Trade Face-Off: A dangerous U.S.-Japan confrontation

It is no larger than a few grains of rice, but it was big enough to cause one of the most serious episodes between the U.S. and Japan since the end of World War II. It is the tiny microchip, a sophisticated bit of silicon that is the indispensable heart of the techtronic age, the raw material for everything from talking teddy bears to personal computers to intercontinental missiles. After the Reagan Administration imposed trade sanctions against Japan in an attempt to protect American makers of microchips, it suddenly looked last week as if the U.S. and Japan were headed for what could become a major trade row. In fact, Tokyo TV commentators described the event with the phrase Kaisen zen- ya (the eve of war), an expression used to describe the days before Pearl Harbor. In Washington, U.S. Trade Representative Clayton Yeutter, while insisting that a trade war was not at hand, nonetheless called the confrontation a “serious dispute.”

Sizable shock waves rattled around the world in the wake of the U.S. action, which was prompted by alleged Japanese cheating in the sale of the useful semiconductors and by Tokyo’s alleged intransigent protection of its domestic microchip market. Partially in response to the specter of trade confrontation, the Dow Jones average of 30 industrial stocks sank 57.39 points as the week began, its third worst plunge in history. Yet the amazing 4 1/2- year bull market in stocks, fueled in part by billions of dollars in Japanese investment money, recovered quickly, and the Dow closed the week at 2390.34, a record. In Tokyo money markets, the price of the U.S. dollar slumped to a doleful 144.7 yen, the first time in postwar history that the greenback was worth less than 145. Only 15 months ago it was 200. As tempers cooled by the end of the week, however, the dollar had climbed back to 146.05.

In both the U.S. and Japan, the Administration’s tough action sparked widespread consternation. Japan’s largest daily, Yomiuri Shimbun, editorialized that the sanctions were “detrimental to the interests of American consumers.” The liberal daily Asahi Shimbun declared darkly that “trade war has now come about.” In Manhattan, the usually pro-Reaganaut Wall Street Journal warned that “high-stakes trade retaliation, like Russian roulette, is a dangerous game, and the world doesn’t benefit when the President of the United States leads by bad example.”

Japanese officials rushed to keep the trade conflict from spinning out of control. Foreign Minister Tadashi Kuranari urged that “overall U.S.-Japanese relations should not be undermined by this issue.” Makoto Kuroda, a senior member of the country’s powerful Ministry of International Trade and Industry (MITI), prepared to hie to Washington. His job: to convey dismay at the bombshell U.S. decision to retaliate with some $300 million worth of tariffs on a wide range of Japanese electronic goods. In addition, former Japanese Foreign Minister Shintaro Abe has been named as a special envoy by Tokyo to help deflect the trade collision. But the sanctions will almost certainly go into effect as scheduled on or about April 17.

The measures amounted to little more than a blip on the gargantuan volume of annual U.S.-Japanese trade, which totaled $112 billion last year. But the slap at Tokyo was also a powerful diplomatic message. For the first time, longstanding American grievances over the trade practices of its second largest trading partner (after Canada) had resulted in a sharp and pointed U.S. economic response. Said a senior Administration official: “This will hopefully send a signal to all our trading partners that the free ride is over.” As Commerce Secretary Malcolm Baldrige put it to TIME, “You can’t rely on words. You have to rely on actions.”

Those actions may soon provide some trying moments for two men widely touted as close personal and political friends: Ronald Reagan and Japanese Prime Minister Yasuhiro Nakasone. The two statesmen are scheduled to meet in Washington on April 29, and the new strain in their relationship comes at a time when both leaders face serious political troubles. At home Nakasone is currently fighting an uphill battle for political survival. The U.S. sanctions were an added burden that could help force him out of office before his term expires in October.

For Reagan, weakened by the Iranscam scandal, the sanctions were an unprecedented gamble. On one hand, they expressed the Administration’s “profound disapproval” of Japanese trading practices in the sensitive semiconductor field. On the other, they were an integral part of the Administration’s strategy to address the country’s ghastly trade deficit. The semiconductor measures were also intended, ironically enough, to help block a rising protectionist tide in the U.S. Congress, but they could just as easily have the opposite effect.

