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Japan and Germany: American Concerns

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For over half a century Japan and Germany have been at the heart of America's international preoccupations. After a long and destructive war against both countries, the United States worked exhaustively to help its two erstwhile enemies recover and build democratic societies secure under the American defense umbrella. From the late 1960s to the mid-1980s, victor and vanquished moved to a more balanced relationship, especially in trade and finance. Today, in one of history's great role reversals, Tokyo and Bonn have become Washington's fierce trading rivals and also its primary bankers.

The relationship between the United States and its two allies-and, indeed, between Japan and Germany themselves-is now changing dramatically. In the 1990s economic pressures are likely to be the major factor reshaping ties among the three nations. What will the consequent environment look like? What will be the most important points of contention? How should the United States respond?

The search for answers has to go beyond homilies about better coordination, burden-sharing and new partnerships. It should begin instead with a clear-eyed look at the difficult issues arising from these countries today. It should focus on the interests of Japan and Germany, and how their governments, businesses and populations are likely to deal with the crucial issues of growth, trade and finance, as well as how they are likely to behave in certain geographical regions. Finally, it will be important to determine the degree to which the challenges of Japan and Germany ought to be viewed together.

Tokyo and Bonn could be responsible for some of America's biggest headaches in the upcoming years. Each could present Washington with almost intractable problems deriving from their domestic drives, and in some important cases their interests could converge in opposition to America's needs. This combined challenge should lead as quickly as possible to serious soul searching, in the Bush Administration and Congress, for a more effective policy framework.

II

There are many reasons for American concerns. There is no need to belabor disclosures of the growing assertiveness of Tokyo or Bonn, or of the escalating trade tensions between the United States and its allies which are wearing down governments and taking a toll on all aspects of relations. Beyond that, however, the world economy has become dangerously unbalanced. Despite all the attention given to America's "irresponsible" deficits, Japan and Germany are a major part of the problem too. They, after all, are the ones running large trade and financial surpluses. If this situation is not corrected, it could lead to destructive competition for trade and more destabilizing plunges in financial markets.

No letup is in sight. In both Japan and Germany the economies are booming, investment in new production capacity is growing, and exports are not weakening. America, on the other hand, shows no similar strength. The International Monetary Fund (IMF), for example, projects that the U.S. current account deficit will grow to $139 billion next year from $125 billion in 1989, while Japan's surplus will balloon to $90 billion from its present $72 billion and Germany's to $57 billion from $53 billion. Moreover, America, Japan and Germany are at loggerheads concerning how each ought to handle its deficits or surpluses, and whose responsibility it is to change policies.

This standoff is part of a larger problem of diverging perspectives. America's objectives, for example, are easy to define, at least when expressed in the most general terms. Washington wants Tokyo and Bonn to bear more of the financial burden for troops, weapons and foreign aid around the world. It wants the two countries to keep their powerful economies wide open to U.S. grain, semiconductors, and American banks and insurance companies. It wants a strong helping hand from its two allies to keep the dollar stable, but Washington also wants to remain in control of its own security and economic relationships.

Japan and Germany see the world differently. They want America to maintain most of the obligations it assumed in the early postwar years. They are less clear, however, about their own goals and responsibilities. Both countries lean toward free market policies, which would liberalize trade and deregulate and privatize state-owned companies, but each has been slow to move in this direction. They expect to be partners in big decisions and small, but they want the United States to be out front and to take the political responsibility for efforts that fail. Japan and Germany have the power to influence outcomes-especially by refusing to go along with U.S. initiatives-but if they have a positive vision of where they want the world economy to go, they have not been able to articulate it.

Moreover, the nature of domestic politics in both Japan and Germany seems increasingly out of step with the requirements of international leadership. In Tokyo, for instance, the ruling Liberal Democratic Party, which has dominated the nation in the postwar era, has been wracked by political scandals; it now needs to focus on winning back its popularity. This preoccupation could translate into a pandering to local concerns at the expense of global responsibilities. In Bonn, the two major parties-the Christian Democrats and Social Democrats-have now to contend with growing political power on the left (the "Greens") and the far right (the Republicans and others). The prospect is for shifting coalitions of leadership and increasing polarization. For both nations, then, the implication is for stronger than usual resistance to new policies that hurt any major constituency-precisely the kind of inhibitions that will make meaningful global economic collaboration difficult.

