Trade disputes have moved from the business page to the front page. No longer can they be considered ordinary commercial frictions to be dealt with in a routine way through existing institutions and within agreed rules. Nor are they simply the unhappy consequences of an international economic decline that will melt away with the first burst of economic resurgence.

It is becoming obvious that a basic long-term conflict over national economic position and advantage underlies many of the present trade troubles. In the narrowest sense it is a question of which countries will create substantial commercial advantage in the growth industries of the future, which countries will be able to defend employment in today's mainline industries during that transition, and which countries will move up to substantial roles in traditional sectors. More broadly, the very international rules determining the appropriate roles for government in national and international economic life are being challenged and the premises of multilateral trade arrangements are being questioned by a series of state-centered industrial development and trade strategies.

Trade conflicts are already generating tensions that directly affect political relations between America and its allies, and among the allies. The open trade system-free exchange of goods among countries-has been a part of the foundation of America's international leadership. Sustaining an open trade system in the years since the Second World War required that the American economy be able to absorb-without substantial domestic political dislocation-the impact of foreign strategies for adjustment and development. The system-supporting role presupposed a preeminence of the American economy that meant we could absorb imports and foreigners would hold dollars. It rested ultimately on the competitive position of American producers in a wide range of manufacturing sectors. As foreign producers have established themselves as substantial rivals, they have-by the very dint of their success-weakened the willingness and the ability of American policymakers to maintain the openness of the international trade system in manufactures.

Unless we are careful, a real struggle about international economic position and the economic role of the state-problems obscured when the present liberal trade system was designed-will result in an unmanageable burst of mercantilism that will undermine the liberal system and threaten the stability of the international political order. There are those who believe that reordering the international monetary system and, in particular, the setting of stable and workable exchange rate parities, would in itself resolve many of the sectoral trade problems we now encounter. The mercantilist challenge would then go away. The present valuation of the American currency and the rapid shifts in monetary values that dramatically alter the competitive position of firms without any change in the underlying industrial reality certainly create problems that might not exist otherwise. Monetary readjustment, stabilization, safety nets, and shock absorbers are all necessary for the health of the international economy; so is an end to recession.1 However, neither a restructuring of the monetary system nor a quick technical fix in the trade rules will dissipate the basic challenge to the present trade order.

A dilemma of enduring international significance poses itself. Unless America responds to the competitive threats to its producers, we risk substantial damage to many sectors and, very quickly, to our ability to maintain an open international economy. If we do respond, in the ways that seem so successful for our now powerful competitors, we inevitably threaten the stability of the open trade order that has been vital to international growth and security. The stakes are high and visible. The dilemma will not be easily resolved: the policy debate will endure. Neither the end of recession nor an exchange rate readjustment nor a change of administration will push the trade news back to the business section.

II

For a generation at least, the liberal trade system lived up to its billing. Trade among the advanced countries expanded dramatically. It contributed to their growth and helped to provide an international web of economic interests that held together the Western Alliance. After the self-defeating era of protection between the world wars, the gains from expanded trade in the post-World War II era were exhilarating.

The open trading system has rested on rules and institutions that were the careful construction of primarily American and British policymakers for the years after World War II.2 From the beginning, the rules underpinning the open system have been designed to reduce substantially tariffs and other barriers to trade by reciprocal trade agreements and to assure that all nations would be treated the same. All countries would receive "most favored nation" treatment; that is, concessions made to one nation would apply to all parties to the multilateral agreements. To maintain the general principles, deviations in practice from the rules of the General Agreement on Tariffs and Trade (GATT) have been framed as exceptions and "escape clauses." Trade zones such as the British Commonwealth, which existed before GATT, preferences to developing countries, and regional free-trade areas and customs unions have all been tolerated. For national industries which are damaged by specific reductions in trade barriers, escape clauses allow governments to impose import restrictions to ease adjustment. There is also a series of arrangements to permit government retaliation against dumping or subsidization, making domestic policies that distort trade the subject of international negotiation-though no multinational enforcement procedures have ever been established.

In operation, the system never achieved completely free trade. It never addressed agriculture or services or the movement of labor. The exceptions and exemptions in manufacturing were extensive. However, the successive rounds of multilateral trade negotiations, at least through the 1960s, succeeded quite well in reducing formal barriers to trade.

It was assumed that unrestricted and non-discriminatory trade would increase economic efficiency. Since production costs and production structures in the various advanced countries were thought to converge, it was believed that expanded trade would result in greater specialization. Consequently, trade between nations could grow without painful dislocation of workers and firms. For example, in the machine-tool industry, Germany might capture a large share of the market for some tools, while the United States would become increasingly dominant in other segments of the market. No advanced industrial country would face absolute losses in its share of trade in any sector, or at least in its share of trade in a set of related sectors. The implication is that countries should produce what they make most efficiently and trade for the rest. Even the country with an absolute disadvantage-a higher domestic cost of production for all traded commodities-gains from free trade by importing those goods in which its absolute disadvantage is greatest. The sectors in which a nation is relatively strongest, compared to other sectors in the same country, is where the nation's comparative advantage can be found and these sectors would be "revealed" by examining what goods a nation trades under conditions of free trade. There would be only winners in the trade game: the general welfare would increase for all.

The GATT system, then, was constructed around a set of definable premises. First, trade arrangements that are built on multilateral negotiations among all nations are preferable to bilateral or other partial arrangements. Second, trade will be conducted by private actors in markets in which prices are set by a free interplay of supply and demand. Third, free trade will generate the expansion of all economies, if only each will bear the strains of internal expansion and adjustment. Fourth, government intervention is seen as a distortion of the market aimed centrally at delaying domestic adjustment to international price signals.

When considering trade among advanced countries, the premises of the GATT system ignore or deny the potential influence on trade of development strategies working through domestic structures. Thus they only awkwardly fit many of the new realities of international trade. The assumption-half fact and half fiction-that governments are negotiating about the rules of trade and leaving the market to settle the outcomes, is increasingly less tenable. Governments are increasingly negotiating directly about trade outcomes. Moreover, in each of the issues discussed below the rules of the domestic economy and the appropriate use of national government power in the world economy themselves become the subject of negotiation.

Even a few years ago it seemed that the exceptions to reasonably free trade could be contained and the goals preserved by some system of "organized muddling through." It was believed that the reduction of non-tariff barriers could be negotiated in the same fashion that had so successfully removed more direct limitations on trade during the previous generation. But bargaining over external barriers and negotiating over the arrangements of the domestic political economy in fact involve very different things.

