Trade collapse and international supply chains: Japanese evidence

Kiyoyasu Tanaka 27 November 2009

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Global trade flows collapsed at a historically unprecedented rate between the end of 2008 and beginning of 2009 (Baldwin and Taglioni 2009). Trade, however, did not collapse evenly across the globe.

Among the worst hit was Japan (Sommer 2009). Why was this? To help understand the causes of the great trade collapse, this chapter places international supply chains of manufacturing production at the centre of the reasoning. Specifically, the composition of the collapse of Japan’s trade provides clear evidence on the role of vertical specialisation in the trade collapse.

Trade collapse

The stunning drop of global trade stemmed ultimately from the subprime crisis. The US subprime mortgage crisis inflicted high capital losses for domestic and foreign financial firms that had invested in securities backed with US real estate loans. This triggered a severe credit crunch in the US, which grew into a full-blown financial crisis of global proportions and later ended up affecting the entire global economy. The prime characteristics of the global economic crisis were plummeting stock and equity prices, and skyrocketing bank failures. The recessionary spiral in OECD countries brought international trade to a grinding halt in the fourth quarter of 2008; a 9% contraction in global merchandise trade, by volume, is already underway for 2009 (WTO 2009).

Such a collapse in trade could be a natural consequence of high levels of interdependence in finance, trade, and FDI. Indeed, some consider that falling trade is caused by a massive decline in final demand and a shortage in trade credit (see for example Baldwin and Evenett 2009).

Shortcomings with the standard explanation

I believe, however, that these explanations fail to account for key peculiarities of the unprecedented contraction in world trade, notably that the trade contraction has been rather asymmetric across industrial economies. Another important piece of evidence is that this asymmetric fall in trade is not correlated with exposure to the crisis in any simple and straightforward way.

For example, Japan’s trade declined much faster than the US’s. The impact of the economic crisis on Japan has so far been relatively moderate – at least in financial institutions – yet Japanese trade has been badly hit. Figures for February 2009 indicate a 50% year-on-year contraction in Japanese export volumes and a 43% decrease in volumes of imports.1 Meanwhile, comparable trade figures at the epicentre of the crisis, the US, show a mere 24% decrease in exports and 34% decrease in imports.2

For a further perpective on the uneven drop in foreign trade between Japan and the US over time, Figure 1 shows exports and imports in goods for Japan and the US from April 2008 through September 2009. For comparability, the volume of trade is expressed as an index, with the figure for April 2009 being 100. What is clear is that Japan’s exports started to fall from October 2008 at a dramatic pace. Such a decline was much more severe than that of US exports. Both of their exports appeared to have bottomed out around March 2009. On the other hand, the imports also declined suddenly for the corresponding period.

Figure 1 The collapse of trade in goods for Japan and the US, 2008-2009.

Source: Trade Statistics of Japan, Ministry of Finance; US Census Bureau

Note: The volume of trade in goods is expressed as an index with the figure for April 2008 being 100; export and import are reported in f.o.b and c.i.f. prices, respectively; US trade on the basis of total balance of payments is not seasonally adjusted.

Vertical specialisation

What explains such a difference in the speed of trade collapse across Japan and the US? One suspect is the differential importance of international supply chains.

The emergence of global production networks has promoted the vertical specialisation of countries and increased trade in both intermediate and final goods. Manufacturing firms increasingly specialise in particular stages of the production process and export intermediate inputs for further processing. Products may cross national borders several times and endure several transformations before they reach their final consumer.

The link between vertical specialisation and international trade enjoys strong empirical backing. In fact, back in 2001, Hummels, Ishii, and Yi showed that vertical integration could account for almost one-third of the export growth in OECD countries. Yi (2009) clarifies that this link can work in both directions. In fact, he suggests that vertical integration accounted for much of the trade collapse – though does not provide an estimate.

Vertical specialisation boosts the values and volumes of foreign trade for statistical reasons. Trade is measured in gross value-added terms, rather than net value- added terms, as is GDP. This measurement technique partly explains that flows in trade increase (decrease) at an accelerating rate when demand rises (falls).

From this point of view, the trade collapse could result from a breakdown of vertical trade chains. While vertical specialisation can account for possible differential impacts of trade, a full explanation of the disproportionate scale of trade contraction in response to demand shocks across Japan and the US requires examining the different strategies of US and Japanese multinationals.

