D E C E M B E R 1 9 8 9
by James Fallows
LET us assume, as I argued previously in these pages ("Containing Japan," May, 1989), that Japan's businesses and its government will not restrain the one-sided expansion of Japanese exports, and that normal economic forces, including currency adjustments and consumer demand in Japan, will also fail to balance Japan's trade accounts. Let us assume further that these imbalances are bad for the international trading system and threaten certain national interests of the United States. What, if anything, can America do?
The most important step the United States can take is to stop haranguing and negotiating with Japan, and instead act politely but firmly to defend the industries and technologies that are important to us. Through the past generation the American government has nagged too much and done too little in its dealings with Japan. Because Japan's trade surplus stays so large while its consumers and workers continue to live such arduous lives, our representatives tell the Japanese that they should buy more, work less, demand lower prices, take longer vacations, and basically be modern consumer-minded citizens like us. The logical culmination of this process is the "structural impediments" negotiation, now under way in Tokyo, in which the United States is asking Japan to get rid of its cumbersome retail-trade system, its preference for sweetheart deals over open bidding, and other social and political factors that make life difficult for outsiders. When Japan fails to respond, we escalate the level of nagging and complain that Japan is "cheating," while we do very little to strengthen our economy or avoid the dangers that we believe Japan's expansion poses to us.
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The all-talk, no-action approach practically begs for Japan's contempt--and has
been getting it. This fall American politicians were huffily passing around
translated passages of a controversial book called The Japan That Can Say 'No',
which had been published in Japanese earlier in the year. The book. by a
prominent politician named Shintaro Ishihara and the famous Akio Morita, of
Sony, was full of braggadocio about the superiority of Japanese products and
Japanese ways, and was likely to irritate any reader who was not Japanese. But
it expressed an emotion that in Japan is hardly confined to hypernationalists:
the sense that America has been pushing Japan around for too long, and it's
time to push back.
We will serve ourselves and the Japanese best in the long run if we suspend this attempt to persuade Japan to change its internal system. Instead, we should decide on the measures that are most important for strengthening our economy and, without blaming or hectoring any other country, put them into effect. These measures fall into three categories, in this order of importance:
Reducing the domestic problems that handicap American business in general, changing the unrealistic attitudes that make it difficult to deal with Japan, and trying to moderate at least Japan's external behavior;
Devising special measures to encourage industries that have unusual problems competing with Japan, or whose survival is unusually important;
Abandoning the negotiating strategy that we have applied to Japan, along with the view of Japan's intentions on which it has been based. We can replace it with a policy that helps us more and aggravates the Japanese less, if we are willing to recognize the way that Japan's rise has changed the rules of international trade.
The first category is familiar and includes such "eat your spinach" items as reducing the federal budget deficit. The second is an evolutionary change from our current policy. The third would of course be a fundamental change. Remedies from these three categories are logically connected, and each approach will work best if we can pursue all of them at once. Maybe it will be impossible for us to make all these changes. My purpose for the moment is to suggest how we could improve our fortunes relative to Japan if we were determined to do so.
ACCORDING to most economic theory, a trade deficit is not in itself a problem for a country. It means that a country has the luxury of consuming more goods than its factories produce. and it is much less significant than other indicators of a nation's wealth. (North Korea has a proportionately smaller trade deficit than America, yet is worse off in every economic way.) But two aspects of a trade deficit can create problems for a country: how large the deficit is, and what kinds of products flowing into and out of the country create the deficit.
The size of America's trade deficit has already become a political problem for America. Maybe "strategic" is a better word, since the deficit does not affect day-by-day domestic politics so much as it slowly changes America's place in the world. Each week for the past few years the United States has been sending about $2.5 billion more to foreign owners to pay for imports than it has earned from exports. About $1 billion a week has gone to Japan. Along with the money, of course, has gone a claim on American assets or future American earnings. There is a strong if indirect connection between this shift of assets and a decline in America's ability to support and bankroll values we believe in. When President Bush went to Poland last summer to say that capitalism would produce more wealth than communism, he couldn't offer enough money from the American-style capitalist system to back up his declaration. He had to hope that Japan's capitalists would agree, and would support his commitment with their money.