The sanctions actually cheered legislators who are preparing a new version of a tough omnibus trade bill that passed the House of Representatives last year but died in the Senate. One version of the new bill is expected to reach the House floor on April 28, the day before Nakasone’s visit. Says Senator Max Baucus of Montana, a leading congressional activist on trade issues: “The President’s semiconductor action is sort of a turning point. We’re going to stop talking and start taking action.”

The clash over microchips also went far beyond commercial concerns in pitting two vastly different cultures against each other. After more than 130 years of contact with the West, Japan is hard-working, thrifty, highly organized but still relatively insular in its world view. On the other hand, free-wheeling, free-spending and individualistic America is now becoming fully aware of the loss of its postwar industrial primacy. By its latest trade actions, Washington was clearly attempting to force Tokyo to change not only its outlook but also its historic attitudes. For the Reagan Administration, and indeed for America, the issue of protecting high-tech industries went beyond economics and politics to national pride. Long the world’s technological leader — and still in many respects the world front runner — the U.S. was fighting hard to protect that role.

The semiconductor fray, predicts Clyde Prestowitz, an expert on Japan at Washington’s Woodrow Wilson International Center for Scholars, “is probably just the beginning of much more rocky times between the U.S. and Japan.” Or between Japan and just about everybody else. In London last week the Conservative Cabinet of British Prime Minister Margaret Thatcher closeted itself to discuss economic measures against the Pacific island power. After the hour-long session at 10 Downing Street, Thatcher dispatched one of her trade ministers to Japan with the threat that Britain might soon take retaliatory action to keep additional Japanese banks and securities firms from operating in London. The aim was to pressure Tokyo into ending its stonewalling of British firms that want access to highly protected Japanese financial markets.

The British have urged their eleven fellow members of the European Community to take part in the Japanese sanctions campaign, and several E.C. members seem inclined to join in. Said European Community Industrial Commissioner Karl-Heinz Narjes: “Our patience has snapped. We have had enough of giving the Japanese the benefit of the doubt.” At a meeting of Community foreign ministers scheduled to take place last weekend, the Netherlands and West Germany were expected to support the British proposal. Last month in Brussels the European Commission urged Community members to get tough with Japan. The commission had earlier slapped a 20% retaliatory tariff on Japanese photocopying machines, which take up 75% of the $1 billion European market.

Behind the sound and fury aimed at Japan were profound alterations in the familiar international economic landscape that will continue to shake trading relationships for years to come. An unwholesome tide of global protectionism has been slowly rising for several years, but now it seems to be heading toward flood levels. That unsettling prospect comes despite the avowed intention of most of the world’s trading nations to broaden free trade through a new round of negotiations involving the 96-member General Agreement on Tariffs and Trade. Even though talks for that round began in Uruguay last September, the Geneva-based staff of GATT is deeply concerned about the outcome. In its latest annual report, issued last December, the organization declared that economic policies being introduced around the world might not lead to open trade warfare but could produce a “prolonged stagnation.”

Free trade has been a central tenet of the postwar economic order. The system that was put in place with U.S. leadership took as a cardinal principle the belief that “beggar-thy-neighbor” protectionism in the prewar years had helped cause the Depression-era misery and social turbulence that eventually led to World War II. In economic terms, protectionist barriers largely benefit inefficient companies and hurt consumers by forcing them to pay more for products. Even though the competition engendered by free trade can cause temporary pain by destroying obsolete industry and generating unemployment, the final result is more jobs, more income and more opportunity if every manufacturer is allowed to produce and export what it makes best. The value of free trade has been spectacularly displayed in the tremendous expansion of postwar Western wealth.

Protectionists, on the other hand, argue that free trade is a fine theory but it is not the real world. They claim that at any given time trading nations are subsidizing production costs, stopping imports by stealth and off- loading their own products on less sheltered trading partners. The strongest protectionist argument is that industries may need either temporary or permanent help in combatting such unfair competition, usually in the form of % trade restrictions. The biggest problem with the argument is that temporary help often turns into the kind of permanent dependence that fosters stagnation.

