US-Japan Trade: The Broader Context

by Ellen L. Frost, Peterson Institute for International Economics

Testimony before the Subcommittee on Trade Committee on Ways and Means
United States House of Representatives
Washington, DC
March 28, 1996


Mr. Chairman, and members of the Subcommittee, my name is Ellen Frost. Roughly half of my 24-year career in Washington has been spent in the private sector, and half in the U.S. Government. Until last June I served as Counselor to U.S. Trade Representative Mickey Kantor, a non-legal position roughly analogous to Director of Policy Planning. I am currently a Senior Fellow at the Institute for International Economics, headed by C. Fred Bergsten. The Institute is a private, non-profit, non-partisan research institution devoted to the study of international economic policy.

I will not attempt to evaluate the specific conflicts that dominate much of today's hearing. Instead, I will try to sketch the broader context of these disputes. My "bottom line" is that changes in the pattern of global business dictate a shift in priorities vis-a-vis Japan, and that new regional and global institutions give us an opportunity to pursue those priorities more effectively. These are the areas the Subcommittee should focus on, not bilateral statistics or overheated rhetoric.


I. Changes in the Pattern of Global Business

A. The Importance of Investment, Services, and Intellectual Property Protection

Changes in the way companies do business around the world have specific implications for U.S. trade policy toward Japan.

The twin revolution in information and transportation enable companies to engage in flexible manufacturing and customized production for local markets. Mass production in a single location is disappearing. In globally traded sectors, companies are dispersing different phases of the industrial life cycle among different countries: research and development, production of components, system integration, final assembly, marketing, and after-market sales and service. Dispersing these various phases means moving a company's knowledge around the world.

Taken together, these changes have at least three major implications for U.S. trade policy. First, trade has become inseparable from investment. More than 40% of U.S. exports go to U.S. subsidiaries abroad. Second, merchandise trade has become inseparable from trade in services. U.S. service exports are now equivalent to about 40% of merchandise exports, and they are catching up rapidly. World trade in services are expanding at roughly 12% a year, leading some observers to believe that trade in services will exceed trade in goods within a decade or so. Third, the diffusion of knowledge requires adequate protection of intellectual property.

These trends suggest that the main focus of U.S. trade policy vis-a-vis Japan should be on investment, services, and the protection of intellectual property. Product-specific disputes should be pursued as usual, but they should not be blown out of proportion.

In the area of investment in particular, Japan is an "outlier." In the United States, foreign direct investment is equivalent to over 7% of GNP, but in Japan that figure is less than half of one percent. In 1994 U.S. investment in Japan amounted to only $37 billion, while Japanese investment in the United States was $103 billion. By contrast, U.S. investment in Europe exceeded $300 billion, as did European investment in the United States. This gap reflects a number of obstacles: structural barriers associated with the corporate groupings known as keiretsu, the exorbitant price of land, and excessive regulation, to name a few. The current economic recession in Japan only makes things worse.

All three of these priorities — investment, services, and intellectual property — are the subject of multilateral agreements negotiated during the Uruguay Round. Along with Europe, Japan and the United States share a common interest in strengthening these agreements. Scheduled reviews of Uruguay Round agreements and the December ministerial meeting in Singapore should provide opportunities for closer U.S.-Japan collaboration.

B. Deregulation and Competition Policy: The Twin Essentials

As companies become active in more and more countries, it becomes increasingly important to improve the way they are treated in domestic markets. It does little good to achieve free trade at the border if domestic barriers effectively block new entrants to the market.

This is why the scope of trade rules has expanded over time from border-based measures such as tariffs and quotas to a variety of measures hitherto considered "domestic." Examples encompassed in the Uruguay Round include government procurement, subsidies, and protection of intellectual property. Since the United States is already a relatively open economy, with few domestic barriers to new business, we stand to gain considerably from this trend.

One key area is not covered by Uruguay Round agreements, however, and that is competition policy. In 1948, the Havana Charter explicitly recognized that anti-competitive behavior could act as a barrier to market access. But the Charter never came into effect, nor was it revived during the Uruguay Round negotiations. Many U.S.-Japan trade disputes stem from anti-competitive behavior in Japan, not because Japan lacks adequate laws, but because they are not enforced. In the absence of WTO rules, the United States has no choice but to use bilateral or even unilateral measures.