Fortunately, the size of a country's trade deficit is largely determined by internal forces. If a government's macroeconomic policy supports more consumption than production, as ours has done zealously through the 1980s, the goods to be consumed have to come from overseas. This is why trade-deficit talks usually start with discussions of the federal budget deficit, which has been declining slowly but should go down more. Of all the ways to deal with this tedious problem, the simplest and most effective, as I argued last month in these pages, would be an increase in the gasoline tax, starting with twenty-five cents a gallon the first year and going up another twenty-five cents each year until it reaches a dollar. A dollar-per-gallon tax would bring in some $100 billion a year, would be the single quickest and most politically palatable way to reduce the deficit, and unlike most taxes would have generally useful side effects, such as encouraging conservation.
The American savings rate also affects the size of the trade deficit. The easiest way to increase savings would be to change tax incentives--for instance, to put a ceiling on the mortgage-interest payments that could be deducted from federal tax. Simultaneously, we could make the first $1,000 or $2,000 of annual interest earnings tax-free and bring back the individual retirement account, as Senator Lloyd Bentsen has suggested. Like the gasoline tax, these steps would be somewhat regressive, because the poorest people don't have any interest income to exempt from tax. Just about any measure to raise the savings rate will have this drawback, since the people with the most money have the most to save; it would be more sensible to find ways to offset the regressive effect than to decide not to encourage savings.
The other problems that spill over to affect American business are familiar, especially the troubled American school system and pressures on companies for shortsighted profit-taking. We'll no doubt be debating these broad "competitiveness" problems for years to come. Here are two specific suggestions:
To improve the schools, we should admit that we've outgrown the era when 15,000 local school boards could sensibly or fairly decide how students should be prepared to compete in the adult world. Nearly every other developed country sets nationwide standards for academic performance. We could set competence standards in subjects such as math and science, which students would have to meet before they could move on from the sixth, ninth, and twelfth grades. These would not be intelligence tests or weeding-out devices but rather something like driver's-license tests. We should also at least dream about reviving the Head Start program, to give more students a chance by the time they reach high school. While we're at it, we should follow the lead of much of the rest of the world and make at least three years of foreign-language study mandatory for high-school students.
To help change the business culture, we could alter the security and exchange laws so that corporations would have to file detailed profit-and-loss reports once a year, not every three months. No, this would not eliminate the bias toward short-term thinking, and yes, it would make it easier for shady corporations to hide their problems from unsuspecting investors. But such a change would diminish the notorious American obsession with quarterly profit rates and would send a signal about the direction in which we'd like our businesses to head. We could also change the laws governing fiduciary responsibility, so as to encourage pension-fund managers and others in charge of investing large pools of capital to stop insisting on short-term profits and concentrate instead on long-term gain. If it were possible Iegislatively to reduce the gap between managerial and blue-collar salary scales in American corporations, we should immediately do that, too.
BY starting with these domestic improvements, we can avoid working up unhealthy emotions about Japan. Japan is, undoubtedly, America's major trading problem. The U.S. trade deficit with Japan is about 40 percent of America's total trade deficit, and the Japanese surplus with the United States is more than half of Japan's total surplus. Japanese companies sell about as many cars and consumer electronics in America as they do in all other foreign markets combined. In September the prominent newspaper Asahi Shimbun published figures. based on a report by the Ministry of International Trade and Industry, indicating what a total cessation of U.S.-Japanese trade would mean for the two countries. Japan's economy would shrink by 5 percent--at least temporarily--MITI concluded, and America's by only 0.6 percent. (The difference between these figures indicates how much more of Japan's economy is based on sales to America than vice versa.)
The fundamental reason to correct the U.S.-.Japanese trade imbalance is so that the larger partnership between the two countries can survive. Americans are accustomed to the idea that they should separate their human feelings for the Russian, Chinese, and Cuban people from their objections to those countries' political systems. Even though our disagreements with the Japanese system are much milder, it is crucial to make the same distinction with Japan. One small but useful step in this direction would be to discourage use of the term "Japan-bashing," or its Japanese counterpart, "Nihon tataki," to describe criticism of Japan's trading policy. I don't know who came up with the term. but its obvious and perhaps intended effect is to make criticism of the Japanese system seem like a roundhouse punch against a culture and a people. The main damage it does is inside Japan, where it aggravates suspicion that the world will be against the people just because they're Japanese. It's not America-bashing when residents of Atsugi, outside Tokyo, complain that fighter planes from the nearby U.S. military base make too much noise. It's not Japan-bashing to point out the problems caused by chronic huge trade surpluses.
