Why Pressure Tokyo?

Roger C Altman. Foreign Affairs. Volume 73, Issue 3, May/June 1994.

The strained relations between Japan and the United States cannot be explained by spurious charges that the Clinton administration is pushing managed trade, capitalizing on anti-Japanese sentiment to score domestic political points or needlessly bashing Japan over economically meaningless international surpluses. Rather, the tensions arise from two fundamental and related developments: changed American priorities and the pronounced drag of Japan’s huge current account surplus on global demand, economic expansion and job creation.

The Clinton administration’s drive to spur global economic growth and strengthen U.S. economic potential requires a new deal with Japan. For itself and all other nations, the United States is seeking to converge Japan’s international accounts with the rest of the industrialized world and to open Japan’s markets.

No More Free Ride

The search for such convergence marks a transition in U.S.-Japan relations–the fourth such transition since World War II. First came the reconstruction period, running through the early 1950s, in which the United States consciously helped rebuild Japan’s industrial capacity in order to make democracy permanent. The United States tolerated Japan’s protection of home markets, its resurrection of certain prewar practices and the resulting keiretsu structure of industrial cross-share holdings, in which companies cooperate informally.

The second phase began with the 1952 Mutual Security Assistance Pact, which ended U.S. occupation of Japan. The pact extended the U.S. nuclear umbrella over Japan and made Japan the Asian cornerstone of the Cold War containment strategy. Japan became vital to the defense of Pacific sea-lanes and host to the largest U.S. military base in the region. Although economic issues were steadily emerging, they remained secondary to security interests.

Japan’s growing economic prowess ushered in the third phase, which lasted from the early 1970s until the end of the Cold War. During that period economic policy differences and trade frictions continually rose even while the security issue remained paramount. Japanese firms, assisted by Tokyo’s administrative guidance and targeted industrial policies, became world-class producers and successful competitors for export markets. Aided by massive domestic savings and an undervalued yen, Japan ran growing trade and current account surpluses with the rest of the world, especially the United States. U.S. pressure on Japan to open its home market produced a pattern whereby the Japanese government engaged in protracted trade negotiations while opening its economy as little as possible. When agreements were finally reached, they were often vaguely worded and subject to conflicting interpretations.

Beginning in 1983, the U.S.-Japan relationship was jolted into its fourth phase by newly elected President Clinton, whose sense of post-Cold War priorities put economic matters first. Assessing the relationship, his administration found the security component to be solid and cooperation on global development and environmental issues to be in working order. But the economic dimension was badly in need of repair and required a new perspective on Japan. A diminished need for a bulwark against Soviet expansionism accompanied a rise of other viable economic partners in the Asia-Pacific region. Within the United States, public attention sharply shifted toward unmet domestic needs. The electorate wanted a leader whose primary focus was jobs and economic growth at home. And in trade competition, the public, business and Congress clamored for tough action to level the playing fields, particularly with Japan.

Measurable Results

The Clinton administration conceived its policy on three broad premises. The first premise was that ending stagnation at home required key initiatives, of which the first was congressional passage of the president’s $500 billion deficit reduction plan. The second premise was that Japan’s trade surplus of $130 billion ($50 billion with the United States) was too large to be sustained. Weak stimulus packages were inadequately addressing this surplus, despite Japan’s structural budget surplus. The third premise was that continued recalcitrance explained why Japan’s imports of manufactured goods represented only 3.1 percent of Japan’s GNP compared to an average of 7.4 percent for other Group of Seven countries. Further out of line, Japan’s incoming foreign direct investment stood at 0.7 percent of GDP versus 28.6 percent for the United States and 38.5 percent for Europe.

Japan’s import and investment penetration problem reflects a series of longstanding visible and invisible trade barriers that have proved impervious to sectoral negotiations, structural impediment initiatives and investment access agreements. Thus a fresh U.S. approach was needed. The new relationship required a framework encompassing both macroeconomic and trade policy. Stronger domestic demand-led growth in Japan would help facilitate import penetration. The trade component would focus on removing structural and sectoral barriers to raise the quantity of imports the Japanese will buy when their incomes increase and thereby reduce the current account imbalance After tough negotiating, the framework agreement of July 1993 committed both parties to four basic commitments, two on each side.

The Clinton administration committed to further deficit reduction efforts and policies to raise savings and improve competitiveness. The administration also pledged a continued openness of U.S. domestic markets provided that Japan holds up its end of the bargain.

For its part, Japan agreed to pursue policies that over the “medium term” would lead to a “highly significant” reduction in its global current account surpluses. The United States made clear that it interpreted “highly significant” to mean a fall in those surpluses from 3.5 percent of GDP to below 2 percent. Further, the United States defined the “medium term” to mean three to four years. Japan’s second commitment was to pursue structural and sectoral policies that would lead to a significant increase in imports from all countries (not just the United States) over the same period. The American interpretation of “significant” was a one-third increase. In fairness, however, the U.S. interpretation in both cases was unilateral. Japan fiercely resisted quantifying these areas in the agreement and acknowledges only that the United States has such interpretations.

Nevertheless, in a significant departure from past agreements, a provision called for qualitative or quantitative indicators” to measure progress. To the United States, this provision meant the two countries had finally agreed to a dialogue on measurable results. But the ink had barely dried on this provision before a fierce public relations campaign ensued against the use of such indicators. The Japanese claimed the agreement represented managed trade and that such a results-oriented approach is antithetical to liberalized trade. Indeed, they argued, the United States was demanding market-share targets in key sectors similar to those granted in the now-infamous 1986 semiconductor agreement.

