Can We Get Out of Trade Mess? : U.S. and Japan Must Face Music and Correct Failed Policies

The trade imbroglio with Japan was a crisis waiting to happen.

Last week Washington announced penalty tariffs on Japanese electronic products in response to Tokyo’s apparent failure to enforce a semiconductor agreement concluded last July. The escalation of this dispute in turn undercut the fragile cooperation between Treasury Secretary James A. Baker III and Japanese Finance Minister Kiichi Miyazawa on stabilizing exchange rates. So the yen soared, Tokyo and New York stock markets plunged and “trade war” headlines now abound.

Immediate attention in both capitals has focused on semiconductors--their importance to each nation’s technological and industrial leadership, whether last July’s agreement was wise, whether the Japanese have violated it, whether the specific American sanctions were appropriate, whether they will lead to counterretaliation and a trade war. But the roots lie deeper, in the egregiously unbalanced economic policies pursued by both Washington and Tokyo.

For half a decade now the United States has been running federal budget deficits well above $100 billion--and peaking last year at more than $200 billion. We have borrowed increasingly from abroad to help finance these deficits. This inflow of funds drove the dollar’s value upward in 1982-85; that plus rapidly expanding U.S. demand triggered an unprecedented rise in imports. The value of what Americans bought overseas reached nearly twice what we sold. This trade imbalance in turn skewed the balance of U.S. trade politics as firms hurt by imports pressed the Administration and Congress to toughen U.S. trade policy.

Meanwhile, Japan was doing the opposite, persistently reducing its budget deficit. Given the high Japanese savings rate, this meant more funds available for lending abroad, which has helped us finance our budget imbalance. And just as American fiscal loosening produced record trade deficits, Japan’s tightening led to an enormous trade surplus--the largest that the world has yet known. This in turn brought intense political pressure on the Japanese policymakers. But for them the heat has come from abroad, as Japan’s trading partners see an economy relentless on exports and “closed” to imports.

Since 1985, exchange rates have swung back sharply, encouraged initially by the governments of the leading industrial nations and continuing as the trade imbalances persisted. For Japan this has meant stagnation in the volume of exports and a rise in the volume of imports. Loss of the stimulus from increased foreign sales--measured in yen--has driven Japan’s economy toward recession, but the government has continued to tighten fiscal policy. And Japan’s dollar trade surplus has continued to grow. For the United States the dollar’s decline has stopped the trade deficit from getting worse, but has not yet shown the hoped for improvement. And we have made only modest progress on our budget deficit.

With overall trade still skewed, and both governments feeling squeezed economically and politically, conditions were ripe for an explosion on whatever product issue was most prominent. Along came semiconductors, a product on which U.S. and Japanese producers compete all over the world. U.S. negotiators, responding to evidence that Japan’s domestic and international semiconductor marketing was at variance with liberal trade principles, last summer forced on reluctant Japanese counterparts an agreement that breached these principles--setting minimum prices in America and third-country markets, and setting market share targets in Japan. Tokyo’s enforcement of this complex agreement proved wanting--mainly because government did not get firms to reduce production sharply enough, soon enough.

The U.S. Administration, frustrated in other Japanese market negotiations--supercomputers, telecommunications, rights to bid on construction of the Kansai airport--was under strong domestic pressure to retaliate now lest Congress enact legislation requiring such action in the future. It did so.

Now that we are in the same mess, how do we get out? Immediate negotiating attention is focused on semiconductors, with the Japanese seeking removal or modification of the punitive tariffs before Prime Minister Yasuhiro Nakasone’s forthcoming visit and the Americans determined to keep them on until they win desired changes in computer-chip markets. Far greater is the need for both nations to adjust their broader economic policies. Japan must loosen its budget to provide new stimulus for the economy and increase demand for imports. The United States must stop spending beyond its means, through budget tightening and--alas--increased taxes. That is the road to attacking the trade imbalance without descending into trade war or plunging into recession.