A more substantial step would be to look for ways to draw Japan into an international role as something more than an accumulator of surpluses. Changing policies within Japan is notoriously difficult, because of the domestic lobbies that lock up the political system. Japan's external behavior may be somewhat easier for outsiders to affect.
With so much money pouring into the country, Japan has the leeway to serve as the world's philanthropist for a while, if it chooses to. Therefore, part of our strategy should be to make Japan understand, and live up to, the responsibilities that the rest of the world assumes come with being the richest country on earth.
The nice way to put this point is to say that Japan has a lot to teach the world. Through its postwar example it has shown the rewards of pacifism, self-discipline, and making do with limited resources. To say the same thing slightly less politely, if Japan is not willing to open its markets fully to foreign products (the United States takes more than half of all manufactured exports that the Third World sells; Japan takes less than one tenth), or to open its doors to immigrants and refugees, then it should be made to feel tremendous expectations that it will use its money and skills in a benevolent way.
The main areas in which Japan should be made to feel that it is expected to take the lead are environmental protection, development aid, and debt relief. The countries that Japan views as its colleagues--the North American and Western European industrial democracies in the "Group of Seven"--should press Japan to do more and more on each of these fronts.
At the moment, Japan has a spotty record in these areas. It is notorious in Asia as the financier of clear-cut logging operations in the Malay peninsula and Borneo. There is little pressure from within the country to change practices that affect the environment outside Japan. Yet Japan has proved very sensitive to outside criticism on this subject; for instance, it recently banned most ivory imports, even though ivory had traditionally been used in the hanko, or personal-name seals, that almost all Japanese carry. If a future Japanese Prime Minister has panache, he will announce that Japan will henceforth dedicate one percent of its gross national product to finance international research on pollution control. Japan has not had to waste this money on the military, he could say, and thus Japan will use it to help defend all mankind.
Japan is the world's biggest donor of development aid, but three quarters of it goes to Asia rather than to more wretched economies in Africa and Latin America, and a very high share of it has been unofficially tied to purchases from Japanese firms. The rest of the world should press Japan to increase its aid total, to direct more aid to Africa and Latin America, to change most of it to grants, and not simply to "open" contracts to foreign bidders but to require that much of the money be used for purchases from the Third World, North America, and Europe. Similarly, Japan should feel continual pressure to come up with debt-relief plans.
FOR two generations Japan's economic policy has been based on picking out important industries and doing everything possible to help them grow. This is not unfair or predatory. It simply reflects a faith that the government can steer economic development in a direction different from the one that the invisible hand might grope toward. Accordingly, MITI has at various times tried to nurture Japan's textile, steel, machine-tool, computer. and aviation industries, in the belief that these, and the technologies they create, would be future sources of wealth and security for Japan. Japan's government and its consumers have generally accepted the sacrifices this government guidance imposes--mainly, the need to pay more for protected domestic products than they would pay for imported goods.
According to classical free-market theory, of course, such steering efforts shouldn't work. They would squander resources that the market itself could allocate more sensibly; they would probably lead the government down blind alleys, since the technological future cannot be foreseen. At best, they would waste society's money.
Even a casual glance at Japan's achievements raises some doubts about the classical view. Its successes have provoked a rich flowering of economic theory, in an attempt to explain how Japan (and other countries. mainly in Asia but including a few in Europe) has made this approach work. The explanation turns on the concept of "natural" advantage. In the old, pure version of Ricardian trade theory, countries were assumed to have inherent advantages in certain businesses--Costa Rica in growing bananas, France in making wine--and the workings of the market would steer demand to the world's most efficient suppliers. The recent theories, whose best-known proponent is Paul Krugman, of the Massachusetts Institute of Technology, suggest that countries can to a large degree create natural advantages for themselves, as Japan has in high-tech industries. According to this view, countries that try to promote higher-value, higher-tech industries will eventually have more of them than countries that don't.
