Gains from Digital Services Imports in Japan

Introduction

Japan is a long-standing champion of an open, rules-based international trading system and has pioneered the creation of regional and multilateral agreements to promote digital trade. In recent months, following the Japanese government’s expression of concern about the country’s trade deficit in digital services in its 2024 Priority Policy Program for Realizing Digital Society, there has been growing discussion in the Japanese media about a “digital deficit.” The digital deficit concept has been framed as a negative: Foreign digital services providers are “draining” Japan. To be sure, Japan is seeking to use the concept to promote the export of Japanese digital services and local digital services start-ups.

However, the concept can also be viewed as promoting protectionist trade policies and in that respect could be rethought, as suggested by many Japanese experts and academic studies. After all, data strongly indicates that access to imported digital services helps promote Japanese firms’ and exporters’ competitiveness.

This paper will discuss the digital deficit concept in light of the critical importance of open digital trade for the millions of Japanese firms that import such services, and in light of the strong growth of Japan’s digital services exports in the past few years. The five main findings are listed below:

• Concerns about a “digital deficit” appear to be overstated. Since 2014, Japan has had a trade deficit in telecommunications, computer, and information services sectors, and its magnitude, as this paper will discuss, has remained most years at 2 to 0.3 percent of gross domestic product (GDP). Japan runs much larger trade deficits in goods, other business services, and insurance and pension services, for example.
• While much attention has been paid to digital services imports, Japan’s digital services exports have expanded even faster, placing Japan in the ranks of the world’s top 10 exporters of digital services. Japan’s digital services exports have grown faster than imports in the past 15 years. Exports to the United States, Europe, and Singapore in particular have expanded rapidly in recent years. Japan’s strength as a digital services exporter reflects, for example, the remarkable growth of the creative industry and its rapidly growing start-up ecosystem, and only underscores the need for Japan to champion open digital markets and digital trade agreements.
• Focus on the trade deficit disguises the important fact that Japanese firms overwhelmingly use domestic digital services in their production. The value added of Japanese digital services used in making Japanese products and services is still very high. For example, per calculations based on the Organisation for Economic Co-operation and Development (OECD) Trade in Value-Added (TiVA) database, over 70 percent of the value added from digital services in the gross exports of Japanese manufacturing industries comes from Japanese digital services. Similarly, over 90 percent of the value added included in Japan’s services exports originates from Japan. In fact, the value added of domestic digital services in Japanese manufacturing exports is higher than that in Germany or South Korea. Further discussions on the trade balance in digital services should put imports in perspective and weigh them vis-à-vis the continued high importance of domestic digital services for Japanese firms.
• The use of imported digital services promotes Japanese companies’ export competitiveness, while digital trade barriers would have significant negative effects—especially in sectors where Japan enjoys a comparative advantage. Business surveys carried out for this study by Nextrade Group (see Appendix I) show that Japanese exporters of manufacturing, services, and digital services use a wide variety of imported digital services in their production and operations, finding them critical for their competitiveness. As such, barriers to foreign digital services imports would ironically only raise costs to firms and exporters already battling the weak yen, undermining Japan’s exports and thus widening the overall trade deficit. Import barriers would also likely invite retaliation from trading partners and directly undercut Japan’s digital services exporters.
• Japan has long championed technology-driven businesses, innovation, and open markets, including free digital trade—and amplifying these efforts can have significant payoffs. To bolster its digital exports and ensure companies across sectors also get access to world-class imports, Japan can deepen its many digital trade agreements, promote convergence across those deals, continue its recent remarkable efforts to promote the start-up ecosystem, enable Japanese businesses to connect to international customers and investors, and leverage its artificial intelligence (AI) capabilities to scale its digital services exports. Helping Japanese companies access foreign digital services and export digital services would strengthen their competitiveness and contribute to Japan’s newfound economic growth.

The following sections deepen these findings. The paper first reviews literature on how imported digital services promote countries’ export competitiveness. The next section puts the digital deficit concept in context by reviewing Japan’s trade balance across sectors and examining the actual value added of foreign versus domestic digital services in Japan’s consumption and exports. It also examines the results of a survey of Japanese firms on the importance of digital services and foreign digital services for their production and export competitiveness. The fourth section makes policy proposals to promote Japan’s digital exports and is followed by a conclusion.
 