Vertical foreign direct investment

The growth of vertical specialisation was driven in part by investments of multinational firms bent on taking advantage of the lower costs of unskilled labour in some countries (Tanaka 2009). Multinationals established offshore production plants in unskilled-labour-abundant countries to conduct the unskilled-labour-intensive stages of production. Under these schemes, parent firms supplied intermediate inputs to their foreign affiliates, which performed the final assembly, and subsequently exported the final products back to the home market, or third markets.

Vertical specialisation is particularly clear in the case of FDI by Japanese multinationals, but is less so in the case of FDI by US multinationals.3 The vertical specialisation of Japanese multinationals has been spread broadly across many countries; the vertical FDI of US multinationals, by contrast, is concentrated on a narrow set of countries, notably Canada and Mexico.

In my view, the difference in vertical FDI strategies between US and Japanese multinationals is one possible cause of the disproportionately large collapse of trade flows in Japan in response to global demand contraction. As Japanese firms have embraced vertical FDI, Japan has been more fully immersed in vertical specialisation patterns than the US

Further evidence from Japan’s trade statistics

In order to get further insights on trade patterns in the wake of the trade collapse, I focus on the decline of Japanese trade for April-September 2009 relative to that for 2008. Figures indicate a 36% decrease in the volume of Japanese export and a 40% contraction in import volumes; the volume of these declines reaching a whopping 15.6 and 16.8 trillion yen, respectively. What commodity and partner country accounted for the decline?

Figure 2 The regional share of trade collapse for Apr.-Sep. 2009 relative to 2008.

Source: Trade Statistics of Japan, Ministry of Finance

Note: The volume of export and import for Apr.-Sep. 2009 relative to that for Apr.-Sep. 2008 decreased by 15.6 and 16.8 trillion yen, respectively.

Figure 2 shows the regional composition of the trade volumes that declined during April-September 2009, as compared to April-September 2008. Clearly, Asia plays the largest role in the collapse of Japan’s trade for the recent period, with a pronounced share in the export decline.

On the export side, North America is the second largest region that reduced exports from Japan, followed by Western Europe. These observations indicate the importance of Asia and North American in explaining the causes of the extremely rapid collapse of trade in Japan. On the import side, the Middle East accounts for a surprisingly large composition of the import decline. The recession significantly decreased Japanese demand for imported goods from the Middle East.

Figure 3 The country share of trade collapse for Apr.-Sep. 2009 relative to 2008.

Source: Trade Statistics of Japan, Ministry of Finance

Note: The volume of export and import for Apr.-Sep. 2009 relative to that for Apr.-Sep. 2008 decreased by 15.6 and 16.8 trillion yen, respectively.

As Figure 2 points to the substantial decline of Japan’s trade with Asia and North America, Figure 3 further decomposes the regional share of the trade contraction by country for these regions. The recent fall in Japanese exports to the US is the largest among individual countries. This indicates the great dependence of Japanese exports on the US market.

In other words, an economic downturn in the US economy dampens sharply the US demand for imported goods from Japan. Looking at Asian countries, China accounts for the largest decline of Japan’s exports and imports. Japanese export volumes also declined substantially for South Korea, Taiwan, and Hong Kong. Although China is the major market for Japanese trade, individual countries in Asia have an equally significant impact on the collapse of Japan’s trade.

Figure 4 The commodity share of trade collapse for Apr.-Sep. 2009 relative to 2008.

Source: Trade Statistics of Japan, Ministry of Finance

Note: The volume of export and import for Apr.-Sep. 2009 relative to that for Apr.-Sep. 2008 decreased by 15.6 and 16.8 trillion yen, respectively.

To further explore the characteristics of trade contraction, Figure 4 displays the commodity share of decreased volume of trade. The export contraction was most sizeable in transport equipment, general machinery, and electrical machinery equipment. On the other hand, the import decline was explained mainly by the declined volume of imported mineral fuels, which would in part reflect a drop in the price for crude oil. The commodity composition of the collapse of trade differs significantly by export and import. Manufacturing products are crucial in explaining the cause of the sudden collapse of Japan’s export.

Figure 5 The commodity share of export collapse in Asia and the US for Apr.-Sep. 2009 relative to 2008.

Source: Trade Statistics of Japan, Ministry of Finance

Note: The volume of export to Asia and the US for Apr.-Sep. 2009 relative to that for Apr.-Sep. 2008 decreased by 6.5 and 2.8 trillion yen, respectively.

