The Future of U.S.-Japan Economic Relations

T. J. Pempel (Professor, University of California-Berkeley)

This paper was presented at the NBR conference hosted by NBR in collaboration with GLOCOM and the Japan Foundation Center for Global Partnership in Tokyo on March 25, 2003.

Economic relations between Japan and the United States have gone through several major twists in the last decade plus. Throughout the 1980s, Japan's exports and the overall economy boomed while America's sagged. The result was a gaping bilateral trade gap and a series of testy economic confrontations aimed at reducing it. The so-called 'voluntary export restraints,' the MOSS talks, the Structural Impediments Initiative, the semiconductor agreement and the Plaza Accord were among the most prominent and contentious. The climate changed substantially by the early 1990s with the breakdown of the Framework Accord. Moreover, Japan's asset bubble burst, ushering in thirteen years of torpid economic performance. In contrast, America's economy boomed as a result of its quick transformation from a manufacturing to a service base, one that was heavily dependent on successfully taking a global lead in information technologies.

The Clinton Administration pursued policies of military reduction, concentrating instead on domestic economic revitalization and global economic multilateralism. The latter was particularly successful with the negotiation of Uruguay Round, NAFTA, Free Trade Area of the Americas (FTAA) and the embrace of APEC in Seattle in 1993. The U.S. also pressed for improved economic relations with China which culminated in the accession of both Taiwan and China to the WTO in December 2001. APEC agreed to pursue "free and open trade and investment" across the Asia-Pacific--by 2010 for advanced, and by 2020 for developing, economies. In short, much of America's focus was no longer on Japan and bilateral economic trade problems.

Meanwhile, throughout the late '80s and early '90s, Japan's strong yen unleashed an outflow of investments, roughly one-half of which went to North America and roughly one-quarter going to fuel a regional economic surge across Asia as Japanese companies, particularly in automobiles, electronics, and machine tools put in place a series of regional production networks. The Japanese government supported such moves through its overseas development assistance programs while Japanese banks sent huge amounts of loan capital to the area. Meanwhile, despite what many saw as an anemic pace for economic reforms at home, Prime Minister Hashimoto put in place a "Big Bang" that transformed the Japanese financial sector while Prime Minister Koizumi has pursued a number of attacks on previously off- limits targets that may yet prove to bear fruit. All of these moves also contributed to a reduction in bilateral trade frictions.

The specifics of U.S.-Japan economic relations retained their own independent dynamics, of course. But bilateral ties in the last ten years or so have evolved within the context of three much broader trends. First, there was a general improvement in the security climate within the Asia-Pacific, driven by the end of the Cold War, the move toward pro-Western economic policies by China, the reduction of military tensions in Southeast Asia and the South China Seas, and the success of various confidence building measures among the governments of the region. Overall, the clear cut Cold War lines between 'friend' and 'foe' that had shaped the Asia-Pacific for years gave way to a more generally positive military environment. This, in turn, made the region much more conducive to a collective concentration on economic improvement through trade, investment, cross-border production networks, broadened communication and transportation networks, as well as a host of pan-Asian cultural patterns that began to span the region and engross its citizensJapanese cartoons and karaoke, Korean pop music, Star T.V., soap operas and cartoons, multinational Asian singing groups, and the like. No longer was Japan the sole capitalist success story in Asia; no longer did it play the same trans-Pacific anchoring role for U.S. economic actions in Asia that it once had. Meanwhile, regional economic success boosted both countries' economies and also worked to reduce their bilateral frictions.

A second broad trend involved the phenomenal increase in trans-border capital flows. As is widely reported, by the late 1990s, $1.5 trillion or more in capital flows was moving across national borders on a daily basis. Most of this money was private- rather than government-directed capital. Two key results followed. First, capital and investment flows became a much larger and more important portion of "economic policy" than merchandise trade. Second, governments, including those in Washington and Tokyo, found it increasingly difficult to pursue distinctively 'national' economic policies. Cross-border investments and global capital markets simply made it ever more difficult, in the words of Robert Reich, for governments to determine "who is us?"

Third, Asia, which had been largely devoid of regional institutions, except for ASEAN which was formed in 1967, saw a substantial increase in the number and influence of regional forums, particularly in the economic arena. The Asian Development Bank, the ASEAN Regional Forum (ARF), the Asia-Pacific Economic Cooperation (APEC) forum and a host of informal, non-official institutions such as the Pacific Economic Cooperation Council (PECC), the Pacific Basin Economic Council (PBEC), and the Pacific Trade and Development Conference (PAFTAD), as well as dozens, if not hundreds, of so-called track two dialogue processes, all combined with well established global multilateral organizations such as GATT/WTO, the IMF and the World Bank to create multiple new forums within which issues salient to the U.S.-Japan economic relationship were also addressed. No longer were issues restricted, as they had largely been in the past, to government-to-government negotiations limited to the Beltway and Kasumigaseki.