The protectionist argument is flaring up anew because of Japan’s phenomenal success. After only 30 years of aggressive, imaginative but often highly protected industrial growth, the Japanese are the prodigies of the industrialized world, reveling in a trade surplus of $83 billion in 1986 alone. Says Robert Hormats, a partner in the Goldman Sachs investment house and a former trade adviser to the Carter and Reagan Administrations: “No country in history has ever gained international wealth as fast as Japan.” Many economists estimate that the accumulated Japanese balance of payments surplus could reach anywhere from $500 billion to $1 trillion by the year 2000. The Japanese, like the OPEC nations in their heyday, are already investing their current surplus funds around the world. Last year they placed $132 billion abroad, roughly half of it in U.S. Government and corporate bonds.

Japan’s rise to such riches has been particularly painful for the U.S., the world’s foremost military power and Tokyo’s most important ally. As of last year the U.S. had also become the world’s biggest foreign debtor (1986 total: more than $200 billion). That debt is steadily being compounded by the trade deficit, which rose to a new record of $169.8 billion last year. Of that total, $58.6 billion was owed to Japan, based on $85.5 billion in Japanese imports to the U.S. and only $26.9 billion worth of return U.S. exports.

The irony is that probably at no other time in postwar history have the U.S. and Japan managed to cooperate as well as they have under Reagan and Nakasone. In the past five years, the two countries have reached an unprecedented degree of understanding on Japan’s strategic role in the Pacific. That Japanese contribution is, quite simply, invaluable. Says Katsuro Sakoh, a senior fellow in Asian studies at the conservative Heritage Foundation: “Security is the cornerstone of the U.S.-Japanese relationship.” Japan’s 1987 military budget of $32 billion is now the world’s third largest after that of the U.S. and the Soviet Union. Under Nakasone, Japan is beginning to meet a long-standing but unfulfilled commitment to safeguard its own sea-lanes up to 1,000 miles off the Japanese coast.

But while the security ties have thickened, the trade imbalance has widened. It is now more than three times as great as it was only five years ago. From year to year a trade deficit may not be a bad thing, but over time it becomes debilitating, since money must be borrowed abroad to finance the shortfall. Even then, such borrowing can be useful if it is used to finance needed capital improvements, as the U.S. did in the 19th century. The current U.S. trade deficit, however, is largely a result of America’s passion for more consumer goods.

Another problem is the deficit’s intractability. During the past 15 years, the U.S. has had successive trade crises with the Japanese as the archipelagic powerhouse has conquered world markets in textiles, television sets, steel and automobiles. In each case, the problem was supposedly solved by the imposition of controls on Japanese exports to the U.S. But the imbalance has become worse, creating a climate — at least in Washington — that threatens to undercut the much broader mutuality of interest that binds the U.S. and Japan. Says an Administration official: “It really is a problem of perception. The Japanese are seen as being unfair.”

That is not the Japanese view. As concern over the U.S. trade deficit has grown, Nakasone has taken the lead in trying to persuade his countrymen to become more energetic consumers, especially of foreign goods, in the interests of averting a trade war. The Prime Minister two years ago made an unprecedented appearance on national television to underscore that appeal. He then went on a highly publicized expedition to buy foreign goods in Tokyo. At that time he also announced relaxations in the maze of bureaucratic regulations that often seem to make the Japanese market impenetrable to foreign competition.

Nakasone’s efforts at liberalization, though, have had little effect on U.S.-Japanese trade figures. Indeed, most economists estimate that if all protectionist barriers in Japan were removed at a stroke, Japanese imports would increase by only $8 billion to $15 billion.

The factor that has had the greatest single impact on Japanese trade is the skyrocketing value of the yen, which has risen 60% against the U.S. dollar since September 1985. The steep rise in the yen has helped push the Japanese economy into a trough. The change in currency value was expected to help correct the trade imbalance by making U.S. exports to Japan cheaper and Japanese exports to the U.S. more expensive. Finally, after long and frustrating delays, there are signs that such changes are slowly coming about. The Japanese claim their U.S. imports last year rose by almost 24%. When special circumstances are subtracted (notably, a $2.5 billion purchase of gold for coins commemorating Emperor Hirohito’s 60 years of rule), the figure is more like 4.8%. But at the same time, global Japanese exports declined in volume by 1.3%.