III

Several developments set the informal agenda of preoccupations. The Americans discovered that the American economy, as well as the other national economies, was "interdependent," that is, sensitive and even vulnerable to developments abroad. Two emblems of the new era focused attention on powerful new forms of private actions in international trade and obscured the enduring ability of governments to shape economic outcomes: the dramatic ability of the multinational corporation (MNC) to formulate international strategies and to operate across national boundaries; and the rapid expansion of the Eurocurrency market to produce an international private financial system of similar size to the one inside the United States, but outside the control of any governmental authority. Compared to these new and powerful forces government interventions were treated as relatively negligible, rather rearguard exceptions to a transforming liberal order.

Though attention and concern were focused on the MNCs and the Eurodollar market, their preeminence was not the inevitable market outcome of improved communications and transport technology. Critically, the bargains that host countries struck with the American MNCs depended in the end on the administrative resources and will of the government and the economic structure of the country. The Japanese first showed that a government could act as doorman to the national economy, breaking up the package of management, finance, technology, and control represented by the MNC and forcing the pieces to be recombined under national authority. Other countries quickly learned those lessons. Government and politics had mattered all along; their influence had simply been obscured.

It is not that multinational corporations and private international financial markets have diminished in size or importance, but rather that state strategies to shape markets have become more prevalent, more powerful, and more central to the future shape of the international economic order. The particular state strategies that challenge the liberal trade order of the GATT system can be grouped under three headings.

-State-centered policies to create comparative advantage: the "developmental state."

-Managing surplus capacity: the negotiation of industrial transition.

-The state as trader: the problem of barter.

Let us consider these issues in turn.

IV

The central purpose of the "developmental state" is the promotion of growth. Critical sectors, those that by their links to other industries can affect the entire economy, are thus seen as a form of industrial infrastructure. Such critical industries are treated as the equivalent of roads and bridges in an earlier era and consequently are seen, even in a capitalist economy, as an appropriate concern of government. The state pursues the competitive development of specific economic sectors in the short run with the long-term purpose of assuring the industrial base required for the expansion of the entire economy. Japan is the most successful and closely examined example. There, systematic government policies have sought to move the economy from labor-intensive goods such as textiles, to consumer durables such as televisions and automobiles, and then into the advanced technology sectors of computers and, soon, aircraft. The Japanese have demonstrated clearly that under some circumstances developmental policies can work. They have shown the path and the stakes.

In promoting internationally competitive industries in telecommunications, aerospace, nuclear energy, petrochemical and off-shore engineering, avionics, and transportation equipment, the French have also understood the power of this approach.3 They have demonstrated to such interested nations as Brazil that success is not tied to inimitable particularities such as Japanese management traditions, the dutifulness of Asian labor, or a natural (or imposed) political consensus. Rather, with careful planning success is open even to nations with communist workers, cultivated managers, and a political and social heterogeneity perhaps best characterized by de Gaulle's complaint, "How can you govern a nation with three hundred different kinds of cheese?"

The governments of the newly industrializing countries (NICs) are attempting to repeat the trick, starting again at the beginning of the cycle with labor-intensive production or in sectors with stable and easily available technologies. Such late developers have a series of advantages, including the ability to apply the best available technology, which in established industries is not difficult to obtain or to use. The notion that comparative advantage can be created and not, as static trade theory suggests, just revealed, lies behind the concerted government strategies to create international industrial advantage that are the core of development policy.4 The developmental state, then, pursues clearly defined goals of industrial expansion rather than attempting simply to umpire the economic rules while leaving the economic outcomes to be settled in market competition. In doing so it acts as a player in the market through specific financial and administrative arrangements.

The argument about which economic theory should guide government policy has been absent from U.S. trade theory literature. Traditional trade theory does not deal well with questions that do not fit its static orientations and its assumptions of perfect competition. It certainly does not confront the role government can play in creating comparative advantage. The theory behind the developmental state, however, took concrete form a generation ago in Japan as a fight over policy between the Bank of Japan and the Ministry of International Trade and Industry (MITI). Proponents of developmental approaches argued, in effect, that government policy can gradually turn a temporary competitive disadvantage into enduring comparative advantage because government policy affects the gradual accumulation of physical and human capacity that underlies production technologies.5 National comparative advantage is in part a product of national policies over time.

That implication has been absorbed by many governments which are attempting to create enduring advantages and to alter their national place in the world economic hierarchy. In competition among the advanced countries, these government strategies create intense trade controversy in sectors such as electronics, telecommunications and aircraft. The U.S.-Japanese high-technology trade negotiations-currently underway-are sparked by just these issues. The development strategies of the NICs pose problems in other sectors. Although many American industrialists would like to forbid such state strategies, it would be difficult at best to enforce a judgment that Japanese or Korean, French or Brazilian practice is simply illegal. Those who pursue developmental strategies do not accept "free" market outcomes as inevitable or automatically legitimate.

Since we cannot here review a long series of country and sector stories, let us at least briefly consider some fundamentals of the Japanese case. The Japanese government exerted influence on the economy during its boom years of the 1950s and 1960s in two principal ways. First, it was a gatekeeper, controlling the links between the domestic and international economy. It was, in T.J. Pempel's terms, an "official doorman determining what and under what conditions capital, technology and manufacturing products enter and leave Japan."6 The discretion to decide what to let in and, at the extreme, out of Japan permitted the doorman to break up the packages of technology, capital, and control that the multinational corporations represent. In almost all cases, neither money nor technology could in itself allow outsiders to buy or bull their way into a permanent position in the Japanese market. This closed market then gave Japanese firms a stable base of demand which permitted rapid expansion of production and innovation in manufacturing.

Second, government agencies-most notoriously MITI-sought to orient the development of the domestic economy. Although government bureaucrats did not dictate to an administered market, they have consciously contributed to the development of particular sectors. MITI is not so much a strict director as a player with its own purposes and its own means of interfering in the market to reach them. Government industrial strategy assumes that the market pressures of competition can serve as an instrument of policy. It is not simply that the government makes use of competitive forces that arise naturally in the market, but rather that it often induces the very competition it directs.7 This intense, but controlled, domestic competition substituted for the pressures of the international market to force development. The competition is real, but the government and private sector work together to avoid "disruptive" or "evasive" competition. We do not need to select between cartoon images of Japan, Inc. or a land of unfettered competition. It is the particular interaction of state and market in Japan that is interesting.