Throughout most of the 1990s, this combination of factors moved U.S.-Japan economic relations in at least two directions. First, most issues became far less bilaterally contentious. The U.S.-Japan trade balance as well as specific product competitions attracted less political attention, fewer headlines and less overall heat. Meanwhile, an improved bilateral economic climate resulted from the rapid expansion and interconnectedness of economies across Asia. A network of open regionalism in which most economic issues became far more embedded in multilateral processes and organizations such as APEC as well as the WTO reduced bilateral frictions. These changes also gave Japan in particular the opportunity to pursue various counterweight trade strategies that made the country less subject to U.S. bilateral pressures. The U.S. in turn had other economic avenues in Asia that it could pursue independently of Japan. Bilateral U.S.-Japan tensions thus cooled substantially. And undoubtedly, while not explicitly economic in nature, the reaffirmation of the U.S.-Japan Security Treaty simultaneously improved the general climate of relations between the two countries.

Economic conditions in both countries, as well as across the Asia-Pacific have soured substantially since, starting with the Asian crisis of 1997-98. But interestingly these have not reenergized the rasping charges and counter charges between the U.S. and Japanese governments that characterized the 1980s. They have, however, shifted the focus of potential economic problems between Japan and the U.S. No longer is bilateral trade per se the most logical source of friction. Instead, new potential problem areas have emerged.

The crisis of 1997-98 was a watershed event in Asia. The Japanese government sought to ameliorate the conflict by proposing to create an Asian Monetary Fund (AMF), a proposal that was essentially vetoed by the U.S. along with China. It was the IMF that eventually provided bailout packages for Thailand, Indonesia and South Korea, forcing U.S.- style economic policies on all three. Japan's Miyazawa Initiative subsequently sent some $30 billion in financing to the five countries hardest hit. However, today, with a few notable exceptions, most of the national economies across the Asia-Pacific, plus of course the region as a whole, remain in substantial slumps and across Asia there has been a collective vow never to allow a repeat of the crisis. Resentment against U.S.- IMF neo-liberal economics remains strong and across Asia there is strong pressure to reconsider the global financial infrastructure, including the current imbalance in the weighted voting of the IMF.

In a related vein, another important source of possible difficulty has been the move toward an increased role for ASEAN + 3 (APT). In particular, the thirteen APT countries (the ASEAN-10 plus Japan, China and South Korea) agreed at Chiang Mai in May, 2000 to a set of currency swap arrangements designed to forestall a repeat of the 1997-98 crisis. In their present form these arrangements remain largely "IMF compatible;" however, APT members hold monetary reserves of nearly $1 trillion that could obviate future IMF rescue packages. They could also rival U.S. financial influence in the region and perhaps, in the long run, become a major tool of Asian influence vis a vis U.S. monetary policies. They could also add to the pressure within the IMF for a reallocation of voting rights that would reduce the influence of both the U.S. and Europe.

Bilateral U.S.-Japan economic ties have also shifted as the result of increased numbers of bilateral free trade agreements among various Asian-Pacific countries. Globally 143 such agreements were in effect as of June 2002, with fully 117 of these coming into being after 1990. Japan entered its first such agreement with Singapore (Japan Singapore Economic Partnership AgreementJSEPA) in January, 2002. The country is moving forward on negotiations with Mexico and is considering bilateral ties with several other countries, including South Korea. The U.S. already has dozens of these accords. To the extent that such FTAs become the opening wedges for liberalization of economic sectors within Japan (as is anticipated by METI, for example) as well as building blocs for a global free trade system, their impact on U.S.-Japan economic relations will undoubtedly be mostly positive. But such arrangements also have the potential for enhancing certain sector specific conflicts. Thus, if Japan secures an FTA with Mexico, that could provide much easier access to U.S. markets for Japanese goods shipped through Mexico under NAFTA-FTA procedures. A big rise in FTAs also runs the risk of reducing the collective focus of both governments on their mutual relationship. That may be good, in allowing problems to be resolved more quietly and technically, but it also opens up the possibilities of serious problems of omission and inattention.