The strength of high-tech industries takes us back to the second troublesome element of a trade deficit (the first being its absolute size). Malaysia usually enjoys a trade surplus with Japan, but since it is selling palm oil, rubber, petroleum, and some computer chips while importing cars, computers, and other capital goods, its long-term economic prospects are worse. It will have a harder time raising its wages and living standards, and developing new technologies. The natural tendency of Japan's trading system is to put most other nations in Malaysia's position, as sources of raw materials and markets for finished manufactured goods. To avoid being on the receiving end of this practice--that is, to have airplanes and satellites to sell in the future, not just tuna and logs--the United States could try to steer a few industries of its own. America will never be as good at or as enthusiastic about this kind of guidance as Japan is. So many fundamental characteristics of our society, from our racial diversity to our Naderesque suspicion of concentrated power to our ethic of "I gotta be me," work against coordinated economic strategy. Many fundamental characteristics of Japanese society, not least the funneling of talent into the government ministries that guide the economy, make coordination much easier for Japan.
Still, it is not entirely fanciful to think that the United States could improve the environment for high-value industries operating here. No doubt in twenty years there will be new industries that none of us can think of now, but some of today's industries will still be important too. Aviation and space exploration are likely to remain technically and commercially important, so it would be better for American companies to keep a stake in those industries than to give them up. Therefore, we could think about the circumstances that would be most favorable to them--certain tax policies, incentives to ensure a supply of trained engineers--and do what is possible to create a benign environment, within which our businesses can compete. We could think about the industries further down the technical "food chain" that supports aerospace, from electronics and composite materials to machine tools, and try to improve circumstances for them, too. It's hard to imagine a future without an increased demand for computers, or for pharmaceuticals and medical technology, or for telecommunications, or for systems to generate and conserve energy. Even the automobile business, an "old" technology that accounts for around 60 percent of America's trade deficit with Japan, is likely to keep generating profits and spurring technical development for many decades to come.
The main evidence that America can do something to foster industries comes from two of our great success stories, agriculture and aviation. The government decided, at different points, that the industries were crucial, and it decided to help them. The main boost to agriculture came through the land-grant university system and many subsequent decades of government-sponsored agricultural research, and through subsidies for public works. American aircraft companies are strong partly because Defense Department contracts created a natural advantage in technology, production volume, and costs. In principle, the United States could help support, rather than plan, certain industries in a similar way. It would not attempt to lay out industrial plans in detail or to suppress the tremendous openness to change that is one of America's main social and cultural strengths.
In order to take this step, however, we would have to confront topics that many economists have considered taboo, so that we could openly discuss the ways in which government and business might interact. Predictably, our squeamishness about the subject has led to more, and clumsier, government intervention than we might otherwise have had. America's general approach has been to declare industrial planning an inefficient distortion of the market--but then to lurch in to save mismanaged industries, like the savings and loans, after the damage is done. There is also a taboo on discussions of tariffs or other efforts to regulate trade flows. This leads the government to accept quotas on the imports of cars and textiles, even though quotas do more violence to principles of free trade than tariffs do. (The reason, in brief, is that tariffs simply change the relative prices of products from various nations, while quotas create an artificial scarcity that is economically more inefficient.) There is a taboo on the deliberate supporting of industries by any part of the government except the Pentagon, which leaves some people arguing that the Star Wars program should continue in order to keep America's high-tech businesses strong. In each of these cases, we would have bent our free-trade beliefs less if we had admitted from the beginning that we needed to bend them at least a little.
Detailed suggestions for helping to promote important industries, without trying to make America into a Japanese-style guided economy, vary widely. Within the past year there have been several major works on the subject: Made in America, by the MIT Commission on Industrial Productivity; Meeting World Challenges: U .S. Manufacturing in the 1990s, by Rudiger Dornbusch (also of MIT, sponsored by the Eastman Kodak corporation); a report by the Advisory Committee for Trade Policy and Negotiations and another by the Twentieth Century Fund; and assorted works by Clyde Prestowitz, Chalmers Johnson, Laura D'Andrea Tyson, Robert Kuttner, John Zysman, Stephen Cohen, Paul Krugman, and many others. The point that runs through all of them is that America can strengthen its economic base. and keep world trade freer than it would otherwise become, if it helps train engineers, relaxes antitrust laws, favors domestic suppliers in certain high-tech fields, and in general tries to improve the climate for its important industries rather than leaving everything except airplanes and agriculture to the invisible hand.
