Until Japan Reinvents Itself, Only a Results-Oriented Policy Will Work : Trade: Critics of this approach are working under the false premise that it has a standard market economy.

With today’s summit between President Clinton and Japanese Prime Minister Morihiro Hosokawa in mind, several editorialists and academics have attacked the Administration’s results-oriented “framework” negotiations as protectionist managed trade and have called instead for reliance on traditional macroeconomic tools to solve the trade problem with Japan. They couldn’t be more wrong.

These commentators begin from the dual premise that Japan’s is a normal market economy and that the problem is the size of the U.S. trade deficit with Japan. They make four major points:

* In a world of multilateral trade, bilateral balances are unimportant.

* The size of the U.S. trade deficit with Japan is due to high consumption and low savings rates in the United States coupled with the reverse in Japan. In particular, the trade deficit is largely a reflection of the U.S. budget deficit, which by stimulating the economy sucks in imports.

* The solution is not sectoral negotiations over such things as auto parts and insurance, but stimulation of the Japanese economy (so that it will suck in imports) coupled with deficit reduction here.

* Management of the exchange rate to strengthen the yen and weaken the dollar should reduce the deficit by making U.S. goods less expensive in Japan and Japanese goods more expensive in the United States.

While superficially convincing, under closer examination this analysis is misleading. The fact that Japan’s most powerful politician, Ichiro Ozawa, has written a book urging Japan to become a “normal country” is a powerful indication that Japan’s is not a standard market economy.

The editorialists’ criticism that the Administration’s insistence on measurable results in various industries will lead to heavy-handed management or cartelization of the economy is valid only if such management does not already exist. But recent scandals in Japan have demonstrated that despite years of insistence by top Japanese leaders that such industries as construction and finance were completely open, in fact they were completely rigged. Indeed, in some cases, the same bureaucrats who insisted that Americans should just try a little harder were precisely the ones who winked as Japanese brokers guaranteed their major corporate clients profits on their stock-market transactions.

Even when the Japanese do import, as in the case of coal or agricultural commodities, the importers form a buying monopoly to exert maximum downward pressure on prices. This in not exactly what Adam Smith had in mind.

Just as Japan’s is not a standard market economy, so the problem is not merely the size of the trade imbalance. Among the most important U.S. exports to Japan are unprocessed logs, scrap aluminum and waste paper. Theoretically, we could cut down enough trees and gather up enough empty soda cans and scrap paper to balance these accounts. But doing so while being locked out of Japanese markets for telecommunications equipment, medical devices and sophisticated services would not be acceptable to most Americans.

While bilateral imbalances are not normally cause for concern in a multilateral system, our deficit with Japan is so large, has persisted for so long and is so similar to imbalances Japan maintains with its other trading partners as to suggest something amiss in the trading system.

The savings and budget-deficit arguments are also misleading. Although overall, savings and investment rates and budget deficits dictate the size of a nation’s trade balances, these factors have nothing to do with the size and shape of a particular bilateral balance. Factors such as trade barriers, collusive business arrangements and regulatory strictures predominate here.

The proof of this is the fact that Japan has a trade surplus with countries such as Singapore, which have higher savings rates and even greater budget surpluses than Japan. But the U.S. budget deficit has fallen by nearly $100 billion in the past year, yet the trade deficit with Japan has soared. Obviously the conventional explanation doesn’t work in a bilateral context.

Nor will the conventional prescriptions of fiscal stimulus and exchange-rate manipulation work either. The structural factors that make Japan’s economy unique also result in a low propensity to import. This and the large gap between export and import levels means that an impossibly large stimulus would be necessary to reduce the trade surplus significantly.

There are also limits to the potential effect of a stronger yen. Based on current propensities to import in both the United States and Japan, an exchange rate of 60 yen to $1 would be necessary just to halve the current bilateral U.S. trade deficit. But at such a level, world financial markets would be in chaos, and it is extremely unlikely to occur.

The only real solution is to change the propensity to import in Japan, and that means changing the structure of its economy. While it would be nice if the Japanese government and industry would recognize this and act accordingly, until they do, the Clinton Administration has no choice but to keep pressing for concrete structural changes that yield measurable results.