Further exacerbating economic problems has been Japan's relentless economic decline and the government's apparent reluctance to attack its problems frontally. At home, the key issues remain the massive problem of non-performing loans and the slow embrace of structural economic reform. Foreign catalysts to change, despite the Ghosn-boom and the Nissan success, remain few. Incoming FDI has increased slowly, but with inflows equal to only 1.2 percent of GNP versus nearly 20 percent for the other major industrialized countries, Japan's remains a largely mercantilist economy and this si certain to remain an irritant to global U.S. businesses that could also spill into the political realm.

Economic strength had long been Japan's most powerful tool in global negotiations. As that strength has waned Japan's global position and influence have deteriorated. Japan's share of global exports has fallen from 10.2 percent in 1986 to 7.6 percent in 2000. Its share of global FDI, meanwhile, was 12.4 percent in 1992, ranking second only to the U.S.; today the country has fallen back to eighth place, the position held by the country in 1980. The country's banks and manufacturers have pulled out huge portions of their loans and investment capital from Southeast Asia since 1998. And as Japan falls further behind many of its neighbors in such key areas as IT, broadband penetration, financial services and the like, its capacity to serve as a regional engine of growth, as well as its centrality to either Asian or U.S. economic activities also decline. Similarly, Japan's scuttling of the proposed Early Voluntary Sector Liberalization (EVSL) within APEC makes it clear that protectionist policies remain deeply entrenched within Japan, especially in agriculture. The collective result has been American as well as Asian frustration plus a generic "Japan passing." It was symbolically telling that in November 2002, China agreed to negotiate a free trade pact with ASEAN while the best Koizumi could do in response was to promise to explore the issue. More broadly, though they are hardly in a zero sum relationship, Japan's economic troubles combined with China's rapid growth and its welcoming of incoming FDI, have combined to shoot Japan down from its prior role as 'lead goose' for the Asian region.

America's shift to unilateralism and preemptive military attack under the Bush administration also holds tremendous potential to damage U.S.-Japan economic relations. Since coming into office, the Bush administration has moved away from America's emerging focus on economics and multilateralism, concentrating its energies instead on military approaches to global relations, while abandoning multilateralism in favor of hyper-unilateralism. A series of policies and accords agreed to by the rest of the international community have been scrapped, including the Kyoto Protocol, the verification protocol for the 1972 Biological Weapons Convention, the International Criminal Court, the ABM treaty and the Ottawa Convention on Land Mines. High handed moralism and expressions of American exceptionalism have gone over poorly with many of America's allies, including Japan and much of Asia. In keeping with its overall rejection of multilateralism, President Bush also spurned APEC by refusing to attend the leaders' meeting in Los Cabos, Mexico in 2002. Ties with Asia have also worsened considerably as a result of Washington's overt disdain for Kim Dae-jung's Sunshine policies and Prime Minister Koizumi's visit to Pyongyang. They soured even more when President Bush announced his Sept. 20, 2002 policy of preemptive attack, declared the DPRK to be part of an 'axis of evil,' broke away from KEDO commitments, and refused to act to cope with North Korea's enriched plutonium and possible nuclear weapons programs despite the possibility that a nuclear-armed DPRK could trigger a massive arms race across Northeast Asia.

American domestic economic policies have also worsened ties with Japan in particular, but with numerous allies more specifically. Thus, despite railing against protectionism in Japan, the Bush administration made massive boosts in farm subsidies, introduced big tariff hikes on steel imports and Canadian timber, and rolled back apparel imports. Domestically, America's inherited budget surpluses have vanished due to slower economic growth, massive tax cut packages and escalating military spending. Though Japan has voiced overt support for American military actions in Iraq, there is little likelihood that it will provide anything like the $13 billion in economic support that was extracted from the country to pay for the first Gulf War. To what extent it will contribute to any subsequent nation-building in Iraq is also unclear, but for the moment it appears that Japanese aid will not be forthcoming unless the U.S. agrees to a post-war regime in Iraq that has U.N. credibility and this is by no means certain.

The U.S. and Japan remain the two largest economies of the world. Many of the frictions that pitted them in zero sum contests during the 1980s have been eliminated. On the surface that suggests "better" economic relations in the future. Yet, in fact Japan's own economic troubles, the slowdown across Asia, the economic muscularity of China, the continued and rising power of private capital, and U.S moves toward protection at home and unilateralism and military solutions abroad all present deep structural problems that could generate economic tensions within new areas. These have the potential to deepen mutual distrust in the near future while simultaneously worsening the ability of either or both governments to resolve problems through bilateral negotiations as they did in the past.