EXCEPT perhaps for Mikhail Gorbachev's Soviet Union, no country is as closely examined for signs of fundamental change as Japan. America is an extremely fluid society, but discussions of America's problems rarely wind up with statements like "Be patient with our failings, our culture is just about to change." Japan has a much older, more homogeneous, and more durable culture than America does, and yet the working assumption in trade negotiations is that important parts of this culture are about to transform themselves.
The constant expectation that Japan is about to change is the central intellectual flaw in our trading policy. If the Japanese do decide to change, for their own reasons, fine. But we should stop wasting time by begging them to do something they are plainly so reluctant to do.
People who talk about change usually mean, in particular, that Japanese consumers will start protesting artificially high prices and that Japanese workers will rebel against demands that they sacrifice themselves for the firm. Change means that the young generation of Japanese will be more relaxed and less disciplined than their parents or grandparents, that women will insist on a place in society more comparable to men's, that urban voters will demand a fair say in the country's policies (right now they're completely outweighed by farm votes, because of a gerrymandered voting-district system), and in general that power will shift away from strong bureaucracies and big corporations and toward the individual citizens of Japan. Change also means blurring the now sharp distinction between ware-ware Nihonjin--"we Japanese"--and the rest of the world.
It is certainly conceivable that any or all of these changes could occur, although they would amount to a social revolution in Japan. But it is foolish for America to adopt a policy that will fail unless they occur--which is what all our market-opening strategies boil down to. Through the century and a half in which America has been dealing with Japan, "fundamental change" has always been right around the corner, but change has come only when the country has faced dire emergencies: the need to catch up with the industrialized West in the .Meiji era, the devastation at the end of the Second World War. Now, with the rest of the world trying to catch up with Japan, it's not so obvious why its people should be eager to tamper with their social formula. Japanese spokesmen have been saying for years that the measures necessary to make Japan a truly open society--exposing rice farmers and small merchants to international competition, accepting immigrants, breaking up big cartel-like industrial combines--are too traumatic to ask of Japan. Maybe it's time to concede the point.
The United States should participate in the debate about Japan's future in a consistent but not arrogant way. When asked, we should say that according to our values, any country will be better off with freer markets and broader individual liberties. But we should not nag Japan endlessly on these subjects, and we should not act as if our overall collaboration with the Japanese, in the many areas where our interests are similar, depends on their becoming more and more like us. We should base our plans on the assumption that Japan's internal order is not going to change. If it surprises us later on, we can always make new plans.
In the meantime, our plans should reflect what we've learned about the Japanese system. For one thing, they should focus on results, not rules. American society is based on certain principles of interaction. Everyone, in theory, has an equal chance to make a million dollars or be elected President or become a movie star. Our basic assumption is that if the rules of competition are fair, the result--whatever it is--must be acceptable. Most aspects of Japanese life start from the opposite premise. In politics, in business, even in the arranged marriages that are still typical in Japan. the result itself is usually more important than the rules that led to it.
America's interest in process, and Japan's in result, have an important bearing on trade problems. They explain why the U.S. negotiating strategy has generally failed. Each year the Americans show up with a new list of complaints. Long ago there were textile talks. and through the 1980s there have been negotiations over beef, citrus, semiconductors, airport-construction and .MOSS ("market-oriented sector-selective") measures, and now "structural impediments." The Americans have generally asked for changes in rules, to make the competition "fair." These the Japanese have generally granted, knowing that the impact would probably be quite small. The most powerful chart in Clyde Prestowitz's book Trading Places shows the share of the Japanese semiconductor market held by U. S. companies from the early 1970s to 1986. During that period almost every part of the "process" changed. The yen rose and fell against the dollar. American companies set up sales offices in Tokyo. Prime Ministers promised to open the market. Sanctions and action plans were announced. At the beginning of the period the American makers held nine percent of the market. At the end of the period they held nine percent.
