94-04-01: U.S.-Japanese Trade Differences Must Not Undermine Basic Relationship Japan's lengthy recession has punctured its image of economic invincibility and further strained its trade balance with the United States, said Michael H. Armacost, ambassador to Japan from 1989 to 1993. Repercussions from the recession, Japan's longest since World War II, include stagnant growth, weak consumer demand, corporate losses, a sluggish stock market and plummeting property values, said Mr. Armacost, currently visiting professor at Stanford University's Asia/Pacific Research Center. He spoke on political and economic reforms in Japan and the tangled issues surrounding U.S.-Japanese trade negotiations at the third annual Cumming Diplomatic Forum in the Rotunda Dome Room March 8. "All growth between 1986 and 1990 was due to domestic investment. The minute the bubble burst, the Japanese began to rely on exports principally as a vehicle for escaping the recession. Exports are at record levels this year with a huge surplus of $130 billion," breeding animosity with trading partners, according to Mr. Armacost, who served as U.S. Ambassador to the Philippines from 1982 to 1984, followed by a five-year stint as Undersecretary for Political Affairs. Japanese business has been forced to consider "structural problems exposed by the recession," he said. "Lifetime employment, seniority pay, companies engaged in cross shareholding -- these features work when the economy is growing at 4, 5 or 6 percent. When growth is sluggish, they become luxuries. Corporate downsizing has become necessary. Companies are sloughing off their shareholding packages to reduce their losses. "Though Japan faces the same laws of economics that we do, these adjustments are more painful for them because these institutions have been important in maintaining social harmony and avoiding adversarial relationships with labor." Shifting gears the veteran diplomat said, "The Japanese economy is down, but by no means out." He cited the Japanese resolve to overcome economic adversity, their high savings rate and investment in research and development, their focus on production and ability to train young people to succeed in sophisticated, technological working environments. He predicted that Japan will benefit from the strong economic links it has forged with Asia through capital investment and technological transference. "The International Monetary Fund expects half of all world growth in the coming decade will come from that region," he said. How quickly the Japanese economy bounces back depends on political developments, he said. The Liberal Democratic Party, in control of the government since World War II, has been ousted, due to arrogant disregard for the people's demand for reforms coupled with public intolerance for recurring political scandals at a time when government policies were no longer fostering significant growth, explained Mr. Armacost. The new coalition government has promised electoral reform, deregulation of the economy and initiatives to stimulate domestic demand and rein in the overweening power of the bureaucracy, he said. "Politics is becoming more competitive. Issues are being brought out into the open for discussion." However, Mr. Armacost cautioned against underestimating the resistance of the conservative bureaucracy, which is used to ruling. "Prime Minister Hosokawa is trying to define new political aims for Japan, but I wouldn't bet on decisive victories over the bureaucracy." The United States' relationship with Japan is not defined exclusively by trade frictions, Mr. Armacost said. "The security relationship between Japan and the U.S. is not in jeopardy," he said. However, he did point out that the Japanese are concerned by President Clinton's obvious intent "to no longer subordinate our economic interests to larger strategic concerns" as well as their continuing concern about North Korea's nuclear capability, nationalist elements in Russia gaining power and China's growing defense budget. Regarding recent speculation in the London Times suggesting Japan has developed nuclear weapons, Mr. Armacost said he accepts the government's denial. "For a generation they have embraced a non-nuclear posture in close collaboration with the United States. Though they have the building blocks for a nuclear capability, I expect they will cling to this position thereby avoiding an acrid domestic debate." Commenting on recent Japanese and U.S. trade negotiations, he said, "the level of mistrust between negotiators is palpable; largely due to the focus of both countries' leaders on domestic matters. "Mr. Clinton approaches foreign policy with a sharp eye on the domestic effects of those decisions. He is convinced that our economic recovery is based on increasing our exports to Japan." American emphasis on numerical targets in the negotiations is a mistake that enables the Japanese to portray themselves as champions of free trade and Americans as proponents of managed trade, said Mr. Armacost. This stance serves to solidify the Japanese business community's opposition to U.S. trade proposals, he said. "Also, the Japanese could attempt to create anxiety in Europe and Asia by intimating that once we have struck a deal with Japan about market share, we'll try to go after them. "The imbalance on investment is greater than the imbalance of trade. The percentage of foreign-held assets in Japan is one-twentieth of what it is here," said Mr. Armacost, who believes this imbalance has not been stressed enough in trade talks. The U.S. should press the Japanese to alter their fiscal policy, Mr. Armacost said. "They can reduce their surplus only by investing domestically; they have the capability and the domestic support to do so. Mr. Armacost has a dim view of the value of economic sanctions because of the great likelihood of punishing ourselves in the process. The idea of raising the value of the yen is even less appealing to him. "It will prolong the Japanese recession and keep imports low. We have a stake in Japan's domestic revival. "We're working in complementary directions in policies that will have an effect on our trade balance over the long haul," said Mr. Armacost. "The U.S. has a budget reduction package that doesn't go far enough, but puts us on the right track. In the meantime the Japanese have put forward the biggest budget stimulus package ever, including a one-year tax reduction that they may decide to lengthen." International trade balance in services as distinguished from merchandise trade is frequently overlooked, according to Mr. Armacost. "The service trade, where the U.S. is especially strong, is generally unreported by as much as 50 percent. [Managing consultant] Peter Drucker thinks that the surplus we run in the service trades runs to two-thirds of the size of our deficit in merchandise trade." Financial service companies like Salomon Brothers, Inc., Goldman, Sachs & Co. and Morgan Stanley Group Inc., which operate in Japan, are more advanced in the technology of modern financial services than their Japanese counterparts, he said. In fact, American companies such as Procter & Gamble, Kodak, General Electric and Dupont are all doing well in Japan, said Mr. Armacost. "The key to success is developing distribution. We need direct access to the marketplace." Joint venture arrangements with local Japanese companies, even if temporary, offer one way of tackling this and other problems, such as staffing and land acquisition, he said. Mr. Armacost reminded his audience that Japan is a friendly, democratic country closely allied to the U.S. "It's difficult to imagine any problem that could be solved without our active collaboration. It's clear that if our relationship deteriorates not only our people but the whole world will experience the baleful consequences."