How Digital Services Promote Competitiveness

There is broad agreement in academic literature on trade policy that imported services, particularly digital ones, are indispensable for driving productivity and export growth across industries. Export-driven countries such as Mexico, Germany, South Korea, and Association of Southeast Asian Nations (ASEAN) members have been able to expand their goods and service exports in part because they have leveraged imported services and digital services.

In 1981, Baer and Samuelson showed that the growth of the services sector facilitates broader economic diversification and helps countries achieve a more stable and diversified export base. More recent works have shown that imported services, whether logistics, professional, or information technology (IT) and computing, provide manufacturing firms with advanced capabilities that can streamline operations and reduce costs. There are four main sets of findings (Table 1):

• Imported digital and other services boost countries’ manufacturing competitiveness. López González (2016) finds that incorporating foreign services into domestic production significantly boosts firms’ export capabilities by introducing advanced technologies and improving operational efficiencies. These services enable firms to focus on their core manufacturing activities while outsourcing noncore functions to specialized service providers, thereby enhancing overall efficiency and productivity. In a 2023 study of firm-level and customs data in China, Zhang, Liu, and Wei show that digital product imports have a significant positive effect on Chinese firms’ export product quality. Using the China Industry Business Performance and China Customs Trade databases, Yuan, Chen, and Wang (2024) show that importing digital products significantly enhances the value added of products.
• Imported digital services improve innovation, industrial performance, and the quality of exports. Damuri (2014) shows that access to high-quality business services is also essential to supporting a country’s active participation in global value chains and upgrading its industrial performance. In a 2018 study of manufacturing firms in Uruguay, a success story in Latin America, Zaclicever and Pellandra show that a wide variety of imported services enabled firms to modernize operations and innovate. Arnold, Javorcik, and Mattoo (2011) show how access to specialized knowledge and skills through imported services allows Czech manufacturing firms to adopt best practices and cutting-edge technologies.
• Imported services promote efficiencies in domestic services and enable environments that foster the competitiveness of all firms. Francois and Hoekman (2010) find that the availability of high-quality services such as efficient transportation, reliable communication networks, and robust financial services is crucial for manufacturing firms aiming to compete in global markets. Nordås (2008) similarly finds that manufacturing firms that have access to a wider pool of services experience substantial improvements in efficiency and cost savings.
• The liberalization of services trade is key to capturing gains from foreign services. Several studies have found that policies conducive to imports of services promote export competitiveness, with clear implications for policymakers seeking to ensure open markets for high-quality services. In a 2018 study of 30 economies, Lee documents that services liberalization has led to a marked increase in global value chain participation, which has, in turn, enhanced export competitiveness, particularly for developing countries. Hoekman and Shepherd (2015) indicate that countries that liberalize their service sectors tend to see greater inflows of foreign direct investment in services, which in turn boosts the performance of domestic manufacturing firms. The increased competition and availability of advanced services drive domestic firms to innovate and improve their productivity to remain competitive.

Japan’s Digital Services Trade

In recent years, Japan has been a champion of an open, rules-based trading system and a leader on digital trade issues, including through its support of the Joint Statement Initiative on E-Commerce at the World Trade Organization (WTO) and in the context of bilateral and regional digital trade agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Japan is the architect of the Data Free Flow with Trust (DFFT) concept, endorsed by the Group of Seven (G7) and Group of 20 (G20), which enables cross-border data transfer while ensuring data privacy. Japan is also open to foreign direct investment (FDI), including in technology sectors, with the exception of restricting foreign ownership in Japan’s former land-line monopoly telephone operator, Nippon Telegraph and Telephone (NTT), to 33 percent.¹ In addition, Japan has led thinking on ways technology can promote well-being, for example through its Society 5.0, which envisions a human-centered society integrating cyberspace and physical space to improve quality of life.

Granted, there are some recent signs that Japan is holding tighter reins in digital markets. The 2024 Act on Promotion of Competition for Specified Smartphone Software echoes, to an extent, the restrictive ex ante digital competition policy law, the European Union’s Digital Markets Act (DMA), which imposes new obligations on leading technology companies. Under Japan’s act, designated mobile software providers have various obligations, such as allowing third-party app stores on their operating systems and allowing alternative in-app payment systems. And recently, there has been discussion of the “digital deficit” in digital services trade. Even if geared toward motivating policies to catalyze exports, the concept can be perceived as implying the need to restrict imports.

