What are the major changes to the foreign trade/investment structure of Japan after the mid – 1980s

Unlike the economic booms of the 1960s and 1970s, when increasing exports played the key role in economic expansion, domestic demand propelled the Japanese economy in the late 1980s. In fact, Japan’s imports grew at a faster rate than exports since the late 1980s. In this essay, I shall explore the major changes to the foreign trade and investment structure of Japan after the mid- 1980s and the policy response of Japan to the regional cooperation in the East Asia.

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There are a number of factors for the changes in foreign trade and investment structure of Japan after the mid- 1980s. The factors that I shall discuss in this essay are as follow: trade friction with the USA and the EU, and Reaganomics in the early 1980s, yen appreciation after the Plaza Accord, expansion of Japanese FDI in the USA, EU and Asia, effects of the Asian Currency Crisis and the bilateral FTA network. Then, I shall examine the prospect of the East Asian Community compared to the development of the EU and the role of Japan. Finally, I shall explore the policy response of Japan to the regional cooperation in the East Asia and then there will be the conclusion of this essay.

In spite of Japan’s full participation in multilateral tariff reductions, it frequently has been involved in contentious trade disputes with the United States and, to a certain extent, with Europe as well.

In 1980, Japan relaxed most controls on inward direct investment. Regardless of these major liberalisations of Japan’s trade policy, it has often been involved in trade friction with the United States. The reason for this is that growth of Japan’s exports provoked protectionist political pressure by import-competing American industries. In 1981, Japan accounted for 45.6 percent of US trade deficit and attention was especially paid to automobiles, television sets and textile industries. Japan-US trade friction is more about how best to appease or deflect that political pressure instead of about Japan’s “closed” markets or “unfair” trading practices.

Japanese automobiles exports accounted for 16 percent of Japan’s export in value. The explanation for this is that after the two oil shocks (the 1973 Arab Oil embargo and the 1979 Iranian revolution), the car buyers from the US and Canada started to switch away from large American cars towards more economical cars made by Japanese manufacturers. Accompanied by the relatively low value of yen, the Japanese car price went further down. Thus, pressure from American car manufacturers for protection increased.

In 1981, the US Trade Representative, William Brock, warned the Japanese government that the trade deficit would result in strong political reaction in the US. Hence, the Japanese government voluntarily imposed export restraints on automobiles in May 1981, for two years with possible renewals thereafter. For this reason, Japanese car manufacturers were given a maximum number of cars to be exported and they then shifted to exporting high quality cars with maximum possible profit margin. This then led to increase in demand for American cars and also a rise in the cars’ prices. The Reagan administration saw such cartel-like implication as harmful to US consumers and announced not to seek renewal of such voluntary export restraints in 1985.

In addition, the government of Japan announced a further tariff cuts on 1600 products that would be in effect in the following fiscal year; plus US $500 million was provided as fund for emergency aircraft imports and a plan to stockpile up to nine million barrels of crude oil. Such welcoming measures did not impress both American and European officials. From the American government perspective, as a full partner in the international trade system, Japan should provide fair and free access to its market. On the other hand, Susumu Nikaido, who was the party secretary general of Japan, pointed out that Japan is not entirely responsible for the growing gap in trade but Americans should also try to raise their competitiveness. Although this argument was true, it increased the tension between Japan and the US.

The tariffs cut in December 1981 did not remove any quotas on agricultural products as Japan had an inefficient agricultural industry. This is to say that the US is likely to benefit from the opening up of Japanese market of agricultural products. This would not lead to any significant effect on the EU, however; since it also had a relatively inefficient agricultural sector protected by the common agricultural policy, unless manufactured goods sector is open up.

The analysis above shows the Japanese trade friction with the US and the EU. It was in fact the relatively low value of yen that worsened the trade friction between Japan and the US, however. In the next section of this essay, I shall explore this in depths.