Seen from the perspective of the firm, government policy helped provide cash for investment, tax breaks to sustain liquidity, research and development support, and aid to promote exports. These public policies-the web of policies rather than any individual elements of it-changed the options of companies. Without the protected markets, the initial investment could not in many cases have been justified by private companies. Without external debt finance, the funds to expand production rapidly would not have been available to the firms. Within a protected market, the easy availability of capital and imported technology was bound to attract entrants to favored sectors.

However, MITI viewed the stampede for entry which it had encouraged and the resulting battle for market share, which limited profits, as excessive competition that had to be controlled. The intensive domestic competition was controlled by a variety of mechanisms that included expansion plans agreed to jointly by government and industry, debt financing of rapid expansion that made the bankruptcy of major firms a threat to the entire economy and hence unthinkable, and the oft-cited recession cartels. The dual facts of purposive government influence on economic outcomes and real market competition are reconciled by seeing the system as one of controlled or limited competition.

The very success of Japanese industrial development-combined with intensifying pressure from Japan's trading partners-has begun to loosen the network of relations that characterized the developmental state, and on which the strategy of creating advantage in world markets rested. Many formal restrictions on entry to the Japanese market have been lifted. Partly as a result there has been a real increase in manufacturing imports into Japan. Serious trade problems still remain, however. As long as Japan had to borrow the generic technologies on which to build its growth and had undeveloped potential markets that could be seized by domestic or foreign producers, formal closure of markets was essential to a system of orchestrated development. Now less formal obstacles to entry may matter as crucially to competition in advanced technology as formal restrictions did a generation earlier.

Japan's imports of manufactured goods remain dramatically below those of the other advanced countries, and have not increased as a portion of the national economy since the early 1970s. Japan's unique trade characteristic is the tendency, relative to its trade partners, not to import manufactures in sectors in which it exports. The system of administrative guidance that affects government programs of finance and procurement, the Byzantine distribution systems, and the habits of private coordination amidst competition all evolved slowly. Indeed, the Japanese government still exercises a leadership role and exerts substantial influence in high-technology industries on the one hand, and declining or mature industries faced with oversupply on the other.

There is a crucial interplay between these two sets of interventionist policies that is likely to continue to spark problems in international markets and enduring tensions between Japan and its trading partners. Promotional policies in which the risks of domestic oversupply are at least in part insured against or underwritten, depending on how one chooses to characterize the particulars of Japanese policies, encourage bursts of investment for domestic demand that translate rapidly into export drives.8 Now that Japanese producers tie domestic investment decisions directly to world market strategies, the relationship between strategies in the Japanese market and their impact in the American market is immediate. There is a pattern of aggressive promotion of advancing sectors and of determined insulation and cushioning of mature sectors. This amounts to confining open international competition in the domestic market to sectors in which major Japanese firms are dominant worldwide or at least able to withstand foreign entry into the home market, and to sectors from which Japanese firms are absent. It implies sustaining closure in those sectors that are under pressure from abroad.9

The Japanese system may slowly open and become fully integrated in manufactured goods with its advanced-country trade partners. Other would-be Japans stand in line. The challenge of the developmental state will not pass from the contemporary scene.

V

The second set of trade problems concerns the management of "surplus capacity." The phrase implies negotiations among companies and governments to reduce supply to meet existing demand. Certainly the notion is very distant from conceptions of "free trade"; it calls for an active government participation in industry affairs.

Surplus capacity has a multitude of sources. A sharp drop in demand which leaves existing producers to battle over a diminished market is the most obvious. When the U.S. steel industry is operating at 44 percent of capacity and the European industry at 53 percent of capacity, every surge in trade has critical implications for the profitability of each company and for employment in each nation. Subsidies, protection, and devaluations all appear as means to export unemployment and maintain profits. Such difficulties are not new, and the analogy to the 1930s needs to be drawn. This, though, is the beginning, not the end, of our story.

The entry of new producers, often from developing countries, into international markets has certainly contributed as much as recession to the present problems of excess production. The series of bilateral deals to limit exports from one specific country to another have come to be called orderly marketing agreements (OMAs). These "voluntary" export restraints ostensibly stay within the rules of GATT, but in spirit step beyond them. They have cropped up as developing countries penetrate advanced-country markets and as firms in one advanced country enter product sectors dominated by established firms in another advanced nation. The production costs of the new producers are below those of established companies. In some cases, such as some segments of the shoe and textile industries, lower labor costs are the issue. In others, such as autos and steel, basic innovations in the process of production are at the root of diverging production costs.10 Thus, there are such bilateral deals in shoes with Taiwan and Hong Kong and in autos with Japan.

At first these arrangements were viewed as exceptional bargains that simply detracted from the broader move toward freer trade. Or, in the case of the American legislation implementing the Kennedy Round of trade negotiations, such restrictions were a price to be paid to the textile industry to obtain its acquiescence to the broader trade legislation. Later, an entire set of rules was devised in the textile sector that provided a common international framework within which these specific bilateral arrangements were worked out. The Multi-Fibre Arrangement (MFA) removed textiles from the general liberal trade regime and established a multilateral system to regulate protection.

The protectionist exceptions to the free trade deal have been systematized in textiles. The public codification is unusual, not the restrictions. In steel and petrochemicals there are a variety of restrictive cartels which provide a setting for negotiation among companies and governments. Together, the sectors in which restrictive international arrangements are commonplace constitute a good chunk of internationally traded industrial production.

The management of surplus capacity creates several very different problems. Formally, the Europeans and Japanese tend to manage excess capacity at home through cartels or cartel-like arrangements, and the Japanese are prepared to negotiate market-sharing arrangements internationally. Such arrangements are legally and politically difficult in most cases in the United States. In part as a result, American policy responds to international excess capacity through external protection.

Financial subsidy is another means by which the Europeans protect their industries. For example, multi-billion-dollar subsidies in France went into saving a bankrupt steel industry. American policy, by contrast, has effectively provided tariff protection through trigger prices which aim at higher prices and higher profits as the means to finance adjustment. Indeed, the steel conflicts between the United States and Europe in June 1982 hinged technically on how to calculate the value of government subsidy. Behind the debate on technique, though, lie fundamentally different notions of the place and role of government in the economy. These differences in domestic approach make international negotiations about surplus capacity exceptionally difficult.

