US-Japan Relations and 9-11: Taking Stock of US-Japan Security and Economic Relations

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I would like to start by making a couple of observations about US-Japan relations before September 11. One important date was March 19, 2001, which was when former Prime Minister Mori visited President Bush in Washington. This visit mainly focused on Japan's non-performing loans (NPLs) problem. The feeling was that Japan's was a systemic problem, not cyclical. The Ministry of Finance and Financial Services Agency were not pleased by the meeting's financial focus. Then Prime Minister Koizumi came in.

Also of mention is the Camp David meeting between Prime Minster Koizumi and President Bush. The two leaders struck a bargain. Mr. Koizumi merely asked Mr. Bush to bless his economic program for Japan and, in return, Mr. Koizumi backed away from the Kyoto Protocol for a couple of days.

Since September 11, Koizumi has been given emergency authority to send medics and ships to help in the US's war against terrorism. But Japan's contribution is frankly trivial when it comes to the war. The Japanese contribution to rebuilding Afghanistan will be much more significant. But the key issue for Japan is the specter of financial meltdown. The September 11 attack on America gave Koizumi a way out from dealing with Japan's financial troubles; it gave him a chance to act Churchillian and to show the flag. But he should use his political capital to move ahead on economic reform. Japan's government gets distracted too easily.

As far as I am concerned, the Japanese government has engaged in systemic fraud: especially the outrageous failure by the FSA. The compounding nature is enormous. After September 11, the Nikkei Index went up: Mycal was allowed to go bankrupt. Mycal was important because there was a lesson: the command economy approach was a failure and there is no silver bullet for fixing Japan's economy. Japan must deal more credibly with the worst part of the country's NPL portfolio. We have to see how the market reacts. Japan has to think about generating positive shocks.

Recently, Minister of State for Economic and Fiscal Policy Takenaka and FSA Minister Yanagisawa made a speech on Japan's NPLs. They said that they needed more inspectors and a better understanding of the size of the problem. That was a typical bureaucratic approach-wanting a larger staff and more power. The plan to cut up Japan's NPLs into seven pieces, like a big sausage, and dealing with one piece at a time does not address the ongoing problems. Mycal was good because it was an honest, messy bankruptcy. The Japanese government is misclassifying and hiding from the problem. All of this has to do with September 11.

President Bush will be visiting Japan in February. I foresee Bush patting Japan on the back for its cooperation in the war on terrorism. But the focus will return to NPLs.

On security matters, September 11 has brought a lot to the surface: While much of the world supports the US, many are also dismayed that the US has never helped other countries when they were victims of violence and terrorism. Bush's reaction to the attack has defined his presidency, but it also puts a lot of pressure on other countries' governments. The US has had a tendency to walk around unconstrained and this has created tension.

The developed countries are the rich players and they are driven by shrewd calculation of national interest. This focus limits the scope of our interaction. The US believes the world wants to be just like the US. You need signals to create dignity for other countries. In my view, President Bush's team lost three opportunities: First, at APEC in Shanghai, the US failed to couple antiterrorism with responsibility. Second, at Marrakech, Japan committed to the Kyoto Protocol, but the US came up with nothing. Bush's tactics are what infuriated the world. Third, at Doha, while we now have a trade round forthcoming and Bush has trade promotion authority, we witnessed too much nickel-and-diming. We need a unifying element.

Finally, the September 11 attack has not changed the basic views of the left and right; it has just hardened them. The US government did not change its basic policies of pre-September 11. The US needs to signal that it will be more collaborative. Meanwhile, Japan must stop being distracted; it needs another John Maynard Keynes, with a new economic policy framework.

Q: What is your view on the Enron story? The US is supposed to have the most transparent system. What will be the impact of all of this?

The impact will be enormous and frustrating. The Enron experience should not de-legitimize deregulation. The fraud was in the derivatives. It will be difficult for the US to lecture other countries with a straight face. Japan has had the most successful corrupt society in the world. The small investors are the ones that got screwed by the Enron collapse. But the US market worked in the long run. Enron should have not been able to inflate a bubble in the first place. The impact will be that the US will not be able to say to other countries, "You need to clean up your corruption."