There are additional reasons why the current semiconductor confrontation has more powerful significance than previous trade squabbles. One is the importance of the microchips — finely etched electronic devices that process thousands of bits of information per second — to the burgeoning world of high tech. Semiconductors are now used in virtually every advanced technology, including the Cray supercomputers that are a key component of the Reagan Administration’s Strategic Defense Initiative. Says C. Fred Bergsten, director of the Washington-based Institute for International Economics: “Practically everyone in the U.S. agrees that semiconductors is a critical industry and that it would be dangerous, both to the economy and to national security, to lose it.”

So far, the U.S. has lost neither its ability to produce semiconductors nor its capacity to manufacture other advanced and economically competitive high- technological goods. Last year the U.S. produced an estimated $227 billion worth of electronic products, including $580 million worth of supercomputers that are widely considered to be the world’s most advanced machines.

The problem is that under the relentless technological advance of Japan, the once unquestioned U.S. dominance in those areas has been seriously eroded. In the semiconductor field, the U.S. in 1982 enjoyed a 49.1% world-market share, while Japan had 26.9%. Now Japan is the No. 1 producer, with 45.5% of the $45 billion world market, while the U.S. has 44%. In the overall area of high tech, the news for the U.S. has been even more depressing. In 1980 the U.S. ran a record $27 billion trade surplus in those advanced products. Last year, for the first time, the American high-tech balance became a deficit of $2.6 billion. Says the Woodrow Wilson Center’s Prestowitz: “It used to be that we could say America should be moving into the future. Now we are finding out that we don’t have a future.”

That considerably overstates the case, but many others have taken even more alarmist positions. In February a high-level advisory panel, reporting to Defense Secretary Caspar Weinberger, issued a study that warned of the imminent demise of the U.S. semiconductor industry unless immediate action was taken to save it. Among other things, the panel called on the Defense Department to invest $2 billion during the next five years in microchip research and development.

None of that concern entirely explains the fireworks that have erupted over the complicated U.S.-Japanese microchip agreement. The crisis actually began in the early 1980s, when both U.S. and Japanese semiconductor manufacturers, anticipating a substantial jump in demand, vastly increased their capacity for production of the microchips that are used in small numbers in personal computers and in much greater numbers in more complex machines. Instead came a two-year slump that drove down the price of the industry’s most important item, the 256K DRAM (dynamic random access memory) chip, from nearly $40 to as little as $2. U.S. manufacturers charged that the Japanese continued to advance their market share in the field by selling the chips at less than cost, a practice known as dumping (see box).

Under the July semiconductor pact, Tokyo agreed to abide by so-called fair market values for microchips set by the U.S. Department of Commerce. Japanese manufacturers could not undercut those prices in the U.S. market without violating American antidumping laws. Tokyo also made a commitment to prevent dumping by Japanese semiconductor producers in other, so-called third-country (non-U.S. and non-Japan) markets, and to encourage Japanese companies at home to buy more foreign-made chips, meaning, by and large, those made in the U.S.

Yet almost as soon as the agreement was signed, the U.S. began charging that it was being violated. The main culprits, in Washington’s view, were Japanese manufacturers who continued to dump semiconductors, either directly or through middlemen, in such Asian markets as Hong Kong, Taiwan and Singapore. Washington was as sure of that activity “as I’m sitting here,” declares Commerce Secretary Malcolm Baldrige. In January the Reagan Administration privately warned Japan that some kind of retaliation was likely unless the practice stopped. Washington finally conducted an investigation and satisfied itself that dumping had taken place. The Administration’s preliminary finding is that there has also been no increase in Japanese purchases of foreign microchips.