A related problem is the management of industrial transition, or the shift in resources from one sector to another, as firms exit from industries plagued by excess capacity or by shifts in comparative advantage. American policy tends to leave the process of industrial transition to the financial markets, mergers, and the bankruptcy court; the executive branch assumes a hands-off attitude toward the outcomes of such proceedings. The Chrysler and Lockheed cases are certainly exceptions, and the extensive debate over specialized legislation required in each case simply underlines their exceptional character.

More and more governments are organizing the adjustments of their domestic economies. They reject profoundly the notion that social and economic structure should be left to the international market to determine.

Arguments about who will bear the pain of recession blur into negotiations about who will be situated in growth sectors to ride the next boom. In fact, what is at stake in the international negotiations that result is often precisely which companies, in which countries, will be able to survive the transition to a different pattern of products, or a new system of production. In a politicized world economy, one in which some governments are attempting to structure market outcomes, a liberal economy with a passive government may find itself at a disadvantage in many situations. The question is how to respond.

Several different sources of excess capacity are often present in a particular trade dispute. In the automobile controversy, for example, the Japanese penetration of the American market was facilitated by the oil crisis that abruptly increased the demand for the small cars the Japanese made and reduced it for the larger cars the Americans made. In that case, the critical problem for American producers was to alter the composition of their product mix to offer smaller, more fuel-efficient cars. The Japanese, however, were a receding target. It soon became clear that they had achieved fundamental innovations in the organization of auto production that gave them a more sustained advantage. By 1980, analysts had begun to estimate that the Japanese had a staggering cost advantage of as much as $1,500 on a $5,000 car.

The sudden Japanese burst onto the world auto scene was substantially assisted by the long-term promotional policies of the Japanese government. The British government intervened to dam the flood of imports that had risen from under 10 percent to nearly 50 percent of the British market; the French, to protect their market and express displeasure with the closure of the Japanese market, simply limited Japan to three percent of the French market. The Americans negotiated a moratorium on increases in Japanese market share.

The several sources of oversupply intertwine, but each calls for quite a different policy resolution. For example, declining demand calls for a division of the remaining markets among existing producers, each of whom may be tempted to gain marginal revenue by operating high-cost plants at full capacity and selling the marginal production at below-average cost in someone else's market. By contrast, divergent production costs or seemingly permanent changes in the composition of demand that give more long-term advantages to one nation's producers pose knottier issues. They make it harder to negotiate a resolution of shifting positions in the market, whether it be the entry of newcomers or a readjustment of position among existing producers. Why should the winners concede at the bargaining table what they can gain in the market?

VI

The third main threat to the liberal trading order is the growing activity of the national state as a trader, directly negotiating the terms of sales and influencing the terms of the supposedly private bargains. State trading, barter, buyback, offset, and mixed trade agreements are not new, but their volume is increasing rapidly. Growing volumes of trade with Eastern Europe and OPEC countries encouraged barter. Leaving arms trade (a case unto itself) aside, national states are important commercial actors in sectors as diverse as construction, aircraft, and telephone equipment. To cases where the government is salesman, we must add the state negotiation of buyback and barter arrangements. Such arrangements have recently been estimated to represent up to 30 percent of all international trade.11

While this is almost certainly an exaggeration, countertrade or barter-trade arrangements have grown in significance in recent years, to open a new arena for state action. Along with their quantitative growth, their role in the international trade system is changing. From marginal and exceptional practices in a few specialized areas (such as armaments), they are coming to occupy an ever more central role in the organization of international trade. Some governments are better organized than others to play the role of "trader." Certainly the same centralization and bureaucratic coordination that permit the French and Japanese states to play developmental roles in their economies at home provide them a capacity to act as traders abroad. Those countries that are technically less suited to this role are also ideologically opposed to such trade activities and condemn them as a violation of the principles of free trade.

These new wrinkles are less a flurry of idiosyncratic innovations than the coherent consequences of growing mercantilism. Behind them lie the two basic forces examined above: 1) the rise of the developmental state as a primary actor in the international trade scene, and its increasingly dominant role as an economic actor in newly industrializing and reindustrializing countries; and 2) the need to manage surplus capacity and to negotiate industrial transition. They tend to come together to diminish the role of private market transactions as the dominant and organizing means of international trade. The dynamic is self-reinforcing. State trading leads to offsets, offsets to mixed packages. As they become accepted practices, expertise, roles, and institutions develop to expand, reinforce, and perpetuate the emergent parallel system. Institutions well adapted for success in one system-such as the entrepreneurial firm-find themselves ill adapted to the other system.

These fundamental tendencies are in turn reinforced by powerful secondary trends. The first, beginning in the mid-1970s, was the sudden availability of funds for developing country governments in which state guidance is central to investment and trade. For some countries, mostly OPEC nations and NICs, the funds came through trade; for others, such as Brazil and Mexico, through borrowing. In both sets of cases, their expanded role in international trade has meant an expansion of the role of state trading, and a relative diminution of direct market transactions between private buyers and sellers. Another important secondary source for the growth of the mercantilist practices has been the rapid expansion of trade with centrally planned economies.

The third trend is the rapid growth of international trade in sophisticated armaments. Armaments is the sector where it is most difficult to distinguish between economics and politics, between the state and the private sector. Governments are clients-they buy the arms. But they are also investment bankers, financing not only production, but research, design, and development. They are also merchant bankers, finding foreign buyers, organizing the sale, financing the sale, organizing the offsets, dumping the bartered counterparts, and financing services, such as training and maintenance, that make the sale-and follow-on sales-possible. The market is characterized by discrete giant contracts rather than by marginally adjusting commodity flows.

The mixed aid packages, offsets, and barter that characterize those contracts make true prices difficult to compute, and the complex financing and costing structures and practices of the manufacturers of large-scale, sophisticated armaments make real costs equally obscure. The contracts are most often negotiated government to government, with complex political considerations replacing simple price-quality calculations. In many ways the arms trade is the model of the new mercantilism, as well as its most important quantitative expression. It is also one of its most important progenitors, developing the habits, the channels and the institutions that then spin off into other sectors.

