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Future Directions for
U.S. Economic Policy Toward Japan
Sponsored by the Council on Foreign Relations
Laura D'Andrea Tyson, Chair
M. Diana H. Newton, Project Director
CONTENTS
- Foreword
- Leslie H. Gelb
- Acknowledgments
- M. Diana H. Newton
- Executive Summary
- The Changing Economic Landscape in Japan
- Conclusions
- Recommendations
- Conclusions
- Task Force Report
- The Changing Economic Landscape in Japan
- America's Interest in a Strong Japanese Economy
- Japan's Record of Reform
- Signs of Backsliding and Fear of Commitment
- A Tale of Two Economies
- Task Force Policy Recommendations
- America's Interest in a Strong Japanese Economy
- Additional Views
- Task Force Members
- Task Force Members
During the last ten years, Japan has faced a difficult period of economic stagnation. Only now is the country showing preliminary signs of emerging from its economic slowdown. In response to its difficulties, Japan is gradually making changes to its traditional financial system. These changes are driven by Japan's desire to catch up with technological innovation and to resuscitate its economy. However, many of these reforms are controversial within Japan since they aim at the heart of traditional Japanese business practices. There are people both inside and outside Japan who perceive the reforms as happening too slowly. Others, however, fear the disruption and social dislocation of current and anticipated changes to the status quo.
These differing views have resulted in a domestic tension that permeates Japan's ongoing process of structural reforms. Although the controversy may cause the pace of reform to slow, the Council's Independent Task Force on Japan says that it also offers the United States a
n opportunity to seize the initiative in its economic policy toward Japan. Washington can now base its policies on the forces for change already at work within the Japanese economy, including technological development, globalization, increased mergers and acquisitions, and growing foreign direct investment.
The Task Force met for the first time in May 1999 and decided to examine structural reforms under way in the Japanese economy to determine whether they were fundamentally changing the way that business was being done in Japan.
In assessing developments in the Japanese economy, the Task Force came to three broad conclusions for U.S. economic policy toward Japan. First, the reforms that have already occurred within Japan's financial system are in keeping with the interests and goals of U.S. businesses. The United States should continue its current shift toward focusing its substantive policy agenda to support those reforms coming from within the Japanese marketplace, and that will in due course enable foreign entrants greater participation.
Second, the Task Force found that the United States could do an even better job in fostering market liberalization in Japan by shifting its priorities from traditional and controversial bilateral trade targets to more multilateral processes. Such a shift would acknowledge that Japan's internal structures are changing, as well as permit Washington to step back from a policy of constant public pressure on Japan for reform. It would also allow the United States to continue recent efforts to focus on Japan's external behavior, more appropriate in this new era of globalization.
Third, the Task Force recommended that the United States adopt a fresh approach in its economic negotiations with Japan to match the changes in the economic environment worldwide. The Task Force concluded that the United States should concentrate on economic issues that enable new ventures to bring value to the Japanese market. While the role of government in both Japan and the United States has been pivotal in the bilateral economic relationship, corporate sector entrepreneurs and investors now must take the lead in forging the path for the future of the bilateral economic relationship. Both governments should do what they can to assist this process.
We were fortunate to have Laura D'Andrea Tyson, BankAmerica Dean at the Haas School of Business, University of California, Berkeley, chair the Task Force. She presided over the group's discussions with great skill and leadership. She brought her extensive expertise to the project but also solicited and incorporated the diverse views and experience of the members of the Task Force into this final report. Happily as well, Diana Newton, a former Council International Affairs Fellow, brought her considerable skills and knowledge to the Task Force effort.
Leslie H. Gelb
President
Council on Foreign R
elations
I am enormously grateful to the chairwoman of the Task Force, Dean Laura D'Andrea Tyson, for being so generous with her time and energy throughout this project. In addition to bringing her experience as a former U.S official to the table, Laura kept the Task Force focused on the key issues and was tremendously effective in forging consensus out of diverse perspectives.
We would also like to extend our thanks to everyone who served on the Task Force, giving generously of their time at our various meetings and in reading various drafts of this report. Tracey Dunn and Chong-Lim Lee worked tirelessly providing important research and administrative assistance throughout the process. Les Gelb, Mike Peters, and Jan Murray at the Council were extremely supportive and offered excellent guidance throughout the process. Publication of the report is made possible by generous support from the Arthur Ross Foundation, for which we are all most grateful.
M. Diana H. Newton
Project Director
THE CHANGING ECONOMIC LANDSCAPE IN JAPAN
Japan's economy is emerging from more than a decade of stagnation, but its recovery remains painfully slow and subject to considerable downside risk. Weak balance sheets and bad debt pervade its banking and insurance sectors, a huge stock of outstanding government debt constrains its fiscal choices, and many of its firms require substantial restructuring to regain profitability and meet global competition. Despite the macroeconomic risks posed by these difficulties, there are reasons for optimism. Japan's economy has enjoyed positive albeit anemic growth for more than a year. Even more significant for Japan's long-run position are the growing indicators that its prolonged malaise has finally sparked a process of real restructuring and meaningful economic reforms.
