Japan-US trade friction

The sixty years that have passed since the ending of the Second World War have been a period of extremely rapid economic growth. On average, world output has grown at a faster rate than in any other period of history. A major cause of the growth in output has been the rapid growth of world trade. Throughout this period, world trade consistently grew faster than world output. This, in turn, was the result of a major increase in the degree of international specialization between countries. Hence, the fact that trade has been growing faster than output implies an increase in the degree of specialization.

Although this has taken place in all sectors, the trend has been most pronounced for manufacturing. The much faster expansion of trade relative to output has also meant that those countries that have shared in the process, have become increasingly interdependent. The proportion of output that is traded has increased in most regions of the world. This means that ‘shocks’ in one part of the world economy are much more quickly transmitted to other parts. At the same time, the growth of world trade has brought important changes in the structure or composition of world trade.

Economic growth in the developed countries has been largely export-led. The economic growth on international trade has excited increasing interest since the war, in connection with discussions of 'dollar shortage' and the development of 'underdeveloped countries'. This work examines, as a background to such discussions, the theoretical effects of international trade for economic expansion. The work begins with an analysis of trends in international trade. This is followed by a close look at the growth of world trade and the economic development.

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For simplicity, the discussion is presented in terms of two countries, the US and Japan. That the two countries are similar in economic strength, yet different in institutions and policies, raises two important questions. The first is whether government actually matters in promoting long-term economic growth in an advanced industrialized society. If Japan and the United States differ in their institutions, culture, and public policies, yet for several decades do battle as the world's two most important economic forces, perhaps their differences do not matter very much in their overall economic performance.

The second question is why policy differences emerge, and whether either country's policies are likely to change substantially in the next decade or two. The period since the Second World War has been a period of unprecedented global expansion. The developed market economies have experienced faster and generally more stable economic growth than any other period in history for which records exist. The exceptions to this were the two global recessions, which followed the oil crises of 1973-74 and 1979-80. To varying degrees, the developing world shared in this growth.

Most successful were the newly industrializing countries of East and South East Asia. At the other extreme, per capita GDP grew more slowly in the poorest, least developed countries, particularly in the African continent and West Asia. Globalization has brought about important changes in the composition of trade. In terms of commodities, the major shift has been from primary to manufactured goods. Geographically, the most important change has been the increase in the share of international trade accounted for by the developing countries and the decline in the share accounted for by the advanced industrialized countries.

Among the developed market economies, however, a major development has been the emergence of Japan as a major trading nation. In the developing world, the biggest increases in export share belonged to the newly industrializing economies of South and East Asia. These trends were particularly apparent if attention is focused on trade in manufactured goods. There is much debate about the costs and benefits that increased globalization has brought to the world. On the one hand, by making possible a more efficient use of resources, trade increases global economic welfare and makes it possible for countries to enjoy a higher standard of living.

On the other hand, globalization makes countries more interdependent. Not only are they more affected by developments in other countries or regions, they may well enjoy less power to determine their own economic policies. However, globalization is now a reality. There is unlikely to be any return to the more sheltered existence of previous eras. The important question for countries is how they can reap the maximum benefits from globalization, while retaining some control over their own destiny.

Japan’s successors—the group of so-called ‘newly industrializing’ countries (NICs) or economies (NIEs) have followed in the wake of Japan. NICs or NIEs are countries that have been successful, in a way that other developing countries have not, in breaking through into rapid economic growth. Like Japan, their growth performance has been closely related to their success in exporting manufactures to the rest of the world. Such countries have experienced not only a big increase in their per capita income, but also a radical transformation of their economy.

In particular, the importance of agriculture within the economy has declined and that of manufacturing industry increased. An important feature of the industrialization process of all these countries has been the adoption of outward-looking, export-oriented trade policies. However, despite these similarities, all are very different in other respects. Some have placed reliance upon state regulation and direction of the economy, while others have attached greater importance to market forces. They also differ greatly in their political systems, culture and religion.