In sum, the rules and the structures of the game of international trade are being changed by these institutional innovations. Market trade practices, observed chiefly within a small group of Western liberal economies, are being threatened. It is a bit like what happened to football when the hard-shell helmet and all that protective padding were introduced. They first came as defensive measures to protect the more delicate parts of the more vulnerable players. But they quickly transformed the head into a battering ram. To defend themselves, everyone else was forced to adopt the new defensive/offensive innovation and change the way they played the game. Safety did not necessarily increase; the game did not necessarily improve.

Examples of these new wrinkles in buybacks, mixed aid packages, offsets, and barter abound. The General Electric Company recently reported losing an important contract for the sale of CAT scanners to Austrian hospitals when a competitor, Germany's Siemens, agreed to increase production of electrical goods (not CAT scanners) at a plant it owns and operates in Austria, thereby offsetting the purchase with additional Austrian employment. McDonnell Douglas, in order to sell over $2 billion of military fighters to Canada, agreed to locate employment in Canada and to help to market a miscellany of Canadian goods. Northrop has similar complex deals all over the world, as do GE, General Motors, and a host of other major American companies.

Barter is certainly not new. Indeed, money was first introduced to overcome its obvious inconveniences, and 1983 seems like a strange time to begin to reinvent the East India-or the West India-companies. But its spectacular rebirth is only the tip of a great iceberg of new trade conditions, forms and objectives. Why the increase in barter?

Certainly a palm-oil-producing country could sell its own palm oil as well as GE, Northrop, or Aerospatiale. If not, they could purchase the international trading expertise. If Mitsubishi could sell the palm oil better than the producer government or firm, the economist would then expect Mitsubishi to enter that new line of business in a massive way. Even after the usual economic considerations accounting for the substitution of money for barter have been run through, a new set of arguments comes to the surface. The first is the simplest: bartering permits a vagueness in the price of the selling product. It is a way around anti-dumping rules, a way to practice market discrimination (selling cheaper in weaker markets), a way to survive bad times. And once the others do it, even the strongest competitor will sooner or later have to adapt to the new rules. It is, in this view, part of an overcapacity problem. It should diminish in intensity once the world economy picks up, that is, if one's own national producers don't first find themselves excluded from markets where reentry will be extremely costly and perhaps impossible.

The second explanation is that some producers may not be able to buy marketing skills and consequently wish to transfer that problem to someone else. Indeed, they may be willing to let prices shift against them in order to transfer that selling task to their trading partners.

The third explanation is more interesting-and concerns more permanent conditions. Many international transactions are simply not about exchanging one product for another, as in classical trade theory, wine for wool, oil for electronics. They are about deliberate efforts to change a nation's economic situation, to reposition its industry in the international division of labor. The Brazilian petrochemicals case and the European Airbus case illustrate this view particularly well. Japanese computers, a few years back, were a parallel illustration; so were French process engineering, Brazilian automotives, Japanese semiconductors, and East European petrochemicals. The list can be made very long.

VII

The GATT system was premised on the notion that production and exchange would be conducted by private actors and that all countries stood to gain from increased trade. It intended that the rules of international trade would be built on a multilateral basis, as a deal among all the players, rather than as a result of the patchwork of individual bargains. Finally, it assumed that the rules would be applied evenhandedly, without discrimination against, or favoritism for, a few. The faith was that the major economies would abide by the rules, police them, and accommodate to such exceptions as might be required to keep the system together.

Clearly, state-centered economic strategies challenge the various pillars of this system. Individual governments have little reason to play by the rules and leave their markets open to challenges to their domestic industries promoted by foreign states. "Orderly marketing agreements" and other explicit market arrangements between governments to parcel out market shares tend to push problems toward the markets of those not privy to the bargain. If Japanese cars are kept out of the American market, outlets will be sought in Europe. The trade conflicts outlined here cannot be resolved simply by agreements about the procedures of trade. Such agreements merely reiterate the premises and objectives of a liberal economic order-the elimination of tariffs, quotas, and non-tariff barriers on the one hand and multilateralism and nondiscrimination on the other. The difficulty is that the mercantilist challenge sets interest in outcomes against a simple defense of the rules of the game. As Joan Pearce has pointed out, "the United States until recently has clearly benefitted from free trade in manufactured goods and set its sights on achieving conditions of a free market. . . . France . . . adopts the view that in international trade the free market is a chimera, and that the best that can be achieved is a balance of interests."12 Unfortunately, American interests have begun to shift.

The international trade order must now accommodate state-centered economic strategies. This mercantilist challenge to the liberal economic order comes as America's dominant international position in world markets and its ability to regulate monetary and trade affairs have eroded. This will make the resolution of the current set of problems all the more difficult for two quite distinct reasons.

First, stable international economic orders are thought to be maintained by a hegemon, a dominant power able to sustain the rules. Britain once played that role and, for a quarter-century after the war, the United States did. As American economic preeminence has eroded, so has its ability to act as hegemon and to make the side payments needed to sustain all nations' commitments to the international economic rules. For example, in the trade domain, the United States was once able to offer access to its market to promote loyalty to the system. In monetary affairs the United States was able to ignore devaluations of foreign currencies against the dollar that were made to improve the trade positions of the devaluing countries. Since the value of the dollar was a constant, a stable short-term solution to the international monetary equation could be worked out.

While our ability to support the international economic system has eroded, the United States remains by far the strongest single nation in the international economy. We are now tempted to use that power to manipulate and twist the system's rules to accommodate our own domestic problems.

American policymakers and business executives often see the Europeans as neomercantilist, unfairly using state power to gain economic advantage in what should be a liberal economic order. Europeans and Japanese, in turn, view our management and manipulation of the system as a different kind of neomercantilism. We achieve the same purposes, in their view, by manipulating the international rules to gain advantage and to block the political and industrial purposes of other nations. Similarly, the Europeans and Japanese claim that American competitive advantage in many sectors depends directly on U.S. government policies. They see no difference between Defense Department expenditures that help speed civilian aeronautic and electronic industry development, and their own government expenditures intended to close the competitive gap with the United States. When American negotiators complain of the Japanese joint research ventures in electronics, the Japanese quickly point to the Defense Department's VHSIC (Very High Speed Integrated Circuit) program. Even the production equipment developed for this VHSIC program will not be permitted to be sold abroad. Similarly, the French contrast their support of Airbus with the Defense Department's support of Boeing's K-135 jet tanker produced on the same assembly as the 707. We claim that the purpose of such defense programs is not commercial development, or that obscure rules on coastal shipping which have made it difficult for foreign oil-pipe producers to enter the U.S. market did not originally have commercial intent. Whatever their purposes, our trade partners retort, these policies have commercial consequences and must be considered when negotiating.

