Tokyo's big rethink

Just when most people assumed, with the Nafta and Gatt agreements, that a failure of trade talks would no longer threaten the world economy, the underlying trade tension between the United States and Japan has suddenly risen to the surface. The US is seeking to win a market-opening deal with Japan before the summit meeting scheduled for 11 February, and its chief negotiator, Jeffrey Garten, said yesterday that it would be 'extremely difficult' to reach agreement in the talks on imports into Japan of cars and car parts by the deadline. All options were under review, should the talks fail.

We have become so accustomed to brinkmanship in trade talks that this warning should not be taken as particularly dire: naturally all options are open, as they always are until talks are complete.

But there is a fundamental problem in Japan-US trade relations that will be very difficult to solve simply by negotiation. In essence the Japanese economy has structural weaknesses that cannot be cured quickly. The two most serious are that it has been over-dependent on exports to maintain demand, and that it has too large a manufacturing sector.

In the past, Japan has regarded its large current account surplus as something desirable in itself. This is partly because of the country's vulnerability to swings in the price of raw materials, virtually all of which have to be imported, and partly because overseas assets bring influence in the world.

Japan was able to deflect foreign criticism of these surpluses during the 1980s either by promising to do something about them, or by pointing out that the surpluses were recycled into financing the US budget deficit, or paying for foreign manufacturing facilities.

None of these arguments is now acceptable to the US - the imbalance has continued for too long. Instead US negotiators are seeking 'result-orientated' market opening. In other words, they are less interested in the form of the agreement that they might reach with the Japanese, and more concerned about its practical effects. They will no longer allow themselves - as they see it - to be fobbed off with words.

The problem for the Japanese side is that there are few things that can be done in the short term that will enable them to meet US demands. American pressure, in part, encouraged Japan to make the latest tax cuts - a large reduction in income tax, offset in part by a rise in sales tax - announced in the early hours of yesterday.

But it would be difficult to move much further on this front, for the Japanese budget deficit is growing fast and will, quite shortly, be larger than the US one. It is reasonable to expect that these tax cuts will eventually drum up demand, but given the fragile state of both consumer and business confidence, the recovery will at best be slow.

In any case general fiscal measures, while welcomed by the Americans, will not themselves meet the 'results orientated' objectives of the US negotiators. In effect they want a guaranteed share of the market in specific products. This additional share could only be gained at the expense of domestic producers or imports from other regions, in particular the European Union.

It is difficult to clobber domestic producers at this point, given that they are in the middle of the most serious recession since the Second World War. And Japan's other trading partners would rightly be furious were it to give market-sharing guarantees that would squeeze them out.

The Japanese, mindful of this, may refuse to accept 'results orientated' market-sharing deals, betting that the US will not retaliate. While the balance of probability remains that some kind of deal will be patched, this is certainly not clear from the tone emerging from yesterday's talks. As Mr Garten put it, the US and Japan 'do not seem to have even a common understanding of the problem, let alone consensus on the solution'.

Ironically, just at the time when the US is losing patience, the view is gathering weight in Japan that it should redirect the economy away from these excessive trade surpluses. This change has been brought about by the recession, which has convinced the more internationally aware policy-makers of the need for structural change.

There are several strands to their argument. One is that Japan simply does not receive proper value for its foreign investments: that while it has been prudent to build overseas manufacturing plants, some of its portfolio investments have been unwise.

Another is that Japanese manufacturing needs to contract more rapidly and the country import more manufactured goods and build up service industry employment. Still another is that Japan needs to make itself less vulnerable to swings in the exchange rate, by shifting yet more manufacturing production overseas.

This rethinking of Japan's economic strategy is by no means complete - indeed it has yet to emerge as a coherent policy. It is much easier to see what Japan must not do - rely so heavily on industry, than it is to see which new sectors it should develop to take up the slack.

But it is a rethink on the same scale as that which took place after the first oil shock, when the country woke up to the fact that it must not allow itself to be so dependent on imported oil, and so started the world's most effective energy conservation programme.