Their growth has had a profound effect on the world economy. In particular, these countries have provided a potent source of new, import competition for the advanced industrialized countries in certain important sectors of manufacturing. More recently, the NICs have begun to broaden the range of industries in which they specialize and to move up-market into more skill-intensive, higher value-added products. However, this has not always lessened the problems posed for the western industrialized countries by the rise of these economies.

It has simply meant that the competitive challenge is now being experienced over a broader range of sectors. The part played by internal economic policies has clearly been an important factor, although economists are not agreed on whether export expansion was the main cause of their fast economic growth. A favorable external environment may also have been an important factor contributing to their success. The main effect of increased import competition from the NICs has been on employment in the western industrialized countries.

However, it is argued that this is due largely to the difficulties experienced by the western industrialized economies in transferring resources from declining to expanding sectors. Much of the FDI which occurred in the world took the form of one-way FDI, mainly by U. S. MNCs in Western Europe. Such FDI could be adequately explained by the wish of U. S. MNCs to more effectively exploit the technological and marketing advantages that they enjoyed in a number of branches of manufacturing.

Although they could have done so through exporting, the need arose as many of their products reached maturity to seek out ways of servicing foreign markets at lower cost. The establishment of one or more subsidiaries abroad enabled them to cut transport costs, circumvent tariffs and non-tariff barriers and take advantage of lower production costs abroad. However, such one-way FDI rapidly gave way to two-way FDI as firms in other advanced industrialized countries (Western Europe and Japan) developed new ownership-specific advantages in particular branches of manufacturing, which they, too, sought to exploit by producing abroad.

An interesting observation is that much of this two-way FDI takes place in the same branch of manufacturing. In other words, it constitutes what may be called intra-industry FDI. There can be no doubt that export expansion was a major factor generating rapid economic growth. Japanese exports consistently rose faster than the exports of other developed market economies. However, although fast export growth was an important contributory cause of Japan’s post-war success, some observers have questioned whether Japan’s growth could be defined as export-led .

If the contribution of the overseas sector to Japan’s growth is compared with that of the domestic sector, it is apparent, that private domestic demand (private consumption and fixed investment) played the more important role. Export growth was an important contributory factor in Japan’s post-war expansion. First, export growth helped pay for imports and, for the deficit on invisibles. Without rapid export growth, domestic economic growth would have been constrained. With exports expanding fast, domestic demand could be allowed to increase before balance of payments difficulties compelled the authorities to curtail expansion.

Second, the rapid growth of exports had a stimulatory effect on the rest of the economy, especially the manufacturing sector. It created a climate conducive to high levels of capital investment and enabled Japanese firms to reduce costs by exploiting both the static and dynamic economies of large-scale production. The United States is Japan's largest export market for consumer goods; Japan, in turn, has become the largest foreign consumer of the American debt. Such developments are pulling these two countries' economies into increasing interdependence, yet injecting serious political tensions into their relations.

Dissatisfaction is no longer limited to local producer groups - such as Flint, Michigan, auto workers or Japanese rice farmers - that are threatened by the other country's participation in their domestic market. Rather, in both countries their bilateral relations are quickly becoming a thorny political issue. Japan's high savings rate combined with financial market liberalization provided the impetus to its purchases of foreign assets. The most striking feature was the surge in cross-border portfolio investment flows.

Average annual portfolio investment inflow to Japan of US$ 1 billion in 1970-82 changed to an average annual outflow of US$ 52 billion in 1983-88. Meanwhile, average portfolio capital inflow to the United States increased from US$ 0. 1 billion in 1970-82 to US$ 40 billion in 1983-88. Japan's net asset position in the United States increased from US$ 2 billion in 1980 to US$ 129 billion in 1988. By the end of the 1980s, the US accounted for nearly half of Japan's net foreign assets as Japan had become the largest foreign holder of US federal debt securities and the second largest investor in US businesses and real estate.

