US-Japan and US-PRC: Similarities and differences in the two episodes

There are striking parallels and also important differences between the US-Japan frictions that peaked in the mid-1980s and the more recent US-PRC frictions that began in the late 1990s. The most salient common element is the huge size of the bilateral trade imbalances. To many, the imbalances themselves are convincing evidence of unfair trading practices.⁴ In both cases, a large bilateral trade deficit has been linked in the public mind to the steady decline in the share of manufacturing in total US employment. Also similar are the allegations that the extraordinary export growth has been sustained by factors such as government subsidies and persistent currency undervaluation, rather than—or at least in addition to—comparative advantage. Both countries prevented currency appreciation, especially relative to the US dollar, through accumulation of dollar-denominated government securities.⁵ Both countries also channeled capital to preferred sectors through the banking system, in both cases eventually resulting in an overhang of bad loans that complicated efforts to improve capital-market efficiency.⁶ Table 1 [ PDF 10.3KB | 1 page ] summarizes many of these comparisons.

One last and very significant common element in the two episodes is the response from the US as well as other affected importing nations: the persistent use of discriminatory strategies to delay adjustment to growth of competing imports from the new sources. These strategies violate the spirit (as well as, occasionally, the letter of the GATT/WTO) principle of most favored nation (MFN) treatment (i.e., nondiscrimination among trading partners). The immediate result has been to protect established import suppliers as well as domestic producers from the full effects of surging imports from the new sources. The longer-term result has been to promote growth of imports from still newer sources. Protection targeted at Japan promoted export growth first in textiles and later in steel and semiconductors from the “newly industrializing economies” (Hong Kong, China; Singapore; Republic of Korea; and Taipei,China). Recent US and EU actions in textiles and apparel targeted at the PRC have benefited Viet Nam, India, and Bangladesh, along with US partners in various preferential trade agreements. The US also initiated bilateral negotiations with Japan and later the PRC to increase their purchases of US exports. We provide more details on US trade policies toward Japan and the PRC in Sections 3 and 4.

In addition, the US has sought to limit foreign acquisitions of US companies by both nations (as well as others) on “national security” grounds. The Committee on Foreign Investment in the United States was established in 1975 for the purpose of monitoring the effects of inward foreign direct investment (FDI). In 1988, the US Congress gave the President the power to block a foreign takeover based on advice from the Committee on Foreign Investment in the United States (CFIUS) indicating a threat to national security. For example, US authorities prevented the acquisition of Fairchild Semiconductor by Japan's Fujitsu in 1987 and of Unocal, an oil producer, by the Chinese National Offshore Oil Corporation (CNOOC) in 2005. In contrast, greenfield investments, notably foreign-owned auto assembly plants, have been assiduously courted.

Along with these striking similarities, there are also fundamental differences between the two cases. Most important, Japan was already an established industrial nation in the 1980s. By the mid-1980s, Japan's per capita income was above that of most European nations; enrollment rates for secondary and higher education were likewise comparable to those of the richest nations (World Bank 1986). In contrast, the PRC is still poor, at least in terms of per capita income (around US$3,000 in 2007), despite a prolonged period of stellar growth performance. Thus, it is not surprising that earlier trade frictions between Japan and the US focused mainly on direct competition (i.e., Japan's increasing share of the US market and its displacement of US exports in third-country markets). Moreover, as a wealthy country, Japan consumed many of the same types of goods and services produced by the US, but imported too few of those from the US—at least in the view of US producers and policy makers.

Given the PRC's much lower per capita income, only a small fraction of PRC consumers can yet afford the products that represent US comparative advantage (i.e., those supplied by intellectual property-intensive industries [films, music, software, pharmaceuticals]), when sold at prices that reflect full enforcement of US intellectual property rights. Moreover, PRC consumers' desire to acquire such goods at affordable prices feeds the demand for pirated and copycat goods produced locally, thereby adding to US complaints regarding the PRC's lax enforcement of intellectual property rights, but this consumption pattern also implies that the PRC's continued growth may help to increase even further the country's already large imports from the US. As of 2008, the PRC was already the third largest market for US merchandise exports, although a large share of those exports consisted of agricultural products and raw materials.