This section explores this concept further, analyzing the volume and role of imported digital services in Japan’s economy. What volume of digital services does Japan actually import? And how important are foreign digital services in Japanese production? An analysis of trade, value chain, and business survey data provides the following answers.

Data from the WTO shows that Japan’s telecommunications, computer, and information services exports, here a proxy for digital services exports, have grown rapidly and faster than digital service imports in the past 14 years. Japan’s trade deficit in digital services has grown somewhat, from 0.17 percent of GDP to 0.27 percent, between 2014 and 2023; the highest trade deficit, at $15.5 billion, was recorded in 2021 as Japanese firms purchased foreign digital services amid the Covid-19 pandemic. Japan’s imports of digital services in 2023 were still twice as large as digital services exports. However, it is also the case that digital services exports expanded from $1.7 billion in 2010 to $11.7 billion in 2023, or 43 percent per annum, and thus faster than imports, which grew from $4.6 billion in 2010 to $23.6 billion in 2023, or by 32 percent (Figure 1). According to WTO data on digital services exports, Japan’s digitally deliverable services grew between 2014 and 2022, especially to the United States (47 percent annual growth), the European Union (22 percent), Singapore (21 percent), and China (19 percent) (Figure 2).

Japan’s trade deficit in telecommunications, computer, and information services should be put in perspective: It is not new nor is it large compared to other sectors. Japan has run much larger trade deficits in goods and services for years (Figure 3). Further, it has had larger trade deficits when measured as share of GDP in goods, other business services, and insurance and pension services (Figure 4). The industries where Japan has a surplus include financial services, travel, and charges for intellectual property.

The vast majority of information services value added in Japanese gross exports are not foreign but originate from Japan. Looking at the trade balance alone is not an accurate reflection of the use of domestic services. A better measure is an analysis of the origin of the value added from domestic digital services included in domestic products. Input-output data from the OECD TiVA database shows that Japan in 2020 was the source of 71 percent of the information and communication industry value added included in Japanese manufacturing exports, down only slightly from 74 percent in 2015 (Figure 5).² The same holds true in Japanese services exports: 91 percent of their value added is Japanese. The share of domestic information services value added in Japan’s gross exports is much higher than the share of domestic information and communications industry value added in South Korean or German manufactured gross exports.

Also, Japan is the source of the bulk of information services value added in Japanese final demand (in domestic consumption that is not exported) in manufacturing and especially in the services sectors. It is the source of 61 percent of the information and communication industry value added included in Japanese final demand in manufacturing, and 83 percent of the information and communication value added in domestic final demand in services. The sources of value added in manufacturing final demand include China, the United States, the European Union, and ASEAN nations; the role of China has grown as a source of value added. 

These same insights emerge from Nextrade Group’s online survey of 600 Japanese firms conducted from July 5 to October 5, 2024: Japanese manufacturing and service providers do import digital services, but most of their spending on digital services is on Japanese digital services.³ The typical Japanese firm invests 5 to 10 percent of its revenues on digital services (Figure 6).

The foreign digital services included in Japan’s gross exports originate from a wide range of parties, and their shares were remarkably steady from 2015 to 2020. China increased its share in that period as the origin of information and communication industry value added in Japan’s gross exports; the European Union and the United States are still the leading sources.

Japanese manufacturers and service providers use a wide variety of foreign digital and cloud services—and these imported digital services are of critical importance to the surveyed firms’ export competitiveness. All surveyed firms used at least one type of foreign digital service, and over half report using five or more, most of them U.S. digital services used for communications, collaboration, customer resource management, cybersecurity, data visualization, payments processing, and more (Figure 7). The use of AI, including generative AI, is growing rapidly as a means for Japanese firms to translate their data into actionable insights.

Export-driven firms in particular leverage foreign digital services, the survey found. Spending on imported digital services rises with export intensity: Of Japanese firms that derive more than a quarter of their revenues from exports, 70 percent spend 25 percent or more of their digital services expenditures on foreign services—compared to only 10 percent of non-exporters (Figure 8). As many as 31 percent of all firms and 35 percent of digital services firms find imported digital services “extremely” valuable and said those services make them at least 20 percent more competitive (Figure 9). Another 32 percent find foreign services “very” valuable. In short, imported digital services are especially critical for Japan’s export-driven digital services firms and exporters, which use foreign services to add value in their production and exports.

