Turning Trade Friction between Japan and China into a Win-Win Game

C. H. Kwan
Senior Fellow, RIETI

A boom in imports from China has given momentum to calls for safeguards and other import restrictions. If such restrictions widen from agricultural to manufactured products and precipitate a trade war between the two countries, an enormous burden may be imposed not only on Japanese consumers but also industry. Safeguards are certainly a right granted under the WTO Agreement. But they not only run counter to the spirit of free trade, but also against the goal of "structural reform without sanctuary," which the Koizumi administration is seeking to push through.

To revitalize its economy, Japan should adopt a strategy that combines the relocation of sunset industries overseas and the fostering of new domestic industries-in other words, industrial upgrading without hollowing-out. As part of this strategy, Japan should aim to use the dynamism of the Chinese economy in building an international division of labor, based on comparative advantage.

The first round of trade friction between Japan and China started in April 2001 when Japan instituted provisional safeguard measures on three agricultural products-scallions, shiitake mushrooms, and rushes for tatami mats mainly imported from China. In response, China has retaliated by imposing special tariffs on cars, mobile phones and air conditioners imported from Japan. Meanwhile, a succession of petitions for safeguards and anti-dumping measures has already been issued from industries including eels, wakame seaweed, timber, towels, and short-staple polyester, primarily targeting Chinese products. The number of products on this list is increasing day by day.

When discussing the pros and cons of import restrictions, it is vital to go beyond the particular products or industries being protected to examine the interests of the country as a whole. If safeguards are instituted on Chinese products, this will not only hurt Chinese producers and Japanese consumers, but will also hurt the efforts of those many Japanese companies engaged in business with China. Such a policy would effectively rescue businesses that have lost to competition and place the resulting burden on the winners; the pursuit of "equality of outcome" could discourage innovation and obstruct domestic structural reform. Moreover, given that Japan is China's biggest trading partner, while China is Japan's second largest trading partner after the United States, any escalation of trade friction will have a serious impact on industries in both countries.

To avoid this situation, in instituting safeguard measures, the authorities should strictly observe the WTO rule, which states that the time limit for safeguard measures (in principle, up to four years) cannot be extended, as well as the principle of "restricting application of such measures to those products viewed as likely to regain their competitiveness or where domestic industry adjustment is likely to occur through some other mechanism during the period of safeguard application" ("Basic concept on Safeguard Measures," the Sub-Committee on Special Trade Measures, Industrial Structural Council). This means that once the term is over, the principle of competition will be enforced, including market-exit by losers.

Abusing safeguard measures would damage Japan's credibility in the international community as a proponent of free trade. China and other countries have already warned that Japan is leaning toward protectionism. Since the 1960s, the United States and Europe have thrown up numerous barriers, including tariffs and import quotas, against Japan as a new industrial power. Having battled against this discriminatory treatment, Japan now finds the shoe on the other foot, and it would be extremely unfortunate if Japan were to take the same sort of measures against China.

Building barriers against imports to protect domestic industry is only symptomatic therapy. Far from encouraging the improvement of the industrial structure, it could well slow the process. There are in fact no examples of sinking industries in developed countries that have recovered their competitiveness through government-instituted protection policies. For Japan to upgrade its industry while avoiding hollowing-out, rather than using import restrictions and subsidies to lock labor, capital, land and other resources into industries which have lost their competitiveness, we must eliminate those factors hampering productivity growth and focus on fostering new industries. This holds not only for the manufacturing industry; we should also seek to develop the service industry in response to the increasing use of information technology.

The maneuvering that led up to the Upper House elections in the summer of 2001 by certain Diet members affiliated with special interest groups has been highlighted as a key factor in the current trade friction. But the more fundamental issue is that the Japanese government and industry do not have a consistent strategy to deal with China's rapid catch-up. Industries competing with China will undoubtedly be hit by corporate bankruptcies and rising unemployment. Nevertheless there is still a major disparity between Japan and China in terms of development stage. The economic structures of the two countries complement rather than compete with each other. Both sides could gain enormously from working together.

This is borne out by the growing number of companies that are successful in combining China's abundant workforce and Japan's high levels of technology through direct investment, outward processing, OEM, and other means. As epitomized by the popularity of the Uniqlo brand, such management efforts are not only boosting the profits of the companies concerned, but are also offering significant merit to Japanese consumers through the increase in cheap, high-quality imports from China.

Japan urgently needs to find a way to realize its potential complementarity with China while avoiding trade friction. The WTO, which has just granted China new membership, should play a positive role in solving trade disputes between the two countries.

May 29, 2001

May 29, 2001