U.S.-Japan Economic Relations in the Aftermath of the Global Crisis

Date June 14, 2010
Speaker William W. GRIMES(Associate Professor of International Relations, Director of the Center for the Study of Asia, Boston University)
Moderator KURIHARA Jun(Liaison Officer, RIETI / Senior Fellow, Center for Business and Government & John F. Kennedy School of Government, Harvard University)
Materials

Summary

William W. GRIMESWilliam W. GRIMES
My presentation today is based on a paper that I am writing for a conference volume that is looking at U.S.-Japan-China triangular relations. The basic question it addresses is how U.S.-Japan economic relations have shifted in the wake of the global financial crisis. There has been a great deal of discussion lately about the U.S.-Japan-China triangular relationship, the G20, global governance, and the overall U.S.-Japan relationship.

In all of these areas, it is easy to be drawn into the details of current events, but if we take a step back and look at the broader relationship, my contention is that U.S.-Japan economic relations have shifted surprisingly little in the wake of the global financial crisis. If I am correct, this seems to be an important phenomenon to explain.

There is a variety of evidence that demonstrates the low level of bilateral frictions. For example, if we look at the number of trade disputes, specifically at the U.S. International Trade Commission investigations, there are 12 investigations ongoing of which 11 concern China. Looking at International Trade Administration data on anti-dumping and countervailing duties, of the cases that were initiated in 2008, 15 out of 22 concerned China, 21 out of 34 concerned China in 2009, and in 2010, all four cases so far concern China. In contrast, there have been no anti-dumping or countervailing duties investigations against Japan since 2007. Presumably, this has mostly to do with the things that Japanese firms are producing and the fact that the Japanese exports are not growing at the same rate as the Chinese exports, but it also points to the general fact that the U.S. and Japan have a very stable relationship.

The reason I say that such positive U.S.-Japan economic relations appear to be surprising is because many have argued that U.S.-Japan economic relations should deteriorate, based on a combination of evolutionary changes and critical junctures. A key trend is that Japan's pattern of interdependence has been shifting in terms of trade and FDI toward East Asia in general and China in particular. This trend has been buttressed by growing regional cooperation within East Asia in the form of ASEAN+3 financial cooperation and a variety of FTAs. ASEAN+3 has embarked on an ambitious program of financial regionalism that has consciously excluded the U.S. and that seeks to reduce dependence on the U.S. dollar and dollar intermediated financial markets. Finally, the rise of China is the third long-term trend that should have an evolutionary impact on U.S.-Japan economic relations.

In addition to these trends, recent years have seen major events that could easily be seen as potential critical junctures. These include large-scale electoral shifts in the U.S. in 2008 and Japan in 2009. Many in Japan have traditionally feared the effects of Democratic administrations on U.S.-Japan trade politics, raising the possibility that the 2008 elections would bring about new U.S.-Japan trade frictions and place Japan under the microscope in terms of currency issues. Japan had an even more epochal election in 2009, and many on the U.S. side were convinced that Hatoyama meant to significantly shift the way in which Japan oriented itself.

Largest among critical junctures is the global financial crisis. This could easily have been a "perfect storm" in causing deterioration of U.S.-Japan economic relations. The global financial crisis was created in the U.S. due to U.S. policies, in particular policies that the Japanese have been criticizing for a long time as "excessive market fundamentalism." This contributed to efforts to advance regional cooperation as a safe harbor for such crises. Indeed, looking at the major regional policy responses to the current financial crisis, there has been an acceleration of the ongoing process of improving regional cooperation. This is best symbolized by Chiang Mai Initiative Multilateralization (CMIM). While the reality of CMIM is not as significant as it has been described, it is still significant.