While Japan and Germany share many broad economic and social goals with America, there are important differences between the United States and its allies. Japan's main policy objective has been to protect its economy-access to raw materials abroad, access to foreign markets, and the nurturing of powerful conglomerates in industry and finance that are big enough to perform stabilizing roles in society. In America the purpose of economic policy has been different: individual choice and customer satisfaction.

In Germany the main goal has been to maintain low inflation, even at the cost of significant long-term unemployment. In America, by contrast, there has been more balance in the trade-off between prices and jobs.

In both Japan and Germany, government institutions symbolize and reinforce national aspirations. The Ministry of International Trade and Industry and Ministry of Finance embody and guide Tokyo's economic drives. The Bundesbank oversight of Germany's interest rates and currency is a surrogate for political responsibility and moral rectitude. There is no U.S. commercial or financial institution that has such a status in the American psyche.

Finally, in both Japan and Germany, the distinction between economics and foreign policy is far more blurred than it is in America. Partly because they are smaller nations and more dependent on the world economy, and partly because of constraints on their ability and willingness to have independent military capabilities, Tokyo and Bonn have learned to make economics an extension of politics by other means. It is a perspective not characteristic of America.

III

What are some of the characteristics Japan and Germany have in common that could drive their future policies? Culture, language, geography and resource endowments separate Germany and Japan as nation-states, as does physical size, GNP and population (see Table 1). Japan's direct impact on the world economy in the years ahead, for example, is likely to be far greater than Germany's. This stems from several factors besides its much larger size.

TABLE 1

1989 COMPARISONS

Japan Germany U.S.

Population 122 61 244

(millions)

Gross Domestic Product 2,400 1,100 4,500

(billion dollars)

Export of Goods 8 26 6

(percent of GDP)

Imported Goods 6 20 10

(percent of GDP)

Area 145,856 95,975 3,618,770

(square miles)

Source: OECD, Economic Survey 1988/89

First, Japan's ambition and reach far exceed Germany's. Bonn is essentially a European power whose options are heavily constrained by its membership in the European Community (EC). Tokyo has much more flexibility and its drives are global. Second, Japan is more innovative and dynamic; it is becoming the world's foremost laboratory for new products and industrial processes. Third, Japanese domestic markets are, de facto, much more closed than Germany's (where imports as a proportion of GNP far exceed America's); Japan's internal structure, unlike Germany's, will be under pressure from the United States and others to undergo a true revolution in the 1990s. Finally, Japan's relationship to America is starkly intense. Tokyo enjoys no close ties or alliances with anyone else but Washington. The United States and Germany loom nowhere near as large in each other's psyche and future, as do the United States and Japan.

Even with these caveats, there are many common threads. Both nations are economic powerhouses. Japan has roughly twice the GNP and twice the population. But what does or does not happen to Germany-where a quarter of Western Europe's GNP is created-also affects the economies of France, Britain, Italy, the Benelux countries and some 320 million consumers in the region.

Both have a major financial impact on the global financial system. Each has a strong currency with low inflation; the yen and the deutsche mark have become anchors for the world monetary system-in contrast to the instability of the dollar. The sheer volume of Japan's financial surplus, and the strong influence that the Ministry of Finance has over the behavior of Japan's banks and securities companies, give Tokyo extraordinary clout. However, the deutsche mark is used far more often than the yen in trade, investment, reserve holding and intervention in foreign exchange markets. The Bundesbank may soon become the central bank for all of Western Europe, with influence over the entire pace of economic activity on the continent.

Both nations are impressive exporters. Tokyo receives more attention in Washington because Japan's trade surplus with America is so large, and because it totally dominates certain sectors of the world economy. In fact, however, Germany is the world's largest exporter of goods. It is not only running large surpluses with its European partners and contributing to global imbalances in the same way as is Japan, but as a proportion of GNP, Germany's current account surpluses are the highest in the Organization for Economic Cooperation and Development (OECD).