Along with competition policy comes deregulation. The Japanese government recognizes the need and has firmly committed itself to deregulation. But like Mark Twain's effort to give up smoking, officials have done it hundreds of times, with only limited results. Bureaucratic caution and vested interests impede the process. More than most other societies, the Japanese tend to hold the government responsible for safety and order in ways that would not occur to the average American.

Competition policy and deregulation are the keys to a more open Japanese market, and they go together. Deregulating an industry will not open up opportunities for new entrants to the market unless an effective competition policy is in place.

C. The Sea-Change in Developing Countries

To put U.S.-Japan trade disputes in perspective, the biggest single change in the global environment since the declining years of the Cold War is the sea-change in policy in developing countries, especially those in Latin America and the Asia-Pacific region. As a result of a shift toward market-oriented policies, many developing countries are exhibiting rates of growth that are two or even three times higher than growth rates in developed countries. This sea-change has consequences for both the United States and Japan.

A major consequence for the United States is that the growth that is now taking place in developing countries has sparked an enormous demand for goods and services that Americans excel at producing. First, the population of these countries includes a very high proportion of young people hungry for products of the American lifestyle, from blue jeans to American movies. In this huge and lucrative market, American exporters face virtually no competition from Japan. Second, there is a growing demand for the goods and services associated with productivity — the same goods and services that have given rise to the revolution in American manufacturing. Third, there is a pressing need to modernize the infrastructure of these countries, from ports and roads to modern telecommunications and environmental products and services. Again, Americans are world-class competitors in these areas.

A major consequence for Japan is that the Japanese market needs to more open to manufactured exports from developing countries in order to sustain their growth. As the world's second biggest national economy, Japan has a responsibility to help promote global growth. By any measure, however, Japan accepts a far lower proportion of manufactured exports from developing countries than other industrialized countries. There are definite signs of improvement, much of which stems from Japanese investment abroad, but progress is hampered by the sluggish rate of growth in Japan. The best contributions that Japan could make to developing countries would be to further open its markets to non-Japanese affiliated companies and to grow faster.


II. Changes in the Institutional Environment

A. The Role of APEC

The new factor in U.S.-Japan trade relations is the Asia-Pacific Economic Cooperation forum (APEC), whose eighteen members account for about half of the world's output. At the 1994 APEC summit, APEC leaders made a political commitment to achieve "free and open trade and investment" in the region by 2010 for industrialized countries (which account for about 85% of APEC's trade) and 2020 for the rest. APEC's Osaka Action Agenda, announced last November, reaffirmed this commitment and declared that APEC economies "will take the lead" in strengthening the open multilateral trading system, possibly including initiatives for the first WTO Ministerial Meeting in Singapore.

Several features of APEC have bearing on U.S.-Japan trade tensions. First, APEC offers an institutional mechanism in which many nations, not just the United States, can work to open Japanese markets. At Osaka, APEC leaders beat back challenges to scale back the comprehensiveness of their commitment to free trade and investment, notably from Japan and South Korea on agriculture. Second, APEC's goal is to identify and remove all barriers to free trade and investment, including competition policy. Since many U.S.-Japan trade disputes arise from anti-competitive behavior, and since competition policy is not yet encompassed by WTO rules, APEC can make a real contribution here. Third, APEC can help to de-politicize U.S.-Japan trade disputes by offering regional mediation services and allowing a bigger role for business.

APEC has other positive effects as well. As nations scramble to compete for investment, APEC stimulates what C. Fred Bergsten calls "competitive liberalization" and thus reduces the chances of mercantilism and protectionism. Moreover, APEC offers opportunities for leverage. For example, U.S. interest in APEC and Latin America arguably helped to bring about a conclusion to the Uruguay Round by sending a signal to European leaders that the United States had alternatives.