During the last few years, there have been some dramatic illustrations of how economic necessity is driving changes in the Japanese economy. In the last three years, the Japanese government has introduced new policies and new federal resources to stem the crisis in its banking system. Two of Japan's largest, most distressed banks have been sold to "outsiders," one to a foreign consortium led by American investors and the other to a Japanese consortium led by Softbank. Such transactions were unimaginable just a few years ago. In another break with tradition, several other Japanese banks are merging. During the last half-year two major Japanese companies - Sogo, a well-known retail chain, and Chiyoda, one of Japan's largest insurance companies - have been forced to declare bankruptcy after the Japanese government failed to find stronger domestic firms willing to acquire them. The
se bankruptcies signal the death knell of a distinctive feature of the Japanese economy known as convoy capitalism - the expectation that firms encountering serious financial difficulties would be rescued by stronger firms or banks.
Signs of significant change extend beyond the sales of distressed assets to unlikely buyers and the bankruptcy of major corporations. Japan's financial markets are becoming more open and competitive as a result of significant deregulation and changes in accounting and taxation. Venture capital and private equity firms are appearing in Japan, some arriving from the rest of the world, others sprouting on home ground. New start-ups are emerging in information technology industries. And older Japanese firms are merging with one another or with foreign firms to restructure their operations.
Significant increases in both foreign direct investment flows and the volume of mergers and acquisitions, most often executed with the help of foreign financial firms, reflect the painful changes taking place. Many of these changes go to the heart of Japan's traditional economic system - the preferential bank lending, supply, distribution, and cross-shareholding relationships among groups of firms and banks. Such relationships have impeded competition from both foreign firms and domestic new entrants. They have also insulated Japanese firms from the pressures for disclosure, transparency, and profitability characteristic of competitive financial firms. Many of these traditional features of Japan's economic system are exactly those that have been identified by American and other firms as structural barriers to Japan's markets. Driven by both necessity and the opportunities afforded by new information technologies, these impediments are finally breaking down.
But the process of structural change and reform, while real, is moving in fits and starts and remains painfully slow. And the dangers of backsliding are strong. There are deep tensions within Japan's political and business leadership between those who embrace such changes and those who steadfastly oppose them. The strength of the opposition should not be underestimated. It took the Japanese government nearly a decade to muster the political capability and will to address the banking crisis. Meaningful policies to stem the related crisis in the insurance sector have yet to be taken. Amid the dramatic examples of change there are signs that traditional approaches to Japan's economic difficulties still enjoy substantial support. The government's share of total fiscal investment and lending remains at an historic high, and new government programs to bolster Japan's semiconductor, biotechnology, and information technology industries have been introduced. Despite a decade of negative returns, so far the majority of Japanese households have chosen to keep their savings in low-risk, low-earning accounts with banks or the Postal Savings System. In addition to political, cul
tural, and bureaucratic reasons to resist change, many Japanese are also concerned that if reforms and restructuring occur too rapidly, they could undermine confidence, reduce demand, and throw the economy into another macroeconomic tailspin. Given the fragility of Japan's current recovery, this is an understandable concern.
CONCLUSIONS
The members of the Council on Foreign Relations Independent Task Force on Japan believe that ongoing changes within Japan's economy provide both American policymakers and American businesses with opportunities to craft a new economic relationship between Japan and the United States. Task force members agree that this relationship must rest on the premise that a healthy Japanese economy serves America's economic and geopolitical interests. Despite its decade-long stagnation, Japan remains the largest economy in Asia, America's third-largest trading partner, and its major ally in the Asia-Pacific region.
The Task Force also believes that the structural reforms and changes now under way in Japan are essential to revitalizing its economy in the long run. At the same time, however, Task Force members are cognizant of opposition to such changes within Japan. Moreover, they are aware that America's leverage for influencing the telecommunications market following lengthy, sometimes contentious negotiations between American and Japanese officials suggests that the American government can hasten reforms at least when they are supported by powerful Japanese business interests. But as - or rather if - Japan continues to open its doors to foreign direct investment, American companies are likely to have many more opportunities to foster structural changes through their ongoing operations in Japan than the American government is likely to have through bilateral negotiations.
RECOMMENDATIONS
Although recognizing that Japan continues to confront significant macroeconomic challenges and risks, the Task Force decided not to address macroeconomic policy questions on the grounds that it had little to add to an already broad discussion of such questions by both American and Japanese scholars and policymakers. Instead, the Task Force decided to focus its attention on the structural changes in Japan, their likely effects on Japan's long-term economic performance, and their implications for the course of U.S.-Japan economic relations during the next administration.