Japan is often accused of deliberately gearing its economy to keep out foreign products. Such charges are not made with regard to Germany. This said, however, in several areas of greatest interest to the United States-telecommunications, financial liberalization and agriculture-Germany is a relatively closed economy compared to the United States, Canada or Britain.

Both countries have had a single-minded preoccupation with international competitiveness. They are extremely high savers, and they ensure that their industries have access to low-cost, long-term money. Research and development has been a high priority for years, as have manpower training and education.

In both Japan and Germany, workers occupy a more central position in industrial organization than they do in America. In the former case their position in industry is nurtured through teamwork and almost permanent job security. In Germany unions are powerful and have a strong voice in corporate management.

Finally, they both share historical legacies that continue to influence their behavior. True democratic revolutions, in which individual rights and individual choice emerged as potent objectives of government policy, never occurred in Japan and Germany. In addition, each country was forced to play "catch-up" with other industrial societies that had experienced the industrial revolution much earlier and had the economic benefit of long sustained trading relationships with large colonial empires. The combined result of these factors was an evolution in which the state has played a major role in the economy, motivated in part by insecurity and a determination to overcome perceived disadvantages in competing with others. It is no accident, therefore, that both Japan and Germany developed tightly woven economies.

In both countries, for example, banks hold significant shares in industrial companies, thereby leading to the presence of powerful financial-industrial conglomerates that are extremely difficult for outsiders to penetrate. Companies have cross-equity holdings in one another, adding to the web of tight relationships. Government plays a heavy role in the private sector by way of regulations and subsidies. Corporate practice, so often a good reflection of society's priorities, favors management and large institutional owners rather than individual shareholders. To varying degrees these features allow for controlled strategies against foreign ownership of each nation's assets; foreign takeovers face a range of regulatory and cultural obstacles and are rare occurrences. In fact, net new foreign investment in Japan has been negligible in recent years; the same is true of Germany.

IV

The drives and policy constraints of Japan and Germany could lead to tensions with America in several ways.

First, there is the specter of a recession in America in the early 1990s. Although economic forecasts for the industrial world have been bright in late 1989, the long business expansion of the 1980s will surely end at some point. The United States is particularly vulnerable to a deep slump. Many companies that have acquired large amounts of debt from leveraged buyouts and junk bonds are already struggling, and a period of slow growth could result in a large wave of bankruptcies. Moreover, the banks and the savings and loan system are in extremely fragile shape; if their borrowers have problems repaying loans, their own plights will worsen.

Recessions have come and gone, of course, but this time Washington lacks the usual tools to dig its way out. In the past, for example, it could increase government spending and stimulate consumer demand. Now, however, existing budget deficits are so large that any more spending would create fiscal havoc. In the past, the Federal Reserve could have lowered interest rates to spur investment. But with deficits and debt putting the dollar in so precarious a position, an easier monetary policy could encourage foreign holders to dump their dollar holdings and send the greenback into a free fall.

It is here that Japan and Germany enter the picture. Faced with recession, Washington-its hands tied domestically-would surely implore its two allies to grow faster and buy more American products. That has been a standard American refrain since the mid-1970s, but it could now assume greater importance than ever before. It is far from certain that Japan and Germany would go along with America's requests. Both are already growing very rapidly and already fear inflation in their own countries. Tokyo and Bonn share the view that Washington's problems are homegrown, that they could do little that would really help the United States without hurting themselves. In Germany, in particular, there is a deeply held view that trying to act as an economic locomotive is contrary to its interests and responsibility.

A recession, in short, could crack open the facade of economic coordination and common direction that have characterized the proclamations of ministers for the last few years, during which strong economic growth has prevailed.

V

Even without a recession, trade and budget deficits in the United States and huge surpluses in Japan and Germany present a longer-term problem. Unless those balances are corrected, they could have a debilitating impact on future American living standards.