Financial interdependence added a new dimension to bilateral economic friction. The degree to which Japanese firms began acquiring American companies heightened concerns about foreign investment in the United States. The rise in Japanese holdings of federal securities also raised fears that Japanese investors could spark a US financial crisis by withdrawing their funds. Even the long-standing security pact between the two countries, firmly footed on mutual advantage, has become controversial.

During the postwar occupation period, the United States required Japan to dismantle its military and agreed to provide in return for that country's defense needs. In addition to preventing the unacceptable remilitarization of its recent enemy, this arrangement gave the U. S. Seventh Fleet strategically important naval bases and legitimated the American presence in Asia. In return, Japan partially subsidized the costs of these military installations and became one of the United States' staunchest allies in international affairs. Today each of these features is the subject of negotiations between the two countries.

The United States is pressing Japan to shoulder a greater share of security costs, while Japan is insisting on greater participation in the development and manufacture of the weapons systems deployed in its defense. And both recognize that Japan should assume a posture in world affairs commensurate with its economic strength. With these and other important issues on the negotiating table at the same time, each country has undertaken a fundamental reassessment of its relationship with the other. They are engaged in this exercise at a moment when their interests are more tightly, yet more problematically, intertwined than ever before.

Each country's most pressing need for information about how the other conducts its business and government is in the area of trade. The United States is pushing for a dramatic liberalization of Japanese trade practices on many fronts - including finished lumber imports, access to the equities markets, participation of American professional services, and opportunities to bid on construction contracts - while Japan is trying to preserve current arrangements and insisting that the United States tackle its budget deficit.

Thus these two countries find themselves locked in a fitful search for some new, as yet uncertain, equilibrium in their relations. Given their differing stances on current arrangements, arriving at agreements for change has understandably been arduous. Because trade balances, currency rates, and macroeconomic indexes have dominated current discussions, it is easy to forget that the relationship between Japan and the United States is founded essentially on each side's domestic political imperatives. Clearly, the ground beneath US-Japan relations has shifted dramatically since the early 1990s.

Not so long ago many Americans contemplated with anxiety and some resentment Japan's inexorable rise towards economic supremacy. Nowhere is this transformation more apparent than in US trade policy. American complaints about access to the Japanese market generated a permanent air of crisis in US-Japan relations for almost two decades. Especially contentious was America's embrace of a 'results-oriented' Japan policy - demanding quantitative indicators of market access gains in bilateral agreements. This policy was a striking departure from America's commitment to multi-lateral, 'process-oriented' trade negotiations.

After the Second World War, the United States was instrumental in establishing a multilateral trading system under the General Agreement on Tariffs and Trade (GATT); albeit with qualifications and exceptions. But in time the view that Japan was 'different' from other trading partners - requiring a unique policy approach - would become conventional wisdom in American trade policy circles. Former United States Trade Representative (USTR) Charlene Barshefsky put it succinctly at a forum marking the fiftieth anniversary of the GATT in 1998.

While praising the achievements of the multi-lateral system, she singled out for criticism countries that had changed the letter of laws reducing trade barriers through successive rounds of the GATT, but did not meet the spirit of their goals. Markets remain largely closed, opaque and driven more by informal cliques than by laws, rules and contracts. Japan is a classic case in point. Needless to say, not everyone sees America's 'Japan problem' the same way. Some analysts identified aggressive attempts by the United States to prize open the Japanese market as the main threat to the international trading system.

International relations scholar John Ruggie has identified America's results-oriented Japan policy as the most serious historical deviation from the 'embedded liberalism' of the multilateral system - a violation of 'both the spirit and letter of post-war norms'. Japan's technological advance came to represent a particular problem for US trade policy in the first half of the 1980s. Through the 1970s the overall US trade position in manufactures remained roughly in balance with an increasing surplus in high-technology products canceling out a growing deficit in low-technology products.