I argue that there are three primary reasons why the U.S.-Japan economic relationship has not been harmed despite these shifts: common interests, the weakness of regionalist alternatives and the role of China. On common interests, in terms of every major economic concern except for "excessive market fundamentalism" as it pertains to financial regulation and supervision, Japan and the U.S. have very similar interests at this point in time. The companies of both countries are increasingly dependent on global supply chains, are competitive at the high end, want to protect intellectual property, want to invest safely and without excessive restrictions, and want to move money easily across borders. Looking at the panoply of issues, Japan and the U.S. have very similar interests, except in a few obvious areas like dealing with macroeconomic imbalances, dealing with climate change and, to some extent, financial regulation. However, the Obama administration has started bringing Japan and the U.S. closer in each respect. Even in finance, whatever the rhetoric is, the Japanese government has been very much in favor of maintaining a system that is open, promotes competition, but has some sort of buffers on it. In a sense, then, there is empirical backing for the Abe administration's much-derided concept of the "Arc of Freedom and Prosperity."

The second possibility as to why U.S.-Japan economic relations have not suffered has to do with the practicality of regional alternatives. There is much talk about the potential for regional cooperation, and financial regionalism has been seen as a means of reducing the dependence on U.S. dollar-based markets, U.S. financial markets and irresponsible U.S. macroeconomic policies. The idea of a regionalist alternative has been an attractive one. In fact, however, this alternative will be very difficult to achieve and there are a variety of problems that have arisen that make it impossible to rely on regionalist alternatives to the dollar-based system. Thus, regional cooperation is simply not a substitute for global cooperation.

When looking at financial regionalism, the extent to which this is a global story is striking. Looking at the old working groups of the Asian Bond Markets Initiative, for example, most have to do with how to get local currency bond markets in emerging markets in East Asia to adopt global standards correctly. The reason is simple.: if a country does not meet global standards, money can go elsewhere. The Chiang Mai Initiative fundamentally relies on the IMF as the trigger. Even though there has been a shift away from a series of bilateral swap agreements to something that looks very much like a regional solution (some would say an "Asian Monetary Fund") as well as gestures toward effective surveillance, in the end, the reliance on the IMF remains. Soon after the Asian financial crisis, there were convincing arguments made about it being a different kind of crisis, so the region had to create a different type of early-warning system. This makes sense, but it has proved very difficult, if not impossible, to implement. This regional story points to the essential nature of U.S.-Japan financial cooperation in the context of the G20 and the Financial Stability Board.

On the G20, the fact is that financial regulation is still going to be made by the biggest financial markets including the U.S., the EU, UK and Japan. There will be a certain amount of policy pluralism and developing countries are likely to have different standards apply. However, in terms of a global solution, the Japan-U.S. relationship is still fundamentally important, more so than the Japan-China relationship. Japan-China relations are generally challenging and the two countries have different economic interests in many respects.

Although there are some common economic interests, the regionalist alternative is fundamentally limited by political and economic cooperation. The basic challenge is that enforcement is very difficult. In order to effectively change the behavior of any group, there must be rewards or punishments. Creating a system of rewards and then enforcing them is hard to do for a number of reasons. In the post-war environment, Japan has never really "punished" a neighbor and, indeed, has gone to great lengths not to do so.

Finally, the role of China must be thought of in a variety of ways. Economic cooperation between Japan and China is good for both countries as well as the rest of the world, but the fact is that there are also potential political and security threats. Japan and China remain rivals and in the long term, the only alternative for Japan to ceding regional leadership to China is a strong U.S.-Japan relationship. Luckily, since our economic interests are so closely aligned, this would not be a painful thing.

There are also questions regarding Chinese behavior. One concern is whether Chinese mercantilism is on the rise. China has been very obstinate about its exchange rate, and this is becoming a larger problem since it is feeding imbalances and large Chinese foreign exchange reserves. Also, the Chinese government has a substantial role in foreign markets. Most of the big and internationally active companies in China are state-owned enterprises. Their ability to move around the world is at least partly based on Chinese mercantilism. In the long term, CIC, the Chinese sovereign investment fund, is likely to be of concern to China's neighbors as it invests in regional companies.