Second, our trade partners note that while America rejects financial subsidies to protect domestic industries or to reorganize them, it resorts very quickly to protection. A recently completed study of a set of trade-impacted sectors found that in each instance where American industry has been jolted by international competition, the primary policy has been protection.13 As long as the sectors facing intense foreign competition were either exceptional or marginal, American policy could live happily with a contradiction between a general commitment to free trade and concrete protectionist policies in the few trade-impacted sectors. But as autos, steel, television, and even semiconductors are pressed hard by foreign competitors, the domestic strategy of protection in the last resort threatens not only the American economy, but also the international fabric of open trade relations constructed in the last years.

VIII

Together these several trade questions-the developmental state actively creating advantage in international markets, state management of surplus capacity, the growth of state trading and barter, and the competitive decline of crucial American industrial sectors-require a reconsideration of American trade policies. There are two policy questions. First, how do we sustain an open system? Second, how do we effectively promote the competitive development of the American economy? It is not a choice. We must achieve both ends. The bet is double or nothing.

Sustaining these twin trade-policy objectives poses a potential dilemma. The mercantilist strategies have worked particularly effectively in an open trade system. That openness has been maintained by American commitment to liberal policies, and by the overwhelming preeminence of American economic and political power. Unless American policy now responds to the specific statist strategies discussed above, we risk the competitive position of many sectors. Yet if our own response is mercantilist, then American policy will simply accelerate the present drift toward world protectionism. The real task is not simply to reconcile these objectives, but rather to use trade policy as an instrument to promote competitiveness.

There is no refuge in no policy: doing nothing will quickly result in more protectionism. Whatever specific troubles trade may generate in particular sectors, America has an enduring economic and security interest in an open trading system. A multitude of special privileges and discriminations, hastily constructed trading blocs, and political manipulations of trade would result from American protectionism. With all advanced countries deeply dependent on imported oil, the struggle for competitive markets would become even more political. The result would probably be a drop in trade not compensated by any pickup in domestic sales-in essence a further shrinking of demand in an already depressed world. Crucially, a fragmentation of the West into rival political-economic blocs would only undermine American hopes for a stable and secure world. Moreover, aggressive state-led economic strategies are not congenial to the ideological bent of this country or particularly suited to the capacities of the federal government.

Certainly exchange rate adjustment and the end of the worldwide recession would ease some of the trade conflicts, but would not eliminate the central conflicts or the need to address them. With steel capacity in Europe and the United States at roughly 50 percent, even after major plant closings, only substantial increases in demand would reduce tensions. But the loss of export markets, and then the rise in imports as Japan and later the NICs introduced steel-making capacity, are not tied to the recession. Detroit's problems with Japan would not end even if auto sales picked up. Indeed, without restrictions on Japanese exports, such a boom might simply draw in more imports.

Similarly, a pickup in airplane sales might relieve Boeing's most immediate cash problems, but it would not alter the penetration of Airbus into world routes previously dominated by Boeing. The problem is that when world leadership in aircraft production or in consumer electronics has in the past shifted, it has done so very rapidly, and one major success can alter the very logic of that competitive game.

Indeed, the difficulty for U.S. policy is that the trade struggle is not simply over the size of the pie, so that a growing pie can satisfy all appetites even if some shares are larger. It is even more a struggle over the relative position of different countries in the ever-changing system of international comparative advantage and division of labor, a question of which countries will most fully take advantage of the growth possibilities new industries represent. Questions of economic welfare, national power, and international order come together. They must be answered together.

American policy must promote the international competitive development of American industry, and it must do so while sustaining the open trade system. These two objectives must be achieved together.

At the moment, America's primary policy response to the domestic problems generated by international trade is protection, even though the general thrust of our efforts since the war has been aimed at creating a world that favored free trade. The array of policies must be broadened. Trade policies must serve to open markets abroad and to promote the competitive adjustment of American industries in international trade, not to insulate the American economy. Domestic policies for industrial development are needed as an alternative to protection and as a means to press for competitive adjustment when-more often than we would like-protectionist measures are adopted.

Since America has enduring economic and security interests in the open economic system, our response to the challenge of state-centered trade strategies must be built within the framework of the current GATT system. While the last round of trade negotiations accepted the notion that domestic economic policies can represent barriers to trade, the resolution was left to later agreement. Limited progress has been made. Indeed, a general negotiated resolution is unlikely.

Certainly strengthening GATT and its associated mechanisms for temporary safeguard agreements to resolve conflicts is an important first step. Unfortunately, of the trade conducted under exceptional quantitative agreements, 90 percent occurred through agreements that were made outside the rules of GATT. Councils for consultation have not resolved tensions over steel, although temporary peace in export finance was achieved. Similarly, greater transparency for government intervention would certainly make the facts of many conflicts clearer. Yet the intention of many governments is to conceal the character of their subsidies, not only from trade partners but from domestic rivals and often legislatures. The obstacles must be clearly understood. First, the very purpose of the mercantilist strategies is to create advantage in critical industries and to promote economic development. These policies are intended to achieve specific economic objectives, such as a competitive electronics industry, not just to establish favorable conditions for them to occur in the marketplace. Consequently, although all countries would pay serious political and economic prices if the trading system broke up as a result of such strategies, those countries such as Japan, which have been successful in employing them, will have to be actively dissuaded from using them.

However, if America responds with a general strategy of protectionism, it will tumble the entire game. On the contrary, three basic strategies to preserve the open trading system must be pursued.

First, we must actively demand access to foreign markets in those countries and in those sectors where the international competitive position of critical American sectors is at stake. State-promoted rapid growth strategies have hinged on privileged access to the domestic market, and the internal promotion of domestic technological development. Since not all trade barriers can be removed at once, we must in fact be prepared to make strategic choices about the primary needs of the American economy. The continued access of American farmers to world markets for agriculture is essential to national prosperity. Nonetheless, expanding their access to one segment of that market-Japan-may be less critical than the need of American high-technology firms to gain access to Japanese markets in advanced technology.14

Opening markets abroad, especially in high technology and especially in Japan, is not fundamentally about the dollar value to companies of sales in that market or about year-to-year balance-of-payments considerations. It is about countering the mercantilist strategies of developmental states. The purpose is to ensure that the Japanese market is not an insulated, privileged and secure base for domestic producers to invest in production innovation, achieve scale and cost efficiency, and launch an export drive.