As a reflection of the large differences in relative factor abundance and productivity between the US and the PRC, direct competition with the PRC has been an important issue for only a few US industries, mainly for labor-intensive “sunset” industries like apparel. Rather, the PRC has displaced other established trading partners in supplying the US market. As Figure 1 [ PDF 19.1KB | 1 page ] illustrates, the PRC's share of the total US trade deficit has largely replaced the share of other East Asian countries over the period from 1989 through 2007.⁷ In 1989, US trade with the PRC (including Hong Kong, China), accounted for less than 9% of total trade, with Japan accounting for about 45%, and other East Asian countries accounting for about 26%. By 2008, the PRC's share had soared to more than 31%, while those of Japan and the rest of East Asia had fallen to around 9% each. These shifts reflect the growth of the PRC's “processing trade” in which PRC subsidiaries of Japanese manufacturing firms import intermediate inputs from Japan and export final goods to the US. Similar supply chains link the PRC to other more advanced neighbors in East Asia, such as the Republic of Korea and Taipei,China (Dean, Lovely, and Mora forthcoming; Van Assche, Hong, and Ma forthcoming; Greaney and Li forthcoming).

Increased competition from the PRC has stimulated interest on the part of other nations in negotiating preferential trade agreements with the US as a means of getting better-than- MFN access to the lucrative US market (Bown and McCulloch 2007). However, the nature of competition from the PRC has been shifting rapidly. US officials have signaled their displeasure that the PRC is encouraging development in high-technology sectors, including some sectors that will offer direct competition comparable to that in the earlier US-Japan episode.

In terms of overall trade patterns, there are similarities as well as differences. Like Japan, the PRC is a major importer of raw materials, and these imports have grown at a pace similar to that of its exports. However, the PRC is far more open to manufactured imports, both of final goods and intermediate inputs, the latter an indication of the PRC's much greater involvement in international vertical specialization. The PRC'S trade to GDP ratio (2005–2007) was 71.3%, an astonishing figure given the PRC's size and level of development. In contrast, the corresponding ratio for the US was 27.2% and for Japan 31.5% (WTO 2008b).⁸ Another significant difference is the role played by FDI. The first of the PRC's export-oriented special economic zones, which opened in 1980, encouraged FDI through preferential treatment of foreign investors. One result may have been “roundtripping” of mainland capital—mainland investors routing funds through Hong Kong, China firms in order to qualify for the preferential treatment reserved for FDI. By 2004, the PRC's stock of inward FDI stood at US$702 billion, with an FDI to gross domestic product (GDP) ratio of 0.42, compared with Japan's 1986 stock of US$7 billion, a negligible share of GDP. Indeed, even by 2004, Japan's FDI stock was still only US$97 billion, and its FDI to GDP ratio was just 0.02 (Hufbauer, Wong, and Sheth 2006).⁹ While Japan and the PRC both achieved rapid productivity improvement through adaptation of advanced technologies developed in richer countries, Japan acquired technology mainly through licensing agreements, while for the PRC, FDI has been a major channel for technology transfer.

Although industrial policy has played an important role in both Japan and the PRC, the dominant role of Japan's Ministry of International Trade and Industry and Ministry of Finance in the 1970s and 1980s has no close parallel in the PRC of today. Instead, much of the PRC's economic policy-making has been decentralized, with the direction of industrial development the result of input at many levels, from the national to the “village” (Perkins 2001; Bergsten et al. 2008; USITC 2007).¹⁰ In this respect the PRC more closely resembles the US or the European Union, where individual sub-national units enjoy considerable scope for setting priorities and implementing policies. Finally, although moving from a planned toward a market economy, the PRC remains a communist state and has not made significant steps toward a democratic system of government at the national level. However, elections are routine at the village level and sometimes even mandatory. Japan's national government is an elected parliament, and economic policy making remains relatively centralized.

These political and economic differences have direct implications for the resolution of trade disputes, whether through bilateral negotiations or through actions taken in the GATT/WTO system. Officials of the PRC's national government may enjoy more freedom of action than their Japanese counterparts since the government does not need to satisfy a representative electorate. However, PRC officials believe that the country's political stability is highly dependent on continued economic growth. PRC policy makers were therefore aggressive in stimulating domestic demand as a means to offset the effects of the sharp drop in exports that the PRC experienced in early 2009.

The trade policy options available to the US and other trading partners in dealing with the PRC may be more circumscribed than in the case of Japan because of the PRC's extensive links to these economies via FDI and vertical specialization.¹¹ In the WTO, enforcement of a successful complaint is accomplished entirely through limited authorized retaliation, or at least the threat of retaliation. Given the important role of FDI and vertical specialization in most of the PRC's export sectors, finding suitable targets for authorized retaliation may prove difficult.¹² Nonetheless, the US has moved since 2006 toward greater reliance on the WTO in handling its trade conflicts with the PRC.

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