Finally, the day before President Reagan announced the sanctions, the decision was endorsed by the White House’s twelve-member Economic Policy Council, a Cabinet-level body chaired either by the President or, in his absence, by Treasury Secretary James Baker. With Baker in charge, the council fretted considerably over its decision. According to one Administration insider, there were sharply differing views about the value of the semiconductor agreement in the first place. Nonetheless, the group reluctantly agreed to go ahead with retaliation.

Much about the semiconductor pact is indeed questionable in economic terms. Among other things, it raises the costs of American manufacturers who use the devices to build computers and other products, thus making them more vulnerable to foreign competition. But to U.S. trade officials, the evidence of alleged Japanese dumping and Japan’s refusal to open domestic semiconductor markets were the last straw. For one thing, the ink on the semiconductor agreement was barely dry before, in Washington’s view, it was being ignored. For another, that Japanese behavior seemed to U.S. officials to be part of a familiar Japanese attitude toward trade issues: delay followed by nominal agreement followed by intransigence.

The American list of similar complaints on that score is long. In the past ten years, Washington has pressed mightily to open Japanese markets to such exports as beef, oranges and even U.S.-made baseball bats for a baseball-mad country. In almost all those situations, the U.S. has eventually succeeded, at least to some extent. Last October, for example, Japan agreed to open its cigarette market to U.S. manufacturers by suspending its 20% tariff on that product. American cigarette manufacturers estimate that their market in Japan will quintuple, to an estimated $1 billion annually. But in every such case, contends an Administration official, “we have had to land the full power and majesty of the Government on the Japanese. Every single thing is a fight that gets up almost to the Cabinet level.”

Adding to the frustration is a backlog of other trade irritants that could continue to flare up. One is Japanese reluctance to allow U.S. bidders to compete for a slice of the country’s premier construction project, the $6.5 billion Kansai international airport now under construction near Osaka. Another is the long-standing American complaint that the Japanese have not been buying enough U.S. auto parts. Particularly galling to the U.S. was a statement attributed to MITI Official Kuroda to the effect that American supercomputer manufacturers were wasting their time trying to sell the advanced machines to the Japanese government and universities. So far, Minneapolis-based Cray Research has managed to sell only seven of its supercomputing systems (cost: $2.5 million to $16 million each) in Japan over the past eight years. All but one of the sales were to private Japanese companies.

According to Commerce Secretary Baldrige, the new U.S. sanctions ensure that there will now be a “different bargaining atmosphere in the future” and, he added, a “much healthier one.” Whether that proves to be true, some Japanese opinion molders, amid the rush to smooth over the incident, were thinking about the longer-term implications of the U.S. action. Japanese business leaders, notes Kimihiro Masamura, an economist at Tokyo’s Senshu University, “are not aware of the extent of the impact they have had on their foreign competitors over the past several years. Now the Japanese have no other choice but to think globally.”

However, for many other, more ordinary Japanese, the U.S. sanctions were both a puzzlement and a frustration. Says Kenji Hatakenaka, 38, a project- development manager at Sharp electronics: “It’s hard for me to see what’s really behind this. Japan doesn’t pose the kind of threat you would expect to provoke such a reaction.” Hatakenaka claims that the Nakasone government’s efforts to boost consumption in response to U.S. pressure are running into resistance at the rice-roots level. Says he: “The government tells us to spend, but with currency instability everyone feels it’s safer to save. The government says, ‘Buy that TV today,’ but we’d rather wait until the price comes down.”

In some cases, Japanese dismay at the sanctions is also taking an unpleasant turn. Surveys by Prime Minister Nakasone’s office show a conspicuous decline in Japanese affections for the U.S. The most recent sounding in October revealed that 67.5% of the sampling felt themselves to be friendly toward the U.S., down from 75.6%. The October reading was the lowest pro-American result since the prime ministerial surveys were started in 1978.