Japanese firms use imported digital services to complement their use of domestic services for a number of reasons: They are seen as higher quality, more diversified, more secure, and cheaper than domestic services (Figure 10). A quarter of survey respondents also find that similar services are not available in Japan.

Digital trade barriers would have significant negative effects for Japan’s goods and services exports, especially in sectors where Japan enjoys a comparative advantage. In the World Digital Competitiveness Ranking, Japan is lagging far behind the top-ranked economy, the United States, as well as most Western European economies, South Korea, China, and Taiwan. Japan underperforms in areas such as technological talent, business agility, and IT integration. Undercutting Japanese companies’ access to imported services would decelerate Japanese firms’ IT integration and digital transformation. Indeed, 47 percent of the surveyed firms stated that their production costs would rise over 10 percent if foreign digital services were unavailable, and as many as 17 percent state that these costs would rise over 40 percent. Unavailability of foreign digital services imports would in particular reduce Japanese firms’ profitability, revenues, and export competitiveness; for 35 percent of manufacturers, lack of access to imported digital services would decelerate digital transformation efforts (Figure 11). These potential impacts are all the more striking given that the currently weak yen implies higher costs of imported inputs.

Case 1: Promoting Japan’s Content Industry Exports Through Digital Services Imports

Japan has long been a successful exporter of creative and cultural industries, such as advertising, music, video games, and anime. Japan has significant opportunities to grow its creative industry exports, which are today digitally deliverable and produced by both businesses and by the solo creators and influencers who proliferated during the Covid-19 pandemic. For example, by 2022, one-half of Japanese companies’ revenues (¥1.5 trillion, about $9.6 billion) in the anime industry (including television, movie, video, streaming, merchandising, and game licensing) came from international markets, and most of the growth in the industry has been from international sales (Figure 12). The most prominent markets were Asia, at 32 percent; Europe, at 21 percent; and Latin America, at 16 percent. In 2023, the Super Mario Bros. Movie by Nintendo and Illumination reached the number-two spot in the North American box office, followed in third place by Sony Pictures Animation’s Spider-Man: Across the Spider-Verse.

In 2024, the Japanese government drafted a strategy to promote the anime and broader content industry to a market size of ¥20 trillion ($130 billion) by 2033. This strategy will require trade, such as the formation of digital trade agreements, to take advantage of the growth of global demand in the creative industry, estimated at 10 percent of global GDP by 2030.

In addition, promotion of creative industry exports requires enabling firms in the industry to easily source digital services, including from international markets. After all, companies and individuals in Japan’s creative and cultural industries use a wide range of digital services, such as video editing, graphic design, content marketing, and social media consulting—and many of these are imported. The Nextrade survey of 120 Japanese creators found that these imports matter to export competitiveness. For example, of the Japanese firms that spend more than a quarter of their total digital services budgets on foreign services, 53 percent report becoming at least 10 percent more competitive thanks to these imports (Figure 13). Still, according to the surveyed companies and value chains data alike, the vast majority of the digital value added in these industries’ gross exports arises in Japan.

Policy Agenda for Open Markets in Digital Services

Given the ubiquity of digital services across Japanese firms, barriers on foreign services industries would weigh on the Japanese economy, which is finally, after decades, resuming its growth. Access to diverse, high-quality, and affordable services will be an essential pillar for Japan’s economic revival.

What then should be Japan’s policy on digital services trade? The author recommends the following five main tenets:

• Promote the growth of digital exports, including from the creative economy. Japan is one of the world’s top 10 digital services exporters, with very rapid growth of digital exports in recent years. As such, Japan should promote an offensive digital service agenda, focused on opening markets to Japanese digital services exporters. To be sure, Japan has already signed numerous trade agreements with robust digital trade rules, including with the United States and the United Kingdom, and with partners in the Asia-Pacific, such as the CPTPP. Japan has also been an important driver of the WTO’s Joint Statements Initiative on E-commerce (JSI) talks, and it has developed its own concept promoting digital trade, the DFFT. As the next step, Japan can advance the priorities emerging from business surveys, including comprehensive and well-implemented digital rules, for example in such areas as interoperable payments, protection of intellectual property (IP) rights, common AI standards, and improved enforcement of the hard-won digital trade commitments. Japan can also promote the JSI, plurilateral negotiation on rules for cross-border e-commerce, and, especially, developing countries’ participation in cross-border e-commerce.
• Unlock the export potential of Japan’s promising start-up ecosystem, composed mostly of digital services firms. There is a great deal of potential in Japan to expand digital services exports through promoting digital start-ups. Japan has in recent years experienced a surge of start-up activity and investment: According to the Ministry of Economy, Trade and Industry, investment in the start-up ecosystem has grown tenfold in the past decade. This is due in part to a strong start-up policy. For example, the government has championed the public-private J-Startup program, provided start-up funding through the Japan Finance Corporation (JFC), and created a start-up visa for foreign entrepreneurs to work in Japan for two years. In addition, the Japan External Trade Organization’s Innovation Program helps Japanese start-ups connect with U.S. companies and investors to improve their business models. Japan now has a base of start-ups that can serve as future drivers of digital exports and can expand efforts to take these firms to new markets.
• Ensure open domestic markets for Japanese firms to access digital services as a means to promote exports. Digital services imports are used by Japanese companies across multiple industries—such as manufacturing, IT services, and the creative industry—as a means to gain competitiveness, especially in international markets. It is imperative for Japan to champion a free trade policy in digital products and services, as open policies support the ability of Japan’s own firms and exporters to access the services they need to maintain competitiveness. In contrast, the imposition of barriers on imported digital services would be self-defeating and hurt Japanese exporters from two sides: It would increase their input costs, and it likely would only result in retaliatory barriers by Japan’s trading partners.
• Continue to promote domestic firms’ digital transformation through access to domestic and foreign services. Japan has been lagging farther and farther behind advanced economies on digital transformation and competitiveness rankings. This is an area that requires urgent attention—and can again be remedied by promoting both domestic digital services and start-up ecosystems, and ensuring that Japanese companies can access foreign digital services at low cost.
• Leverage AI capabilities to promote tech ecosystems, start-ups, and digital services exports. There are many examples of the AI-led transformation of Japanese companies. For example, Hitachi has transformed into a leader in AI applications for industrial sectors, with its data science services–focused division Lumada contributing significantly to the company’s growth. Partnerships with global tech companies such as Nvidia to build an AI ecosystem in Japan and invest in Japanese AI start-ups again highlights the importance of imported technology providers to promoting Japan’s competitiveness and exports.
   

Conclusion

Japan has been a leader in promoting digital service trade, data flows, and a rules-based trading system. The recent discussion about a “digital deficit” has been geared toward promoting Japan’s expanding digital services exports—but the concept may also come across as having protectionist connotations. This report has shown that foreign digital services are widely used by Japanese companies and promote their exports and productivity. At the same time, this report has noted that Japan is poised to grow its digital services exports, thanks to the country’s dynamic creative industries, expanding start-up ecosystem, and advanced technological capabilities. With digital service imports fueling Japanese firms and export growth, restricting foreign digital services could backfire, raising costs for Japanese firms and inviting trade retaliation. Instead, Japan should continue promoting open trade in both imports and exports of digital services, for example by expanding existing agreements with comprehensive digital trade rules, supporting start-up innovation, and promoting AI-driven innovation.

Kati Suominen is an adjunct fellow with the Economics Program and Scholl Chair for International Business at the Center for Strategic and International Studies in Washington, D.C., and the founder and CEO of Nextrade Group.

This report is made possible by the generous support of Nextrade Group.

Please consult the PDF for references.

Appendix I: Survey Methodology and Sample

The Nextrade Group survey “Use of Digital Services in Japanese Companies” referenced in this report included 600 Japanese firms and was fielded from July 5, 2024, to October 5, 2024, using the online survey platform Pollfish. In sum, 27 percent of the surveyed firms were microenterprises with between 1 and 10 employees, 11 percent were small enterprises with between 11 and 50 employees, 24 percent were medium enterprises with between 51 and 500 employees, and 28 percent were large firms. The survey covered both manufacturing and digitally deliverable services sectors, with the latter including business, legal, and financial services; gaming and animation services; and various information technology services. The use of an online survey allowed for a broader scope and faster data collection compared to traditional survey methods, which require creating a sample frame of firms in a country and then randomly selecting them and conducting computer-assisted telephone interviews (CATI) or face-to-face meetings. Firms responded to the survey directly from their devices, which facilitated the survey process. The survey was fielded as a random sample to firms in digital services and manufacturing industries so as to attain a representative sample. Quality control practices included respondent verification, trap questions designed to identify distracted participants, and the use of manually vetted publishers to send unique IDs as an added layer of protection.