The Task Force recommendations reflect this focus and fall into three main categories: recommendations about the appropriate substance, form, and tone of U.S. economic policies with Japan.
Recommendations about the Substance of U.S. Economic Policies with Japan
- Two broad areas of reform should be a major focus of economic dialogue between the American and Japanese governments during
the next several years-reforms that improve the climate for foreign direct investment and financial-market reforms affecting how capital is raised and allocated. The development of modern equity-based financial markets in Japan will ultimately affect the structure and performance of the rest of its economy. And foreign direct investment by American and other companies will be a powerful catalyst for change. In addition, since a country's imports and its stock of foreign direct investment tend to be positively related, the continued growth of such investment by American firms is likely to increase Japan's imports, defusing trade tensions between the two nations to some extent.
- These two broad policy priorities indicate that the U.S. government should focus its dialogue with the Japanese government on policies affecting financial markets and the investment climate in Japan, including accounting and reporting standards, taxation, mergers and acquisitions, and antitrust/competition policies.
- Japan introduced consolidated accounting for listed companies in April of this year, making it easier for Japanese companies to divest non-core business interests and to consolidate. Such reforms provide more transparent accounts of Japanese companies to potential domestic and foreign investors, thereby enabling troubled Japanese businesses to command a higher price for their distressed assets by reducing the risks involved in requiring them. But the Japanese government, under pressure from the Ministry of Finance, has delayed implementation of consolidated taxation reforms based on the OECD practices to an indefinite future date. The absence of such reforms impeded purchases and sales of troubled Japanese companies, slowing the pace of restructuring and foreign direct investment. The U.S. government should continue to urge the Japanese government to enact consolidated taxation reforms quickly. Taken together, consolidated accounting and taxation reforms will make it considerably easier for U.S. companies to invest in Japan.
- Japan's Commercial Code is nearly a century old and has many provisions that affect shareholder rights and corporate governance and that impede modern financial transactions such as company issuance and redemption of stock, stock splits, stock options, and pension portability. The Ministry of Justice has announced plans to update the Code's rules and regulations. Implementation of these plans through a timely and transparent process that allows foreign companies and legal experts to comment on proposed modifications of the Code should be a goal of U.S. economic dialogue with Japan.
- The U.S.-Japan Income Tax Treaty was last amended in 1971. American businesses and the U.S. government have already expressed interest in renegotiating this treaty to deal with a wide range of issues including transfer pricing, venture capital investment, stock-for-stock exchanges of foreign company shares, and withholding rates on
various kinds of income. Two of Japan's major trading partners have negotiated tax treaties with Japan that include lower withholding rates than the current U.S.-Japan treaty. To supplement the ongoing informal talks between the two countries, the U.S. government should prepare a detailed alternative to the current treaty, after extensive pre-negotiation and consultations with the Japanese government and with business representatives from both the United States and Japan.
- The rise of new-economy activities in both the United States and Japan and the spread of cross-national mergers and acquisitions pose new challenges for antitrust policy. Recently, the United States and Japan concluded a new bilateral antitrust agreement. The next administration should monitor the enforcement of this agreement to strengthen consultation and cooperation between the antitrust authorities of both countries. During the last few years, the antitrust authorities in the United States and the European Community have consulted and cooperated on a number of high-profile cases affecting both markets. There may be lessons from these experiences that can be applied to U.S. relations with Japan in the antitrust arena.
- The U.S. government should consider fostering an officially mandated dialogue on new-economy issues between American and Japanese business leaders. (Such a dialogue could be part of the U.S.-Japan Business Roundtable or could be established as a separate entity.) Economic changes triggered by the diffusion of new information technologies are posing new policy challenges for both the U.S. and Japanese governments in such areas as telecommunications deregulation, Internet taxation and privacy, intellectual property protection, and competition policy. A dialogue on such issues could provide useful insights for both governments and could head off policy friction between them. In addition, much of the internal impetus for change within Japan is coming from firms in emerging Information Technology areas. Such a dialogue could yield mutually beneficial reform recommendations and act as an additional channel of pressure on the Japanese government from Japanese business leaders. The U.S. government should also explore the desirability and feasibility of establishing a tripartite dialogue among U.S., Japanese, and European officials and business leaders on new-economy issues.
- Service sectors, including both financial services and telecommunications and Internet services, are areas in which American firms enjoy strong competitive advantages and in which regulation in Japan remains pervasive. Deregulation in these activities is likely to provide significant benefits for Japan's consumers and for American companies as well. It should be a continued focus in bilateral economic discussions between the United States and Japan. Within the telecommunications sector, a key issue remains the dominance of the Nippon Telegraph and Telephone Corp.: the recent
reduction in NTT access charges, although important, is only a first step toward significant deregulation. The disruptive nature of the Internet and wireless technologies is weakening NTT's dominance and creating opportunities for new entrants into Japan's telecommunications market.