To the extent that U.S. trade deficits continue at anything like today's levels, they will require major borrowings from abroad. This, in turn, will result in more buildup of foreign debt. The United States already has foreign obligations of over $500 billion. By the early 1990s it could reach $1 trillion, requiring debt service of some $8 billion to $10 billion per month. This is money that would otherwise have been available to invest in areas critical to American life: schools, police forces, anti-drug campaigns, medical research, environmental cleanup and infrastructural repair. If, as a result of America's large debt overhead, the dollar weakens considerably, then living standards would also decline as Americans pay more for foreign goods, which now constitute an ever larger portion of the products and services Americans use.

To deliberately curtail the growth of foreign debt and eventually reduce it, the United States would have to move from a trade deficit to a trade surplus. The arithmetic is not complicated. In the early 1990s the U.S. would need to cut to zero its $120-billion trade deficit, so that export receipts can cover the cost of imports. In addition, it would need an export surplus of some $80 billion to cover interest payments accumulated in the past. Assuming the United States could generate that incremental amount of new exports without generating bottlenecks, labor shortages and inflation, the question becomes, which nation will "make room" for U.S. products in such magnitude? The logical answer is those nations with the biggest surplus positions and large, booming consumer markets-in other words, Japan and Germany.1

Will Tokyo and Bonn oblige? Unlikely. While both governments will no doubt give lip service to the need to correct global imbalances, they will point to American deficits rather than their surpluses as the culprit. Moreover, on current policies and measured against their own goals, the economies of Japan and Germany are thriving. Almost any significant policy change would be politically painful and, at best, require many years to show results.

Take the case of opening up internal markets. The Omnibus Trade Bill of 1988 authorizes U.S. retaliation against countries that refuse to negotiate reductions in specifically identified barriers determined by the United States to be egregious. Even U.S. trade officials have been careful to point out that prying open foreign markets in this way, while important to certain U.S. firms and industries, will not substantially reduce the overall trade deficit for some time. In just one example, the United States has identified as its highest priority the removal of Japanese restrictions on American supercomputers, satellites and wood products. All told, the benefit might not be much greater than $5 billion.

The real barriers to American exports-after taking account of quality, marketing savvy and exchange rates-are social and cultural impediments. Needless to say, these will be extremely difficult to reduce.

The Japanese case is best known. The complex retail distribution systems keep out most newcomers-domestic and foreign. Because it has so many stages with so many people receiving a markup, imported goods, if they enter the system at all, ultimately lose their price competitiveness. Rigged bidding for many government projects makes foreign participation almost impossible. Interlocking ownership of manufacturers and suppliers makes foreign penetration very difficult too. All manner of "administrative guidance" by government agencies creates a shifting set of barriers for foreigners wishing to sell to Japan or to invest there. Sky-high prices for land have the effect of forcing Japanese families to live in cramped houses, which means fewer purchases of washing machines, furniture and other items that would at a minimum recycle Japanese savings into consumer goods.

In Germany the biggest barriers to a substantial increase in imports are deeply cultural, too. Germany's growth results today mostly from exports, not from domestic demand. One big obstacle to consumer-led expansion, which would open up the economy more, is the high level of permanent unemployment, currently running at over seven percent. This problem results from tight monetary policy, from high unemployment benefits that keep workers out of the labor market, and from rigid labor policies that keep wages at very high levels, thereby discouraging employers from taking on new workers.

Between the United States and Japan, negotiations on these kinds of issues have begun under the rubric of President Bush's "structural impediments initiative." Progress promises to be painful because of political resistance and because Tokyo has demanded that America's shortcomings-from low savings rates to deteriorating education system-be put on the table, too. Washington announced very high expectations for specific results by next summer, and a major trade crisis seems inevitable by mid-1990.

In the German case, there are currently no organized trade discussions at all between Washington and Bonn.