Finally, APEC has geopolitical significance. In the words of trade expert Geza Feketekuty, Director of the Center for Trade and Commercial Policy in Monterey, regional free trade agreements have become "the principal focus for organizing relations among states." APEC offers both Japan and the United States a chance to become more firmly embedded in the emerging Asia-Pacific community and thus to enhance the stability of the region. It is probably healthy for both countries to stop loading so much onto the bilateral relationship alone.

B. WTO Dispute Settlement Procedures

Another change in the institutional environment is the enormous improvement in dispute settlement procedures in the World Trade Organization. With the active encouragement of the Congress, U.S. negotiators fought for and won strong and disciplined language on dispute settlement in the Uruguay Round. This was an important victory. Because its interests are global, the United States historically brings more complaints against other countries than they do against the United States. The new procedures will prevent Japan from stonewalling a U.S. complaint.

As my colleague Jeffrey J. Schott testified before this Subcommittee on March 13, the new WTO dispute settlement mechanism has handled about 30 requests for consultations. The United States has directly challenged foreign practices in eight cases and has joined plaintiffs in other disputes as an interested third party. Three cases have been brought concerning U.S. practices.

Some Japanese have recently claimed that the existence of these new procedures means that the United States and Japan have outgrown the era of bilateral trade negotiations. Such statements reflect misunderstanding of the way dispute settlement works. The WTO process encourages bilateral resolution of disputes and provides a positive framework within which bilateral discussions can be pursued.


III. Substance and Style in US-Japan Trade Relations

A. "Damned Lies and Statistics"

Whenever the Commerce Department releases U.S. trade statistics, both the Japanese government and the U.S. Executive Branch scramble to prove that the bilateral imbalance is improving. Much of this showmanship is aimed at the Congress.

The truth is that bilateral trade statistics are being blown way out of proportion. In terms of changes in global business patterns, they are becoming irrelevant. They disguise rather than illuminate the trends in global competition that I have just described. In purely economic terms, they have always been irrelevant. What counts is a country's global current account position, which includes returns on investment. From this perspective, the news is good: Japan current account surplus has fallen from 3.2% of GDP in 1992 to 2.2% in the third quarter of l995.

Another weakness of bilateral trade statistics is that they often omit trade in services. Last year, the U.S. ran a surplus in services that offset more than a third of our deficit in goods.

Emphasizing bilateral trade balances reinforces the wrong-headed idea that trade policy determines the size of the trade balance, which is not the case. Trade policy has a lot to do with the distribution of trade and the composition of jobs, but trade balances are primarily determined by macroeconomic policy, and specifically by the size of the gap between what a country saves and what it spends. Growth rates and exchange rates also play a part. As long as we spend more than we save, we are going to have a trade deficit with someone. As long as Japan is experiencing such flat growth, the demand for imports will remain sluggish. It is precisely because our economy is so healthy that our appetite for imports is so vigorous. Members of the Subcommittee should not be misled by the "spin" placed on bilateral trade statistics.

B. Style Matters

The Japanese word ijime means bullying or hectoring. Ijime among schoolchildren is something of a national problem in Japan. When Americans appear to be resorting to it in the context of trade, reactions can be swift and negative. The result strengthens the hand of precisely those groups least willing to accommodate U.S. interests. It certainly helped Mr. Hashimoto to become prime minster.

I believe that an unduly aggressive and self-righteous public posture vis-a-vis Japanese trading practices helps to explain why, in the context of last year's auto parts dispute, Japan won the public relations contest on "managed trade." It is staggering to think that Japan and the European Union accused Washington of "managed trade" when they have been managing trade between them for years. The goal of U.S. trade policy is to expand trade, not to limit it. The use of quantitative indicators is one way of measuring what the market would have achieved if the market were free to operate. Yet the United States took a drubbing in the court of world opinion.

Why does it matter? Well you might ask. We are not in a popularity context, and foreigners don't vote. But it does matter, for a very simple reason. When a country's newspapers are full of emotional articles accusing the United States of bullying and urging politicians not to back down, a trade minister who comes to Washington to negotiate is not going to have as much flexibility as he or she would have otherwise. We will do better in Japan if we stop grandstanding, respect the courtesies, and adopt the style of patient endurance that the Japanese admire.

Thank you for this opportunity to present my views.

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