Imposing competition is perhaps unfair in the infant industries of developing nations, but that is not the case in the high-technology sectors of any of the advanced nations. Japan's difficulty in repeating in computers what it was able to do in television, autos, consumer electronics, and (partially) in semi-conductors, is in no small measure due to the exceptional circumstances of IBM's having a strong market position in Japan. That almost unique position forced Japanese producers (as IBM forces U.S. plug-compatible producers) to compete with it directly, on its terms. By strategically timing the introduction of new products, IBM impeded the mercantilist developmental strategy analyzed above. The evolution of the world automobile industry might have been very different had Fiat or VW or Renault been able to acquire a strong position in the Japanese automobile industry in the early 1960s when Japan produced only a few hundred thousand cars, as opposed to 1980 when it produced eight million. Opening foreign markets is not a simple question of quantities, it is a question of strategies.

Second, at its core the trade policy problem is framed by the fact that the open system must now rest on the continuous creation of a new international bargain, a cumulative approach to a negotiated settlement among several strong, though very unequal, partners, without a single hegemon to impose it. The United States must advance its inseparable goals of an open trade system and a strong U.S. economy through strategic thinking and action. But this vital international strategic dimension does not yet seem to have taken a prominent place in our economic policymaking.

For example, the United States has been opening its formerly regulated monopoly market in telecommunications to competition, both domestic and international. Among the biggest potential beneficiaries are such foreign giants as Nippon Electric, CIT Alcatel, Thomson, Ericsson and Northern-many (though not all) of them spearheads of successful national efforts to create comparative advantage. Comparable openings abroad were never demanded; contingencies were never raised. With the exception of the United Kingdom, the major foreign markets remain tightly controlled and largely closed. An opportunity to open vital foreign markets without bluster or threat was lost as one of the biggest potential bargaining chips in decades was squandered by the absence of strategic thinking.

Third, competitive conditions in third markets must be equalized. We must construct bargaining chips to counter practices that distort the terms of competition in third markets, and use them to steer competition back toward market criteria and forms. For example, if used as a bargaining chip, openly charging the Export-Import Bank to match subsidized export-financing arrangements is likely to have much more of a deterrent than a subsidization effect. Once it is seen as being to no particular advantage, foreign governments are not likely to continue to subsidize exports to third markets. Universal arrangements will become easier to negotiate, and one element of destabilizing, market-distorting and non-productive competition will be reduced.

Nonetheless, there will continue to be domestic dislocation from trade, and without a strong competitive position for the broad range of American industry in international markets, all trade policy will fail in its attempt to sustain the open system. There must be domestic policy for industrial competitiveness, but of what kind?

IX

First of all, it must be emphasized that we are not faced with a choice between a blind faith in the long-term beneficence of markets or the establishment of a massive central investment and subsidization fund that will reconstruct the economy according to the judgment of its directors and the strengths of the political vectors that will converge on them. Equally, we can avoid the false dichotomy between Sunset and Sunrise industries. It is not simply a question of whether high-tech sectors can create the jobs to offset losses in the "mature" industries. Nor is it a matter of how to sort out the winners and losers from the usual lists that have textiles, ordinary consumer goods and footwear nearing the end of their day and robotics and biotechnology bringing in the new dawn. Unfortunately for such simplicities, exports in textiles have recently surged and Atari has moved abroad.

Most important, most of the high-tech sectors make producer goods. Success for American robotics and machine-tool companies depends upon manufacturers of automobiles, pens, washing machines, and electric motors purchasing and using the advanced technology and adjusting their manufacturing and strategic reasoning to the possibilities those technologies represent.15 Unless they do so, they will not remain competitive. Unless they remain competitive, the high-tech industries will not realize their promise. The workable strategy, economically as well as politically, is to bring high technology into the production of traditional products. The question is how to do it.

At its core, any policy for industrial development must aim at making markets work more effectively. We simply have no choice in the end. It is evident that proper macroeconomic policies (tax and spending decisions) are necessary. It is also clear that the scope of direct sectoral intervention simply cannot be extensive. Since as a practical matter a national administrative apparatus cannot grasp all the complexities of the market, any industrial policy will perforce focus on broad trends or on particular difficulties of only a few industries. Moreover, the complexities of any single industry should restrain any extensive interventionist ambitions. Without an independent ability to examine industrial dynamics, government is entirely dependent upon the view of firms and sectors that are seeking assistance. It will be forced to deal with any industrial crisis on an ad hoc basis, in a panic, without the proper resources to make informed judgments. Independent analytic capacity is needed not only to diagnose industry difficulties without bias, but also to give legitimacy to policies that may be proposed.

What distinguishes industrial policy is the government's capacity to evaluate the problems of industrial sectors, not the kinds of policies introduced to solve them.

A capacity to intervene may be the only way to avoid systematic protection, the only means of relieving political pressures that would thwart the process of industrial change, the only way to preserve an open system. However, since we cannot have policies for all industries, we must take clues from the few on which we focus to find solutions to the problems of the many on which the nation's economy rests. This means, of course, that there are no panaceas, no quick fixes. We need a multitude of solutions to a multitude of ills.

We must build new kinds of infrastructure for the nation's economy. In the nineteenth century the government ensured that the roads and railroads needed to create a continental economy would be built. That continental economy in turn brought the innovations in management and production that permitted American industry to dominate world manufacturing markets for several generations. Infrastructure in the modern world, however, is not only roads and bridges. Financial systems, for example, are as much a product of government policy as market activity. The difficulties U.S. semi-conductor firms have encountered in financing product development and capacity expansion suggests policies to make our financial markets provide capital to rapidly growing innovative companies. Let us consider how a specific issue can be addressed by constructing the economic infrastructure needed to make markets work effectively.

One present problem is to force a reorganization of our basic conception of manufacturing in order to effectively apply microelectronics to the workplace. America should create a Factory Extension Service, a modern industrial equivalent of the Agricultural Extension. The farm program, with its research centers and extension service, was arguably America's most successful industrial policy. It brought a host of advanced technologies into use by very small, very unsophisticated farm enterprises. It contributed mightily to a dramatic and sustained improvement in farm productivity and to our national prosperity and power. It was also an invaluable aid, far more than a simple capital infusion would have been, for the growing industrial giants of its time, especially farm machinery and chemicals.