Under Reagan administration, the US economy was facing a so-called “twin deficits”. This is due to the fact that there were expansion of fiscal policy together with huge tax cut and increased military expenditure. Inflationary pressure by high government expenditure was tackled by high interest rates eventually. Despite Japan’s huge trade surplus, the yen remained weak.

US dollars still remained strong in 1985 and this raised the concern of other highly industrialised countries over the effect of high dollar on multilateral trading and international competitiveness. After several negotiations, an agreement was signed by the G-5 nations (France, West Germany, Japan, the United States and the United Kingdom) at the Plaza Hotel in New York on 22nd December 1985, which is also known as the Plaza Accord. Having this agreement signed meant that the G-5 agreed to devalue the US dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets.

The exchange rate value of the dollar versus the yen declined 51 percent over the two years after this agreement took place. The Japanese economy was then greatly depressed by the sharp appreciation of yen. As a result, there were cheaper imports in Japan and more expensive exports by Japan. Thus, the US and Europe exports were then more competitive in Japan and Japanese firms reacted by putting enormous effort to avoid rising export prices, which was done through foreign direct investment in the sense of rationalising.

Japanese FDI increased on a large scale and underwent major changes in its regional and sectoral composition in the latter half of the 1980s. The scale of FDI during the four year period of 1986-89 was extraordinary that far exceeding the total FDI from all previous years combined. The Japanese FDI declined after reaching a peak in 1989 and it was as dramatic as the size of the boom.

Several factors may be responsible for such changes in Japanese FDI. Firstly, the globalisation of business activities made possible by a general rise in Japanese firms’ managerial and technological capabilities. Secondly, the rapid and steep appreciation of the yen exchange rate against the major international currencies was the most important macroeconomic factor leading to the expansion of FDI in the second half of the 1980s and also in the early 1990s.

Japanese FDI in the 1980s was directed largely to North America and Europe, mainly in services and manufacturing. These two developed regions together absorbed two-thirds of Japan’s FDI outflows. Although a smaller share of Japan’s FDI went to East Asia in the 1980s, investments in manufacturing were relatively active. During the 1990s, Japan’s FDI to East Asia started to rise, resulting in an increase in its share in Japan’s FDI. Major factors behind Japan’s FDI in East Asia include the region’s robust economic growth, low unit labour costs, liberalisation and pro-FDI policies and yen appreciation. The rate of increase in Japanese manufacturing FDI in East Asia during this period was greater than the corresponding FDI to the world, and the share of East Asia in Japanese manufacturing FDI rose from 19.6 percent in 1985 to 32.9 percent in 1993. The share of manufacturing in overall Japanese FDI in East Asia also rose from 32 percent to 55 percent over the 1985-93 periods.

FDI inflows into China have also grown quickly since 1988-89 due to China’s gradual but persistent economic reforms, open-door policy and its political and social stability despite the Tiananmen Square incident in 1989. By 1994, China was the largest recipient of Japanese FDI in Asia. Attractiveness of China as a host to FDI has increased recently because some ASEAN (Associate of South East Asian Nations) countries have lost their competitiveness. In recent years, despite at significantly lower scale, Japanese FDI to other Asian countries such as Vietnam and India has begun to increase.

Another factor that influenced the foreign trade and investment structure of Japan after the mid-1980s was the Asian Currency Crisis. The East Asian financial crisis was a financial crisis that started in July 1997 in Thailand and affected currencies, stock markets and other asset prices in several Asian countries, many considered East Asian Tigers. Although Japan was not affected by this crisis, it was going through it own long term economic difficulties.

Japan was affected to a certain extent because its economy is prominent in the region. Due to the fact that real GDP growth rate slowed dramatically in 1997, from 5 percent to 1.6 percent, therefore Japan sank into recession in 1998. Moreover, the Asian financial crisis led to more bankruptcies in Japan.

Although the situation has calmed somewhat, it still did not warrant optimism, since the Asian countries concerned continue to face economic recession, and their financial markets remained in confusion. Against this background, Japanese companies continued to see their Asia-bound exports decline, and there was still concern that loans to Asia were going to be rendered increasingly non-performing. After this financial crisis, the bulk of investment and a significant amount of economic weight within East Asia simply shifted from Japan and ASEAN to China.

