Who Won the Trade War?

September 1, 1995 Topic: Economics Tags: BusinessContainmentCold WarIndustryGulf War

Who Won the Trade War?

Mini Teaser: Now that there is an armistice in the latest phase of the trade war with Japan, it is instructive to evaluate President Clinton's settlement, the costs of achieving it, and the implications for U.

by Author(s): Robert B. Zoellick

Now that there is an armistice in the latest phase of the trade war with Japan, it is instructive to evaluate President Clinton's settlement, the costs of achieving it, and the implications for U.S. foreign policy in Asia. I believe the United States received too little and paid more than necessary. Even more troubling, this incident affirms that the administration still does not appreciate how and when to wield power. Worst of all, the Clinton team seems chronically incapable of integrating its ad hoc trade and foreign policies. While Clinton's Asian security specialists publish grand strategies, his economic and political advisors proceed case-by-case with Japan and China, applying contradictory and uncoordinated tactics.

The surest predictor of the administration's position on any foreign policy question remains its calculation of domestic political effect. Ironically, Clinton's bad foreign policy habits are fueling the isolationist sentiments he solemnly decries.

The Trade Hawks Lay an Egg

After displaying front-page photos of Mr. Kantor playfully threatening Mr. Hashimoto with a bamboo sword, newspapers buried in their business sections the first clue that the administration's Japan hawks had laid a modest egg. It turns out that the Japanese auto-manufacturers have purchased almost twenty billion dollars of American-made auto parts in recent years, slightly exceeding the voluntary goal Japan presented to President Bush. Although candidate Clinton criticized Bush's efforts, President Clinton has settled for smaller numbers that now have only the standing of U.S. "estimates" because Japan refused to extend the 1991-92 goals.

The use of these voluntary goals involves a dangerous balance both for Americans promoting open markets and the Japanese economic bureaucrats. On the one hand, frustrated U.S. exporters want voluntary goals to help overcome hidden barriers and prejudices against imports in Japan. The theory is that once Japanese business and consumers are forced to examine foreign goods, they will recognize them as satisfactory and the regular forces of market competition can operate more freely. But voluntary goals can slip into quotas, which make it harder to achieve free competition; they can become ceilings (not floors) on exports, and may lead to a counterproductive attitude of disdain toward the export products that Japanese companies are required to buy. Quotas lead to managed trade, which creates an incentive for exporters to concentrate on getting their governments to bargain for market share, instead of focusing their businesses on developing competitive products and market strategies. The Japanese government's efforts to persuade its industries to establish goals also undermines the cause of deregulation.

The Bush administration decided that the closed nature of some Japanese sectors and business practices warranted pressing Japanese firms to establish voluntary goals, if the goals were complemented by American companies' adjustments to match Japanese opportunities. In early 1993, Japan's Ministry of International Trade and Industry (MITI) probably would have continued to experiment with these arrangements, because the process tended to strengthen MITI's influence within the economy and give it an important role in managing the relationship with the United States.

Unfortunately, the new Clinton administration was oblivious to these subtleties, risks, and tradeoffs. As a result of a failure to analyze Japan's range of flexibility and constraints on trade policy, compounded by poor tactics, Clinton's result fell short of that achieved by Bush.
The administration overplayed its hand from the start by insisting on specific numerical targets in agreements that the United States would enforce with trade law remedies. Given the uncertainties of market conditions, MITI would not accept legal quotas. So MITI retreated from even the idea of voluntary goals and seized the high ground of defending free market principles. The public debate had thus been shifted adroitly from extraordinary measures to overcome Japan's societal and business barriers to Clinton's demands for managed trade. In the end, Clinton blinked, failing to achieve even voluntary goals, much less enforceable targets. Again mistaking rhetoric for reality, the administration trumpeted its own numerical projections, although Japan announced that these projections were "neither shared by the [Japanese Trade] Minister himself, nor the government of Japan."

High Cost, Missed Opportunities

The Clinton administration spent much international political capital for this result, and the United States will pay the costs for some time. The administration ignored the costs to the new World Trade Organization (WTO), intended as the enforcer of the global trading system's market rules and for which the United States had fought many years. Following the logic of Pat Buchanan, Clinton dismissed the fact that the highly competitive American economy, the largest exporter in the world, is a primary beneficiary of a WTO that enforces fair competition according to agreed rules. I have no doubt that in the future, other nations will cite Clinton's policy toward Japan as an excuse to evade the very rules we want to apply.

In addition, by focusing American pressure on the auto and parts sectors, Clinton failed to pursue other worthwhile priorities. It is a fact of international political life that governments have to decide which results warrant an expenditure of their "capital." In doing so, they should look for supporters inside other countries whose shared interests or outlook will lead them to help achieve results. Clinton did not commit U.S. power to press Japan to stimulate its moribund economy through tax and spending policies, even though the United States could have enlisted Japanese allies who also favored pro-growth policies. This macroeconomic approach might have connected U.S. aims to Japan's anxieties over an overvalued yen, further strengthening the U.S position. This option also would have made a bigger overall dent in the trade deficit.

Another more fruitful alternative would have been to concentrate on getting the Japanese to clean up the half trillion dollars of losses in its banking system. They must address this problem eventually. In the meantime, Japan's paralysis on the issue is choking off economic growth and preventing the recycling of yen surpluses.

The administration also chose not to select as a high priority an alliance with Japanese political and economic reformers and journalists, all of whom have been calling for deregulation and competition as a means to lower prices, increase consumer choices, and improve living standards. The recent successes of the New Frontier Party suggest that the movement for change in Japan, although it waxes and wanes, offers an ongoing opportunity to link economic and political openings. Instead, Clinton's blunt demand for legally enforceable quotas united Japanese of all views against the United States. As a result, the United States ended up with little to show for all of its huffing and puffing, and has passed up opportunities to invigorate both macroeconomic and microeconomic changes in Japan.