What we did on the farm we should do in the factory. Not only can a Factory Extension contribute to increasing the productivity of a broad range of American industries, particularly small and medium-sized manufacturers, but it can also significantly help to generate American production of technology at the lower half of the product line now being picked off by foreign competitors.

The massive development of such a market would help to redirect U.S. manufacturers of automated production equipment away from a growing dependence on the protected markets of defense and aerospace and from the habits of producing the highly specialized, very sophisticated lines of equipment demanded by those sectors-but by few others. It would redirect them toward international competitiveness for themselves, and toward a vital role in enhancing the competitiveness of a broad range of American industries.

X

In sum, the fundamental policy dilemma offers no simple out, no chance to choose between preserving an open international system or promoting the competitive redevelopment of American industry, no opportunity to separate international trade policy from domestic industrial policy.

To preserve an open system, trade policy must promote strategic market openings in developmental states and equalization of competitive conditions in third markets. Such openings are needed for the competitive position of U.S. industry. Domestic policy must aim at revitalizing a broad range of American manufacturing industries; otherwise, protectionist forces will overwhelm all efforts to maintain an open trade system.

Neither set of policies can achieve very much in the absence of successful aggregate policy; sustained recession will nullify even the best trade policies and the best industrial revitalization efforts. Both policies must also rest on justice. Strategic trade policy, like domestic adjustment policy, means making choices of substantial and uneven economic consequence. Mechanisms must be created to share the burdens of those adjustments. The domestic costs of change must not simply be heaped on the losers, for, quite correctly, those costs are less and less seen to be the results of distant, impartial markets, but rather the consequences of political choices-that call for political responses.

Recently the United States has been unwilling and unable to confront the kind of strategic choices it must now make. All debate over technique and the details of policy aside, the choice is basic. Without getting caught in a dubious selection of Sunrise and Sunset sectors, we can promote the international competitiveness of American industry by introducing high technology into a broad range of industries, or we can try to preserve the past. It is quite possible that we will continue to fail to act. In the process, and most likely in the name of free trade, we will bring down open trade and the system of alliances we created over the past generation. The burden of action is now on those who would preserve an open international trade order.

1 For a discussion of these issues, see Albert Bressand, "Mastering the 'Worldeconomy'," Foreign Affairs, Spring 1983.

2 Robert E. Baldwin and David A. Kay, "International Trade and International Relations," in World Politics and International Economics, Eds. C. Fred Bergsten and Lawrence B. Krause, Washington: Brookings Institution, 1975.

3 On the French case, see Stephen S. Cohen, Modern Capitalist Planning: The French Model, Berkeley: University of California Press, 1977. See also Cohen, "Informed Bewilderment," and Stephen S. Cohen, James K. Galbraith, and John Zysman, "Rehabbing the Labyrinth," in France in the Troubled World Economy, eds. Stephen S. Cohen and Peter A. Gourevitch, London: Butterworths, 1982.

4 For a development of the notion of created comparative advantage, see John Zysman and Laura Tyson, eds., American Industry in International Competition, Ithaca (N.Y.): Cornell University Press, 1983, Chapter I.

5 See John Zysman and Laura Tyson, American Industry, op. cit.

6 T.J. Pempel, "Japanese Foreign Economic Policy," in Between Power and Plenty: Foreign Economic Policy of Advanced Industrial States, ed. Peter Katzenstein, Madison: University of Wisconsin Press, 1978, p. 139. See also Chalmers Johnson, MITI and the Japanese Economic Miracle, Stanford: Stanford University Press, 1982.

7 See John Zysman, Governments, Markets, and Growth: Financial Systems and the Politics of Industrial Change, Ithaca (N.Y.): Cornell University Press, 1983, p. 237.

8 Kozo Yammamura, "Success that Soured," in Policy and Trade Issues of the Japanese Economy, ed. Kozo Yammamura, Seattle: University of Washington Press, 1982.

9 Japanese strategies of industrial promotion in both the era of formal closure and the period of loosening of the developmental system are evident in advanced technologies. When Japan lacked basic electronic technologies, American firms were forced to license Japanese firms in order to have any access to that market. Texas Instruments, with its strong patent position in generic semiconductor technology, was able to trade its licenses for a permanent share of the Japanese market; its part of that market, however, has not moved significantly up or down over the last years. Even IBM saw its position erode in Japan, despite the fact that no Japanese company could compete with it anywhere else in the world. Formal trade barriers were dropped in the mid-1970s. In preparation the industry was somewhat reorganized and the government-both NTT and MITI-launched coordinated domestic programs of technology development that allowed Japanese firms to catch up to American companies in basic component products. As the Japanese established parity in the most standard of these products, random access memories (RAMs), production in Japan boomed and export drives into America began. Development strategies and private coordination did not cease with an end to formal closure.

10 For a discussion of the footwear, textile and steel cases, see essays by Borrus, Milstein, Aggarwal and Yoffie, in Zysman and Tyson, American Industry, op. cit.

11 Business Week, July 19, 1982, p. 118.

12 Joan Pearce, Subsidized Export Credit, London: Chatham House (Royal Institute of International Affairs), 1980.

13 Zysman and Tyson, American Industry, op. cit.

14 See, for example, Michael Borrus, et al., in Zysman and Tyson, American Industry, op, cit., and Borrus, et al., The Changing Terms of International Competition in Microelectronics, Berkeley: BRIE, 1983, as well as on-going work at the BRIE on high-technology trade issues.

15 Recent research has substantially improved our understanding of the relations between competitiveness and manufacturing innovation as well as the ties between high technology and traditional manufacturing. See, in particular, Charles Sabel, Work mid Politics, Cambridge: Cambridge University Press, 1982, Ch. 6, and Michael Piore and Charles Sabel, "Italian Small Business," in Zysman and Tyson, op. cit. See also, William J. Abernathy, et al., Industrial Renaissance, New York: Basic Books, 1982. A series of projects on these issues is underway at the BRIE.

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  • John Zysman and Stephen S. Cohen teach at the University of California, Berkeley, where they direct the Berkeley Roundtable on the International Economy (BRIE). Zysman is the author of Governments, Markets and Growth: Financial Systems and the Politics of Industrial Change and editor (with Laura Tyson) of American Industry in International Competition. Cohen is the author of Modern Capitalist Planning: The French Model and editor (with Peter A. Gourevich) of France in the Troubled World Economy.
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