With the internationalization of American manufacturing, trade became more important to America's domestic and international politics. The erosion of the United States comparative advantage in low- and medium-technology industries, an adjustment problem made more acute by the post-1973 slowdown in demand and productivity growth, increased demands for new and more restrictive trade measures. The rapid advance of Japanese manufacturing export capacity challenged the ascendancy of American firms across a range of higher technology products.

With a broader range of American commercial interests pursuing direct trade remedies against Japanese imports, Japanese market access negotiations not surprisingly became a more important part of the export politics of the executive branch. Increased Japanese FDI in the United States was a particular focal point for attention. While the sharp appreciation of the yen after 1985 was a key factor behind increased Japanese FDI, the political spotlight centered on the extent to which Japan was an outlier both in terms of the penetration of its economy by foreign firms and the behavior of Japanese-based firms in the United States.

Japanese firms were criticized for destroying jobs and worsening the trade deficit, eroding America's technology base, and potentially compromising national security. Especially prominent were claims that Japanese firms had a higher propensity to import rather than source in the US domestic market. That Japan is a long way from challenging America's pre-eminent position in the world economy points to a more-or-less sanguine outlook for future bilateral relations. Trends associated with the international integration of the two economies tend also to reinforce this conclusion.

Close observers of American trade politics have highlighted the overall weakness of traditional protectionism since the mid-1990s despite record trade deficits. Of course there are exceptions, the most notable being the steel industry's success in gaining import relief. Still, the ongoing internationalization of the US economy has proceeded without the sort of fractious sectoral trade politics that characterized the economic imbalances and macroeconomic cycles of the 1980s.

It would appear that increased cross-ownership and corporate tie-ins involving US and Japanese firms (from semiconductors to financial services) have played a role in reducing market access friction. The preceding analysis provides some reasons governments might want to treat industries differently. Industries are likely to differ in the extent to which growth rates fall short of the economic optimum and in the extent to which they pose conflicts between economic efficiency and other public policy objectives.

Likewise, the applicability of these rationales is likely to differ among countries. Nations may not share the same policy objectives. For example, Japan and the United States have very different national security policies. Consequently, in Japan strategic industries are more likely to be selected on the basis of economic criteria, such as potential for growth in the world market, or domestic political considerations. The United States is more prone to adopt structural policies that favor industries with strong links to international security.

A consequence of its greater concern for noneconomic international objectives is that, in order to pursue them effectively, the United States must expect to sacrifice some economic growth in comparison with Japan. In this work, we saw that one of the reasons for the growth of international trade over the past half century has been the reduction in the level of trade barriers. This made it possible for international trade to grow at a faster rate than world output. This, in turn, has resulted in an increase in the degree of interdependence existing between countries.

Although increased economic interdependence makes it more difficult for countries to pursue an independent economic policy, it does make countries more prosperous. This is because countries tend to specialize more either in particular industries in which they enjoy a cost advantage or in particular products within those industries. The former constitutes inter-industry specialization and the latter intra-industry specialization. Both forms of specialization bring welfare gains to countries. However, the nature of the gain differs according to the type of specialization.

Postwar economic history has many success stories, but none more dramatic than the chronicle of the two countries that outdistance all others in economic strength: Japan and the United States. Today, Japan had become a global economic power, the world's second largest market economy, and the major challenger to American industrial and technological supremacy. Japan's remarkable economic recovery from wartime devastation was both a vindication of American foreign policy and the source of significant adjustment pressure on American manufacturing industry.

With the United States increasingly dependent on international trade and financial flows, Japan would emerge as the major challenger to American economic supremacy. In the economy, Japan's challenge was first apparent via pressure on basic US manufacturing industries, and later manifest in the area of high technology.

Bibliography

Argy, V. The Japanese economy, London: Macmillan, 1996. Asher, David. A US-Japan alliance for the next century. Orbis, 41(3): 1997: 343-74. Baker, J. C. International Finance: Management, Markets, and Institutions. Upper Saddle River, NJ: Prentice-Hall, 1998.

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