Another key question is what commodity accounts for a large drop of Japan’s exports to Asia and the US? Export volumes decreased by 6.5 and 2.8 trillion yen for April– September 2009 relative to 2008, respectively. Figure 5 shows the commodity share of Japanese export declines in Asia and the US. Manufacturing products, such as general machinery, electrical machinery equipment, and chemical products, explained a relatively large share of export drops in Asian markets. As these goods involve particular stages of the production process that can be geographically fragmented, the large contraction of trade flows for these goods suggests the wide development of vertical specialisation across Japan and Asian countries.

In contrast, transport equipment has the disproportionately large composition of decreased exports to the US; motor vehicle’s share is dominant relative to parts and components for the vehicle. This point accords with the contraction in demand of US firms and households for any type of motor vehicles. A sudden drop in Japanese exports was also in part driven by the collapse of US demand for Japanese motor vehicles.

Implications of trade collapse

Overall, the latest trade statistics indicate that the sudden contraction of Japan’s exports was primarily explained by a large drop in manufacturing exports to Asia and the US, even though a substantial decline in the value of oil imports from the Middle East also played a large role on the import side. As the collapse of Japan’s manufacturing exports to Asia has been most prominent in magnitude, Japan’s drop in trade should have been amplified by the global production networks that Japanese multinational firms have extensively established over Asian nations.

Whilst a sudden drop of trade has clearly hit the Japanese economy hard, it is of interest to conjecture a lesson from the trade collapse on international supply chains. One key point concerns the just-in-time system of modern manufacturing production. Manufacturers receive only the components and parts they need immediately in order to reduce the cost of inventory holdings. The flexible logistics in the production system allow for a quick response to defective components and customer orders. Global production networks are in fact now dominated by just-in-time logistics systems. The consequences are a much tighter connection between imports and exports.

The sudden fall of exports clearly illustrates that Japanese firms have been highly responsive to a fluctuation in final demand, possibly through the flexible production network. In this respect, the amplification of Japan’s fall in trade may suggest that Japanese firms have been successful in building flexible international supply chains in manufacturing production. When final demand falls, Japanese companies can slow down a cross-border circulation of parts and final products at the regional level. Once the demand recovers, they would start to expand production capacity abroad by taking advantage of international factor-cost differentials.

Concluding remarks

As fiscal stimulus plans deployed by OECD countries contributed to a recovery in global demand, the sudden collapse of global trade flows have already bottomed out and started to recover in recent periods. Japanese trade volumes also appear to turn up gradually since April 2009, although there is still no clear indication of the trade amplification effects by the international production networks. Still, many economies, including the Japanese economy, continue to suffer from a rising unemployment rate, growing bankruptcies, and mounting budget deficits. An important lesson from the trade collapse is that national governments must coordinate international economic policies, and indeed, have been successful in preventing a collapse in the international division of labour.

Footnotes

1 Value of Exports and Imports February 2009, Trade Statistics of Japan, Ministry of Finance.

2 US Census, Bureau, Foreign Trade Statistics: US International Trade in Goods and Services (Current Release, February 2009).

3 Using panel data on sales of foreign affiliates by Japanese and US multinationals in manufacturing sectors for the 1990s, Tanaka (2009) finds that relative skill abundance has a large negative impact on Japanese affiliate sales, but little effect on US affiliate sales. Results are robust to various tests.

References

Hummels, David, Jun Ishii, and Kei-Mu Yi, (2001) “The nature and growth of vertical specialization in world trade.” Journal of International Economics, 54, 75–96.

Martin, Sommer (2009) “Why has Japan been hit so hard by the global recession?” IMF staff position note, March.

Richard, Baldwin, and Daria, Taglioni (2009) “The illusion of improving global imbalances” VoxEu org., 14 November.

Tanaka, Kiyoyasu, (2009) “Vertical foreign direct investment: evidence from Japanese and US multinational enterprises.” Global COE Hi-Stat discussion paper No.46.

Yi, Kei-Mu (2009). “The collapse of global trade: the role of vertical specialization,” in Baldwin and Evenett (eds), The collapse of global trade, murky protectionism, and the crisis: Recommendations for the G20, a VoxEU publication.

WTO (2009). WTO sees 9% global trade decline in 2009 as recession strikes. WTO: 2009 Press release 554, 23 March 2009.

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Topics:  International trade

Tags:  great trade collapse, international supply chains