imports grow faster than exports the contraction of one sector is not accompanied by the expansion of other sectors; the losses of profits and employment in the penetrated industries are not compensated. Moreover, the speed at which the penetration by Japanese imports boomed and still booms creates serious problems by making adjustments in the affected sectors more difficult and, thus, costly. Producers therefore usually plead for time. If they are, like the European car makers, successful, competitive pressure is taken off by protective measures such as subsidies and VERs at the expense of European taxpayers and consumers.

One might consider that the speed of contraction of domestic sectors justifies protection. On the other hand, protective measures are according to the theory of public choice easy to introduce but difficult to remove. Moreover, protection leads to consumer losses that "in total will almost always outweigh producers gains"[7] at least in the long-run.

Growth Potential and Future Wealth

A trade deficit allows a society to consume more than it produces at the expense of its heirs, since a trade deficit requires that a country "sells off the assets that determine its future standard of living"[8] the possible future growth of the domestic economy declines.

The European long-run growth potential is further weakened if the key for future growth lies in the high-technology industries. Particularly in these so-called strategic industries the Europeans seem to be unable to cope with the Japanese, at least at present. While the EU typically sustains the largest trade deficits with Japan in sophisticated products, the EU recorded the biggest surplus with Japan in 1992 for clothing and accessories.


It is not the extent of imbalance which implies economic problems for the European Union but the highly concentrated composition of imports from Japan. Therefore, the EU member states which are most affected are those in which sectors which face pressure from Japanese import penetration are located (several countries, for example, do not have a car industry). A removal of the Union's protectionist measures would strengthen the pressure.

Japan is possibly more protectionist than the EU. But this is clearly not sufficient explanation for the trade imbalance. There are reasons to believe that Europe, compared with Japan, suffers from a significant lack of competitiveness. The EU has tried to remove pressure from the penetrated sectors with protectionist measures as well as, the introduction of the Internal Market. On economic grounds, however, import penetration is clearly an inferior solution to an increase in exports to Japan.


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