For Nakasone, a more important question is how many Japanese are still friendly toward him. The answer may be not many. The Prime Minister will know better after nationwide local elections on April 12, when he and the ruling Liberal Democratic Party are now expected to take a drubbing. The main reason for that is not the U.S. trade dispute but Nakasone’s announced decision to impose an unpopular 5% national sales tax. Nakasone has not made a single appearance on behalf of local candidates — because no invitations were extended to him. Jokes one Tokyo academic: “If President Reagan is a lame duck, our Prime Minister is a dying duck.” Nakasone probably did not feel any better after U.S. Trade Representative Yeutter told a Senate Finance Committee hearing that he could not understand why Japan was planning to introduce the value-added tax. Replied Japanese Government Spokesman Masaharu Gotoda: “The tax system is our country’s internal affair.”

U.S.-Japanese trade difficulties, not to mention relations between the two countries in general, may become slightly frostier after the Prime Minister leaves the scene. Observes Larry Niksch, an Asian affairs specialist at the Congressional Research Service: “Nakasone and Reagan have been the glue that has kept the relation close. Below them there is a good deal of animosity on both sides. That could cause serious damage later.”

The harsh fact is that the effort to manage relations between the close friends and allies cannot improve while the U.S. trade balance remains so badly out of kilter. This year many economists foresee no more than a $30 billion improvement in the trade deficit, and quite a few see less. Even worse, the U.S. trade balance will have to improve more than the current deficit indicates because the country is now an international debtor. In the current issue of the quarterly Foreign Affairs, Harvard Economist Martin Feldstein, a former chairman of President Reagan’s Council of Economic Advisers, estimates that during the 1990s the U.S. will need to generate $60 billion annually just to repay the interest and principle on its burgeoning foreign debt. According to Washington Economist Bergsten, the pressure will thus be on to create a $200 billion improvement in the American trade balance. That is liable to add to the considerable trade ferment on Capitol Hill. As Senate Majority Leader Robert Byrd puts it, “It is time to make more pragmatic use of our leverage.”

That pressure will be borne not just by Japan but by all of America’s trading partners. Fear of U.S. protectionism is a considerable motivation, for example, behind Canada’s desire to conclude a historic free-trade agreement with Washington that would remove tariffs and most other trade barriers between the two countries during the next 15 years or so. President Reagan was to endorse that effort once again in a meeting with Canadian Prime Minister Brian Mulroney on a one-day state visit to Ottawa this week. But other close U.S. allies fear they may eventually be left out in the cold. Says a top European Community trade official in Brussels: “What worries us is that the U.S.-Japanese trade deficit will be balanced on the backs of the Europeans.”

Avoiding that kind of protectionist debacle will take considerable American self-discipline. Among other things, policymakers must speedily reduce the federal budget deficit, which has fueled so much excess U.S. consumption. But there will also have to be considerable changes in U.S. corporate and educational culture. American businessmen, who have traditionally paid most of their attention to domestic markets, must become more aggressive in going after foreign sales. American managers also need to take a leaf out of Japanese manuals about greater worker involvement in product quality control. The U.S. education system needs vast improvement before it can produce blue- collar graduates on a par with Japanese production workers. If U.S. businessmen want to penetrate foreign markets, there will have to be much greater emphasis in U.S. schools on the successful learning of foreign languages.

More, rather than less, openness in both the U.S. and Japan would also help. Japan’s need to reinvest its surplus cash is one impetus driving the country ever closer to the U.S. Another is Washington’s need for Japanese funds to finance the budget deficit. Notes Goldman Sachs’ Hormats: “Japan and the U.S. are locked in an embrace from which there is no escape. It may create some discomfort, but there is no longer any way out of it.”

The question remains of how much discomfort — not to mention occasional pain — may be involved. If, as the Reagan Administration hopes, the semiconductor skirmish spurs Tokyo to more urgent efforts to settle trade disputes, it will have served a useful purpose.

The history of trade sanctions, however, shows how dangerous commercial conflicts can be. One sobering example dates back to 1941, when the U.S. and other Western powers imposed sanctions on the export of iron and manganese to Japan for its incursions into Manchuria. That embargo played a role in the Japanese decision to attack Pearl Harbor. Nothing remotely similar in the way of hostility, of course, looms in the current trade battle. But as the two sides confront each other, they need to be acutely aware that deep antagonisms over trade can often contain the seed of future disaster.

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