Meanwhile, China has implemented a variety of domestic policies that have created concerns among foreign-invested firms. An example is the indigenous innovation requirements for government procurement, which have brought about an uncharacteristically strong reaction from U.S., European, Japanese, and Korean firms. Other problems include administrative murkiness, weak rule of law, export subsidies and cyber hacking.

The final point is the question of whether China can be locked into existing global rules and institutions. This has been one of the fundamental strategies of many of China's partners and neighbors over the last 20 years. The idea has been that by bringing China into the international system, it will be locked into existing rules and institutions. This has been successful to a considerable extent, as symbolized by Chinese membership in the WTO and G20. However, it is also true that many Americans and Japanese were engaging in wishful thinking in this regard. Locking China into existing institutions is not the same as locking China into existing rules. Their continuing mercantilist behavior raises the questions as to how China will behave as a rule maker. Robert Zoellick famously called for China to become a "responsible stakeholder." However, it is important to realize that in the end it is China that will be the one to judge whether it is being a responsible stakeholder or not, regardless of about others' definition of the term. These issues have reminded Japan that as China gets more involved internationally, the common economic interests it shares with the U.S. become more and more important.

Questions and Answers

Q: Have the rules regarding U.S.-Japan economic relations changed, or are they same and the players are simply not playing by the rules?

William W. GRIMES
The rules of the game have not changed; fundamentally, the players have changed. Taking a broad view, there have been no changes in first principles. Japan and the U.S. have increasingly adhered to and maintained a strong interest in the existing rules of the game. At times, they have competed over preferential access to FDI in third countries. One of the things that is striking about FTAs is that the actual benefits of free trade are minimal, while the relative benefits of investment are considerable where one country has preferential treatment, but another one does not. Even in financial issues, the principles of liberalization, competition, financial innovation and openness are still there. These principles have to do with the interest of Japanese, American, and European financial institutions and investors on one side, and other countries that need to be accommodated differently to prevent problems on the other.

Q: China's mercantilism is definitely on the rise, and Japan and the U.S. need to fight against it. If effective discipline is needed, the WTO rules are the source.

How realistic is a regional FTA arrangement like the ASEAN+3FTA, ASEAN+6FTA or the like?

William W. GRIMES
I do not know the answer to that as I have not looked closely into FTAs. However, I think that having such FTAs would be extremely difficult because it would be very hard to get China to agree to an FTA with Japan. It is also not easy to get Japan or the U.S. into FTAs with anybody at this time. There are huge complications with any of those FTAs. Also, it is not clear what effect these kind of FTAs would have.

Q: Trade frictions between the U.S. and Japan have frequently centered on automobiles. Is the U.S. equipped to compete with Japan in the new age of electric, hybrid, and energy efficient cars?

William W. GRIMES
I know even less about cars than I do about FTAs. It is probably correct that U.S. automakers are behind in terms of electric and hybrid vehicles. It is yet to be seen whether this becomes a trade issue, but when sudden shifts are seen in competitiveness, that is where trade frictions occur. I have been predicting for a number of years that U.S.-Japan trade frictions will mostly disappear, and that has been happening since the shares of incumbent firms have more or less been locked in place, as compared to the rise of Japanese automakers in the 1980s.

Q: This presentation talked about U.S.-Japan economic relations and China, but the broader elements of the U.S.-Japan relationship were not touched upon, including security issues. Also, economic relations can be split into economic activity between firms and individuals, and economic policy interactions that happen at a governmental level. What has been seen is a fundamental change in the understanding of U.S.-Japan economic relations. There is a sense that Japan's eternal premise that they can rely on the U.S. for security and economic linkages has been fundamentally shaken and a fundamental rethinking is going on in Japan.