If we stop worrying so much about process and focus coolly on results, we can dismiss two theoretically promising but actually ineffective solutions to the trade imbalance: "talking down the dollar," and creating a free-trade zone with Japan, like the new one with Canada. Three years of a sinking dollar and this year's slight recovery have been worse than useless in correcting our trade imbalance with Japan. Although the lower dollar dramatically reduced America's trade deficit with Europe, it had much less impact on trade with Japan. The net effect of talking down the dollar has been to double the value of Japan's international assets, in a world where most calculations are still made in dollars, and to cut in half the price of American assets for buyers with yen. (In theory, it should have cut in half the price of American exports, too, but the Japanese retail system has passed on very little of this saving to the Japanese consumer.) We can easily assume that similarly disappointing results would be achieved from the procedure of creating a U..S.-Japan free-trade zone. If it were the kind of zone that Japanese negotiators have in mind, based simply on reducing tariffs and legal barriers, it would make the trade imbalance worse, since formal barriers are the only way America restricts imports. If it were the kind that American economists have in mind, based on truly open markets in each country, it would be unacceptable to Japan.
WHAT, then, does that leave as a solution to trade imbalances? Several results-oriented approaches have emerged from academic and political debate, and the real answer would probably be a combination of them.
The strengths and weaknesses of this approach are like those of the Gramm-Rudman bill. It would set a clear target, which the Japanese would appreciate, but it would not be automatically self-enforcing. Japanese officials might not take it seriously, because they have heard "this time I really mean it" speeches from American negotiators many, many times before. Transferring the burden of controlling the surplus to Japan would relieve America of the necessity of making constant, niggling complaints. It would, however, give the whole Japanese economy the power that Japanese automobile manufacturers now enjoy. Under the voluntary export-restriction system, Japanese manufacturers themselves limit the supply of cars they send to the United States. They've used this power to shift supply away from cheap cars and to the up-market models, making U.S. sales more lucrative than ever before.
The drawbacks of a tariff are many and obvious. It would impose a heavy cost on American consumers. It would jack up the price of many "American" products, since so many crucial components come from Japan. It might simply shift trade to Japanese-owned plants in Korea or Malaysia and defeat its purpose. It might tempt American businesses to profiteer and raise their prices, rather than selling more. It would violate General Agreement on Tariffs and Trade rules of international trade, and it might well infuriate the Japanese. (Then again, it might not. One academic who has specialized in studies of the nikuson shokku said that a new shock could actually seem comforting to Japan. American negotiators could immediately fly to Tokyo and explain how sorry they were that they'd had to take this step, in order to remain strong enough to be a worthy partner to Japan. Japan would finally know where America stood.)
But there are also some advantages to handling problems in this clear, primitive way. Tariffs always make better economic sense than quotas or voluntary export restraints. The revenue from tariffs goes to the U.S. government; the monopoly profits from quotas go to foreign manufacturers. A simple declaration of an across-the-board tariff would get Japan's attention, and its very simplicity would spare the government thousands of detailed decisions about which products should or should not be taxed. No one is eager to see this kind of surprise tariff, but if the United States were forced into it, it might put U.S.-Japanese relations on a more even keel.
Why should we take these steps? The grandiose answer would involve America's ability to sustain its industrial development, or to pay for the values it wants to advance--better schools at home, more democracy overseas. But it may be appropriate to concentrate on a narrower goal--that of preserving our relations with Japan.
America and Japan have a large number of bonds and common interests. Thousands and thousands of people in each country have friends in the other. Universities and scientists have exchanges and ties. The arts and culture of each country, highbrow and popular, can enrich the other. And of course there are all the familiar and important diplomatic, military, business, and financial links. In reality, these shared interests do not depend on the assumption that the two countries have similar economic systems or that their trade problems will naturally work themselves out through free trade. But our trade negotiations, with their constant demands that Japan open markets and change, imply that the two countries can't be friends unless their systems converge.
The United States and .Mexico, for different reasons, need to maintain decent relations with each other, but the relations don't depend on the assumption that the flow of people north and south across the border will "naturally" balance itself out. The two countries attempt to regulate the flow, with immigration laws and border patrols, so that it won't entirely disrupt their relations. Regulating the economic flow between countries may violate the ideology of American-style economics, but it is the only way to preserve harmony between the United States and Japan.
Copyright © 1989 by James Fallows. All rights reserved.
The Atlantic Monthly; December 1989; Getting Along With Japan; Volume 264, No. 6; pages 34 - 38.