The rhetorical campaign has been skillful, and many editorialists and economists have joined the criticism. To be fair, the Clinton administration has occasionally compounded the problem by sending ambiguous signals. But Japan’s rhetorical campaign does not withstand close scrutiny. The Japanese government that berates the United States on charges of managed trade has long been in the business of targeting market outcomes itself. Furthermore the same government agencies that make these pronouncements have tolerated a remarkable degree of collusion among private Japanese companies at the expense of foreign firms.

The reality is that the agreement does not mandate market-share targets, and the United States is not seeking targets. The issues are goals and measurability. In any particular sector, the U.S. aim is to negotiate a series of long-term goals and objective standards against which progress can be judged. The overall goal should be convergence toward international standards of market openness. Moreover, any particular sector can have several measurements. In the auto sector, for example, measurements might include increases in Japanese dealerships that sell both foreign and Japanese cars and domestic content levels in Japanese cars produced in the United States. The framework would measure progress against a series of these indicators of which no one measure would dominate.

The goal of market openness cannot be seriously disputed. It can be achieved almost entirely by deregulation, and that had been a central theme of Japanese Prime Minister Morihiro Hosokawa. And measurable results have no good argument to oppose them. If fair measures are chosen, the entire world can judge whether progress has occurred or not. Nor is the framework an attempt to reconstruct Japan in the U.S. image. The U.S. emphasis on results is precisely designed to shift the debate away from changing the nature of the Japanese economic system.

This new approach is not a bilateral deal for the United States and Japan. The U.S. goal is to open Japanese markets for the benefit of producers from all countries; reducing trade barriers is sought solely on a most-favored-nation basis. The new framework is not only consistent with the principles of the General Agreement on Tariffs and Trade, but, insofar as Japan’s closed markets and unbalanced trade represent a major threat to the soundness of the multilateral trading system, the framework is essential to the viability of the GATT system.

The framework is also essential to maintaining support for further market-opening agreements around the world. For example, congressional support for the North American Free Trade Agreement or GATT cannot be obtained if Japan’s import penetration problem is simply accepted. Those who say that the growth and job gains from opening Japanese markets are trivial and that the whole effort is misguided show no appreciation for this reality. In Washington, it is a matter of fairness.

The framework’s objectives are consistent with the basic aspirations of people everywhere: lower prices, greater consumer choice and higher living standards, a reduction in international tensions and an improvement in their nation’s standing. These principles have particular resonance today, given the new Japanese government’s emphasis on improving the lot of the Japanese consumer.

It’s Japan’s Move

Unfortunately, the two sides were unable to meet the framework’s first six-month deadline for sub-agreements in the procurement, automotive and insurance sectors. Moreover, the macroeconomic developments were also disappointing. Tokyo announced a six trillion yen tax cut, ostensibly to boost domestic demand and work down the current account surplus. But the cut took the form of a rebate, with no assurance of lasting after one year. Such one-time tax cuts usually induce savings rather than spending and do not provide meaningful stimulus. Indeed, most analysts estimated that the tax cut would add only 0.7 percent to growth in 1984 and would cut the current account surplus by only $2 billion. The United States registered its disappointment with the tax package.

President Clinton and Prime Minister Hosokawa acknowledged these failures during their remarkably candid summit on February 11. The president noted a particular disagreement over the issue of targets. He reaffirmed that the United States was not seeking guaranteed market outcomes, which is how most observers interpret the term “targets.” He noted, however, that Japan feared that any goals would ultimately be interpreted as mandatory targets. As a result, therefore, Tokyo was unwilling to accept a combination of goals and measurements. For its Washington was adamant. “No agreement was better than an empty agreement,” the president said.

Now the talks are suspended and both sides agree that the ball is in Japan’s court. Discussions will only recommence if Tokyo develops a new proposal that responds to the framework criteria. After a cooling-off period, there is no reason why such an initiative should not come forward.

In the interim, the United States is taking some unilateral steps. The first has been to reexamine existing trade disputes and seek negotiated solutions or apply sanctions. An obvious example of this step was the cellular phone case and the finding that Japan was in violation. Almost all neutral observers agreed that Motorola had been denied a fair market opportunity. That is why Japan moved and a good agreement ensued, as had happened a few months earlier in the construction case. The second step involved the reimposition by executive order of the Super 301 trade tool. This tool requires identifying, every six months, “priority practices in priority countries” that violate Section 301 of the U.S. trade law. No such countries or practices will be designated before September 30. The administration carefully chose a flexible version of this tool, not the heavy-handed approach favored by some in Congress.

Other steps will be taken in a calm, deliberate manner. This is not a trade war, nor will it spin out of control. The United States will move only where the substance of a dispute is clear. Ultimately, the U.S. Japan relationship will surmount this period of friction. These are the two largest economies in the world and they are highly interdependent. The security relationship remains strong and important, and the two nations share a vital agenda on global political cooperation.

The time has come for Japan to move toward global convergence in terms of its international accounts and the openness of its markets. On these points, industrialized nations concur even if some disagree with the particulars of the American approach. What issues and challenges will dominate the next century are unclear, but two things are certain: economics will be at the center of international affairs, and the U.S.-Japan partnership will play a key role in determining the course of global events. The Clinton administration is committed to charting a new course of relations with Japan that builds on these emerging realities.