William W. GRIMES
I agree that the security relationship and the economic relationship cannot be fully separated. I would like to find out more about how the Japanese now view the U.S. security guarantee. Japan has four choices from a security perspective. One is to believe that the security dilemma has been eliminated. The second is to accept Chinese hegemony in the long term. The third is for Japan to expand its own autonomous defense capabilities by going nuclear; this is clearly not the case. This is due not only to Japan's nuclear allergy, but its slowly decreasing defense budget. The fourth option is to continue to rely on the U.S. security guarantee. For the U.S., Japan is unavoidably important in terms of its global interests. There is no movement to accept China as a hegemon yet and it does not seem likely in the near future.

When looking at the regional cooperation strategy of Japan, there is an interesting dichotomy. In economic terms, Japan has long understood that it needs to reduce its dependence on the U.S. economy in a variety of ways. Japanese officials understand that historically, when imbalances have been large enough to require an adjustment, Japan has been particularly vulnerable. Japan has been looking to hedge economically against this excessive dependence on the U.S. On the other hand, from a security point of view, the opposite is true: Japan is trying to hedge against the rise of China. This has always held the U.S. and Japan together.

Q: It seems that there is a lack of a two-way free flow of exchange between the U.S. and Japan since the final moments of LDP rule. All of a sudden, the accession of the Hatoyama Administration brought on different opinions, which dismayed people on both sides. For the first time in years, Americans have recently responded that China, not Japan, is the U.S.'s most important partner in Asia. How do you assess such slight but significant change?

William W. GRIMES
The polling data are an indicator of a few things, but it certainly points to a sense in the U.S. that China is something that needs to be addressed very closely. The reason why there is so much attention to China is for mixed motives. There is a great deal of interest in the possibility of China. There is a great deal of interest in how the U.S. and China can work together and how companies and people can benefit, but the reason why China is on everyone's minds is also because there are frictions, imbalances, military provocations and the like. The sense of China being a problem that needs to be addressed is very large among the U.S. public and things are actually going fairly well between Japan and the U.S. Too much should not be read into the importance afforded to China because it is a combination of positive and negative.

Regarding the lack of free flow of information, this is a significant problem, but it is a problem that can be fixed. The DPJ was an opposition party that had only a small number of internationally-oriented members who were focused on U.S.-Japan relations. When the DPJ actually took power, many of those people ended up being on the periphery. There were growing pains, but the DPJ is going to be a dominant, if not the dominant, party in the foreseeable future. It appears that the LDP is dying and unless there is another DPJ breakup, the DPJ is here to stay. So the U.S. too must improve its ability to work with the DPJ. Both sides are already investing significantly in improving those lines of communication. There is not much need to worry on this point.

I believe that the arguments that I have made as to why U.S.-Japan relations need to be maintained are very convincing, but they bear repeating even though they are obvious, because so many observers have been focused on specific frictions, in particular those relating to security. I am optimistic that the natural stabilizing factors of the U.S.-Japan relationship that have developed over the last several decades are at a level that will keep the relationship strong.

Q: Your argument on how to make China a responsible shareholder or how to make the U.S. and Japan cooperatively contain China as a status quo power allows a lot to be done in energizing the debate on how to develop a global framework for such things as a green economy, how to develop a code of conduct for FDI that is closely related to national security or state-owned enterprises and how to develop enhanced transparency for military cooperation. There has been much discussed between the U.S. and Japan, but bureaucrats have been too busy to release such information to the public. Thus, suspicious parties like the SDP might raise questions against both the U.S. and Japan. It might be the task of political scientists on both sides to discuss clearly about what kind of division of labor for developing a free flow of information should be done.

William W. GRIMES
That is a great challenge for our time: how to accommodate the rise of China in a way that is mutually profitable to everyone. We all talk about how we understand that China is going to be a part of the rulemaking, but we do not know what that means. Some of it is wishful thinking, but certainly the types of things that you are mentioning are things that I would agree with very much.

*This summary was compiled by RIETI Editorial staff.