Recommendations about the Form of U.S. Economic Policies with Japan
- Efforts by the U.S. government to encourage structural reform in Japan's economy or to resolve trade and other economic disputes with Japan should be rooted whenever possible in the framework of multilateral organizations, including the World Trade Organization (WTO), the Organization for Economic Cooperation and Development (OECD), the G8, and Asian-Pacific Economic Cooperation (APEC). The U.S. government should continue to rely on the WTO as the first step to resolving trade disputes with Japan. Additional WTO cases will help develop multilateral precedents about what comprises a "government" measure and how that term should be applied to actions involving a mix of government and business participants.
- The next administration should support international efforts to restart a new round of multilateral trade negotiations and should seek fast-track authority from the U.S. Congress. In the long run, strengthening the WTO and broadening its coverage to areas currently excluded from its rules and dispute settlement processes will prove to be the most effective ways for addressing trade disputes with America's trading partners, including Japan. As it did to develop support for a global agreement to liberalize trade in information technology products, the U.S. government should also continue to use regional organizations such as APEC to encourage sectoral trade-liberalization agreements that can later be championed at the multilateral level.
- During the past two decades, relations between the United States and Japan have frequently been strained by contentious bilateral trade talks focusing on structural barriers to Japan's markets. As these impediments begin to crumble in response to economic reforms, the impetus behind such talks is likely to dissipate. This is not to say that bilateral trade disputes between the United States and Japan will disappear altogether. After all, the United States continues to have heated trade disputes with Europe and Canada, economies much more like the United States than Japan in addition to being economies in which American companies hold far more direct investment than they hold in Japan. But sectoral trade disputes are likely to become the exception rather than the rule in U.S.-Japan economic relations as they were during much of the last twenty years. As reforms break down the structural barriers to Japan's market, Japan should begin to emerge as a more "normal" trading partner, and U.S. policy should adjust accordingly.
- New regional agreements on monetary cooperation and subregional agreemen
ts on trade are now under negotiation in Asia, and Japan is playing a leadership role in both. Japan is seeking to negotiate bilateral trade deals with Singapore and South Korea and to promote a network of currency swaps to protect the Asian economies from speculative attacks. It is too early to tell whether such agreements will reinforce the multilateral system or compete with it; that is, whether such agreements will prove to be outward-looking or inward-looking. Both the United States and Japan share an interest in a well-functioning global economic system, and regional agreements can be useful ways to explore solutions that can ultimately be applied on a global basis. Regional arrangements to prevent currency crises and contain their contagion effects could prove to be a useful addition to multilateral arrangements. And subregional trade agreements could reenergize the global trading system. The U.S. government should work with Japan to make sure that such regional agreements are consistent with the WTO and reinforce rather than weaken the multilateral financial system.
- Overall, the United States should encourage Japan's role as a partner in the Asia-Pacific region and should work with Japan to promote regional standards on issues of common interest such as the environment, rules for information technology industries, and infrastructure development.
Recommendations about the Tone of U.S. Economic Policies with Japan
- American policymakers and business leaders should take advantage
of the economic changes under way in Japan to foster a more collaborative
and friendly tone in their relationships with their Japanese counterparts.
As domestic pro-reform forces gain strength in Japan, they can take
the place of gaiatsu, or foreign pressure, to open Japan's
markets to foreign competitors. Then the balance in the tone of U.S.-Japan
relations can shift from one of conflict and contention toward one
of consultation and cooperation.
- While remaining vigilant for signs of backsliding, the U.S. government should recognize and applaud Japan's progress in implementing meaningful economic reforms and continue to offer technical assistance to design and implement such reforms through bilateral and multilateral channels.
- The U.S. government must continue to strive for a unified consistent economic message in its relations with the Japanese government. Public differences among government agencies on the appropriate course of U.S.-Japan relations undermine the ability of the U.S. government to achieve its goals.
- Improved bilateral relationships and greater understanding among legislators and administration officials in both the United States and Japan will enhance the ability of the U.S. government to achieve its priorities in its relatio
ns with Japan. The next administration should explore the possibility of introducing a formal parliamentary exchange between the United States and Japan. The United States has such formal exchanges with Canada, Mexico, the United Kingdom, and the North Atlantic Assembly.
- Given the significance and breadth of economic relations between the United States and Japan, the U.S. government should devote more resources to agencies responsible for overseeing them. An increase in the number of government officials with experience or expertise in U.S.-Japan economic relations and knowledge of the Japanese language would help the U.S. government achieve its objectives.
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