Where's the Strategy?

The Clinton administration began with an appropriate recognition of the importance of the Asia-Pacific region to U.S. security, economic, and political interests. But by confusing tough rhetoric with effective policies toward the two biggest regional powers, Japan and China, the administration has achieved little at significant expense, revealed weakness, and dissipated both its strength and credibility. These failures open the door to isolationists and other narrowly-focused domestic forces, making it even harder to forge an integrated strategy toward the Asia-Pacific region in the future.

In an effort to clarify administration policy, Assistant Secretary of Defense Joseph Nye has made "The Case for Deep Engagement" by the United States in East Asia after the Cold War (Foreign Affairs, July-August 1995). He opens by observing that "politics and economics are connected," and then outlines a sensible security framework. But his brief nod to the administration's Asian economic policies dodges the fact that these policies are not integrated with the Defense Department's security concept. Mr. Nye's economic policy colleagues have failed to recognize and relate the economic changes in the region that are the counterparts to his observations on security issues. As a result, the economic side of the house is preoccupied with narrow, bilateral trade complaints, while the security side, though taking a longer view, is not integrated within a coherent strategy.

The unintegrated, case-by-case approach of the administration's trade warriors is building up resentments on both sides of the Pacific that will haunt U.S. policy in the future. Japanese and others in East Asia perceive the United States as increasingly hostile, threatening, and ultimately unreliable. Equally bad, they conclude the United States is weak, because rhetorical bluster is not matched by resolve, and U.S. "victories" are transparently hollow. Meanwhile, on the home front, the fierce chest-pounding stirs those Americans who are intent on finding a new enemy. Because the administration's trade results will not prove significant, Clinton will end up fueling the pseudo-realists and geo-economists who argue that Mr. Nye's strategy does not promote American interests. Because the administration's trade and security policies in Asia are based on different interpretations of the political and economic changes in the region, the administration is in effect at war with itself.

The importance of broad strategic considerations does not justify ignoring Japan's--or any other Asian nation's--explicit or implicit barriers to U.S. imports; it does necessitate evaluating what the United States gets, for what cost, and whether shrewder tactics and assessments of opportunities might work better. The administration's trade team might start, as Mr. Nye does, by examining Japan in the context of its changing politics and place in the region. The same forces inside Japan that are pressing that nation to assume greater regional and global responsibilities are potential allies for deregulating and opening up Japan's economy. These movements within Japan will be strengthened by regional economic trends. If Mr. Nye recognizes the need to blend bilateral and multilateral security arrangements in a mutually supportive fashion, why can't his economic colleagues do the same?

As J.P. Morgan's research staff has pointed out, the emerging economies of Asia are now twice as large as Japan's, if valued at purchasing power parity exchange rates; even using market exchange rates, the rest of the region's GDP is close to half of Japan's, and it is closing the gap rapidly. The extraordinary growth of these countries is also changing their economic structures, with the upper tier turning to services and approaching OECD norms and the next economic tier shifting from agriculture to industry and services. Over the past ten years, the share of Japan's trade surplus earned from its Asian trade has boomed from about 20 to 50 percent, in the range of Japan's surplus with the United States. Yet despite the shift in direction of Japan's trade to Asia, Japan is not gaining market share because non-Japanese intra-Asian trade is growing even more quickly.

The stronger yen and higher Japanese production costs have driven manufacturers abroad, but falling profit margins and banks with little capital to spare have limited Japan's capacity for foreign investment. Although Japan's foreign direct investment in the region is increasing, it is doing so at a rate that lags behind that of Taiwan, Hong Kong, Singapore, and South Korea. Japan's foreign direct investment in East Asia is even slipping when compared to that of the United States.

While Japan certainly remains an important financial influence in the region, the extent of its leverage is diminished because high local savings rates are the primary source of investments. Interestingly, the ASEAN economies are also attracting research and development-intensive industries from the United States and Europe, illustrating to Japan the costs of keeping foreigners out.

In sum, the regional economic picture suggests that Japan will face increasing pressure to improve its competitiveness. These market forces could combine with political changes in the country that will support deregulation and a more open economy. Other Asians may also be more willing to help urge Japan to reduce barriers to trade, as long as they do not feel they risk legitimizing U.S. methods that might one day be directed at themselves. Indeed, Japan and other states in Asia might prove more willing to liberalize trade in a multilateral context like the Asia-Pacific Economic Cooperation (APEC) or the WTO. The early reports are that Japan is preparing for the 1995 APEC Summit in Osaka by engaging in the serious work of starting to prepare practical plans to achieve the free trade goal adopted at last year's meeting. U.S. bilateral pressure should capitalize on these changes, targeting macroeconomic, deregulatory, and even sectoral opportunities where we can generate support within Japan and the region for positive change.

If the Clinton administration truly viewed Asia strategically, it would adjust its trade and economic policies to match regional conditions, move with the momentum of local political changes, support long-term economic and security goals, maximize the likelihood of success, and minimize the costs. But this administration does not work that way.

Why? President Clinton's approach to Japanese trade and the U.S. future in Asia seems illogical until one considers what truly drives his foreign policies: votes. This is the one gain Clinton may derive from his trade exercise with Japan. When pressed about the weaknesses of the policy at a press briefing, a senior United States trade representative resorted to pointing out the support for it in the polls. Over the next year we will hear Clinton campaign on how hard he fought, how he produced trade gains unlike those of his predecessors, and how American industry and workers can rely on his toughness in the brave new world of aggressive trading states. Just remember what the Asians have learned: that rhetoric precedes retreat at high cost.

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