There were, however, some good signs. The exports of Asian countries were beginning to recover, and the business sentiment and earnings of Japanese companies in those countries, especially export-oriented enterprises, were showing signs of picking up. Thus, if the Asia economy moved toward an export-led recovery, this development would also be a factor in propping up the Japanese economy though an increase of exports to Asia.

Although Japan was not affected by the Asian financial crisis, the Japanese economy has undergone an extremely difficult period since its financial bubble burst in the early 1990s. After the period of recovery, both the US and Japanese economies were growing robustly, and the exchange rate between their currencies was nearing equilibrium, it was tie for the two countries to return to a positive agenda to strengthen their economic relationship. Thus, they began aggressive programs of regional and bilateral liberalisation.

Although Japan only completed one bilateral agreement, which was with Singapore at that time, it was actively pursuing several others such as Korea, Mexico, Thailand, the Philippines etc as well as a regional initiative with ASEAN. It also involved in officially sanctioned studies of a comprehensive East Asia Free Trade Area (EAFTA), with ASEAN, China and Korea.

The straightforward economic benefits of a free agreement (FTA) with the United States for Japan would be an increase of 3 percent in total Japanese GNP, from any initiatives that could produce convergence between its high prices and the much lower levels that prevail in the United States and other industrial countries.

Another major plus for Japan would be the provision of an economic counterweight to China though reaffirmation of the security relationship with the United States. Indeed, the US focus on relations with Japan that would be implied by the a bilateral FTA would represent decisive rejection of “bypass Japan” strategy that so many Japanese now fear from the United States because of the rise of China.

In the following paragraphs, I shall focus on the policy response of Japan. After the financial crisis, the Japanese policymakers tackled two immediate issues, one abroad and one at home. The first involved assistance in the recovery of Asian economies. The Japanese felt responsible because their economy plays such a critical role in the overall Asian economic situation. As a result, the Japanese government took serious steps to rescue Korea, Indonesia and Thailand, offering support in the amount of $43 billion in cooperation with the United States and the IMF. In the fall of 1998, Japan announced a $30 billion package (the Miyazawa Plan) to support the economies of selected Asian countries and to help restructure weak financial sectors in the region. Some argued that replying solely on Japanese expansion would not be enough to pull regional economies through.

The second immediate policy goal for Japan was to proceed with its structural reform. One of the lessons learned from the Asian economic crisis must be to control the market mechanism wisely, but that Japan should not slow down or reconsider policies for structural reform.

Japan has gone through a difficult period in the 1990s. Economic recovery has been made possible in the recent years, due to the strong growth of exports and the recent upturn in corporate fixed investment. Japan’s export to East Asia accounted for about 40 percent of total export and has been growing rapidly. Furthermore, there have been initiatives for regional trade agreements, which would benefit Japan’s recovery. One of these is that the region has recently shifted to a three-track approach of multilateral (WTO), regional (APEC, ASEAN) and bilateral (FTA).

The discussion above shows that some progress has been achieved on regional FTAs and EPAs, but Japan and China need to move more aggressively to achieve deeper, real integration. Moreover, if East Asia wants to be an economic community, they will need to develop a long term vision for the region. From my perspective, East Asian economic cooperation will take a European style, a symmetric approach, rather than a North American style, which means US centred and asymmetric.

Several factors have influenced the foreign trade and investment structure of Japan after the mid-1980s and some of them are more significant than the others. Yet, it is hard to conclude if Japan’s foreign trade was unfair or closed in the 1980s. In my opinion, since it is commonly agreed that countries specialise in their comparative advantage would benefit from trade, trade barriers like import taxes and quotas were in fact limiting the possibility or the time required for an economic take off. Thus, Japan’s foreign trade was being treated unfairly to a certain extent.