Q: The NPL issue is the most important in Japan. But it is not the only issue. Dr. Aoki of RIETI argues that there is an institutional transformation going on in Japan. As for the NPLs, they keep cropping up. Japan needs change in the real sectors, a credible inspection system, and a change in the financial sector (especially in management).

I agree. I focus on NPLs because I watched what happed three years ago-it was pure fraud in Japan. It collapsed again after Prime Minister Mori. METI's deregulation plan was very ambitious. But even in the US, each area of deregulation is a war. You cannot deal with 17 areas of deregulation, as METI has suggested. What is more, the USTR has over 100 items for Japan to look at for deregulation. It is too much and it will be a political failure. Instead, you should just pick two or three areas. I oppose the US's heavy handedness in Japan's financial policy. It gets in the way of the operation of interest groups in Japan. It is in Japan's national interest not to be another Argentina. Japan has to reward loan portfolio managers who do well. When you start to see consolidation in the construction sector, you will see what Koizumi is talking about. But at this point, he is keeping his job by not moving forward.

Q: How was Minister Takenaka's visit viewed in the US? What kind of approach is Bush taking toward Japan? We welcome good external pressure. Some in the US say that deflation makes dealing with the NPLs too difficult.

Minister Takenaka is brilliant. I am only critical of his notion that the FSA just needs some more inspectors. In the US, he is seen as an intellectual. Bush wants to create a good relationship with Japan. Koizumi gets a lot of coverage on CNN: They play the tape of him in the White House Rose Garden over and over. Bush wants to find allies in Japan. But the security players and economy players differ. The key players want a non-Clinton approach toward Japan. But it seems that no one is at the helm for Bush's economic vision. The deflation issue is old, but there are few options left. The best Japan can do is to muddle through. I don't worry about modest deflation.

Q: Before 9/11 Bush focused on China. Now terrorism is the key threat. How will the US's Japan policy develop?

Policymakers are using terrorism to deal with issues that they see as good for the country in general. How can we get more of what we want now in an environment of good will? That is what they are considering. The biggest change is that Secretary Rumsfeld has gotten more money to fund the Defense Department and possibly to redesign the Pentagon. People talk about the Powell-Wolfowitz battle in Bush's team. The fact is that there are many more Wolfowitzians in key positions than there are Powellites. I think it would be healthy if the US left Saudi Arabia; otherwise, you are going to have more anti-Americanism.

Q: How will China's discovery of several bugs on the Boeing airplane the US sold it change US relations in Asia? Do you see any future for a US-Japan free trade agreement? Are there any bright spots in Japan's real economy?

This US-China incident will open up the market for Airbus. Airbus will put its Asian office in Tokyo. The US is still shifting its big boat of foreign policy towards confrontation with China (a la Bill Kristol). Again, the Wolfowitzians are dominant. As for a US-Japan FTA, I liked Bruce Stokes's report. If you look at the Structural Impediments Initiative (SII), you see the roots of a positive opportunity. If you can create alternative structures, you can change the way economies interact. Too many cynics are preventing this from happening. In the real economy, I think Japan can move forward. The bureaucrats are now the reformers. You just need to get the LDP on board. You can have domestic demand creation-in sectors like housing and healthcare.

Q: Many people say that there are invisible barriers in Japan, so an FTA would not work. Is this still true?

Even after Easton got to sell their baseball bats in Japan, few people bought them because Japanese felt unpatriotic buying non-Japanese bats. But I don't subscribe to the invisible barriers idea. With greater transparency and price competitiveness, there are opportunities. I believe in embarrassing governments via the media when officials make bad policy.

Q: US-Japan relations are getting weaker. China is one reason. Meanwhile gaiatsu (outside pressure) is declining and expectations are low. Shouldn't the US and Japan collaborate on policy toward China?

I tell US industry, "You have to be in Japan to maintain status and profile." And I ask, "What if China doesn't work out?" Japan needs public debate on what is important for Japan. I would like to see the two countries more on par with each other.