VI

U.S. vulnerabilities and longer-term political questions associated with the growing financial power of Japan and Germany also need to be addressed. America today depends on overseas money to finance large portions of its budget deficit. If Tokyo or Bonn took steps to discourage foreign lending, Washington could not finance all its needs from its own savings. The consequent pressure on the domestic supply of funds would drive up interest rates, which could lead to a marked economic slowdown. Then the dollar would plunge, as investors worldwide lost confidence in the United States.

No one believes that either Japan or Germany would try to orchestrate such a crisis in the foreseeable future. But who can tell whether their political assertiveness will grow, fed by their own view that America is unable to discipline itself? Who can say whether they will react negatively to an aggressive U.S. trade policy or whether some political constellation will develop in either Tokyo or Bonn to put pressure on the United States, as America has pressed them in the past?

Beyond such hypothetical scenarios is a broader range of financial issues-exchange rates, capital flows and investment, banking and securities regulations, foreign assistance-in which Japan and Germany will play an increasingly pivotal role.

Japan's financial power is already enormous, and still growing rapidly. Since the mid-1980s, Tokyo has acted like the world's central banker. It lent huge sums to America, thereby allowing it to run large deficits without igniting inflation, and to keep the dollar relatively stable without having to increase interest rates. Japan's intervention in securities markets stemmed the stock market debacle of October 19, 1987, and offered immediate relief in the shorter crash of October 1989. Its aid program could relieve Third World debt, and its capital outflows continue to find their way to investments in the United States, East Asia and, more recently, Western Europe. If reputable predictions are correct that Japan's financial surpluses will grow to over $800 billion in the 1990s from today's $350 billion, it is almost impossible to conceive of where such power will lead-how many industries will be dominated by Japanese firms; how much clout Japan will have in the IMF, World Bank and other organizations; what kind of political influence will accompany Japan's economic penetration of all global markets.

Less well appreciated in many U.S. circles is Germany's crucial role in global finance. This stems not from the magnitude of the nation's financial surpluses but from its influence throughout the European continent. Europe is moving not only toward an integrated market for goods and services but also toward a monetary union with a common currency and a single central bank. The details are still subject to political and technical wrangling but two conclusions seem inevitable: there will be some meaningful type of union and it will be dominated by the strongest financial power-Germany.

Why does it matter to America? A German-dominated European monetary system could have a bias toward very low inflation at the expense of job creation. This, after all, is the way the German authorities have managed financial matters within their own country. One implication could be a slower-growing Europe with increasing protectionist tendencies. For an America desperate to find new markets for its products, this would not be good news.

World monetary and financial policy is already characterized by close cooperation between the treasuries and central banks of the United States, Japan and Germany. As Tokyo and Bonn increase their weight in the global economy, the nature of decision-making is bound to change. The big issues may seem technical, but at stake are the pace of economic activity, competitive advantages in trade and the nature of outside help to the Third World and the Eastern-bloc countries.

There are deep-seated values inherent in decisions on these issues. For the last 45 years it has been American values that prevailed. If, in the future, Washington, Tokyo and Bonn share the same premises and objectives, the conflicts should be containable. But if they do not. . . .

VII

Other problems between the United States and its two most important allies could emerge because Japan and Germany are becoming major players in areas where Americans have had a relatively free hand.

The United States itself is not immune to this trend, as the pace of Japanese investment quickens. The recent sale of Columbia Pictures to Sony, the announcement in early November of the sale of Rockefeller Center to Mitsubishi Estate Company, the hints that Boeing Corporation may link up with Japanese firms in aerospace-these and other such deals could soon raise protest across the United States that could color all American attitudes toward Japan.

Elsewhere, Tokyo is creating a yen-dominated trade and industrial zone from Seoul to Sydney. To take advantage of lower costs, and to make room for high technology and information-intensive businesses on its own soil, it is moving its industries offshore to neighboring nations. In the process, however, it is not relinquishing much management, technology or ownership. Tokyo has proposed a regional Asian economic association, loosely modeled after the OECD. The Bush Administration has hastened to support a similar idea. But political initiatives are unlikely to reverse the trend of retrenchment in Asia by American banks, and to overcome the increasingly difficult time U.S. exporters will have competing for markets. The handwriting is on the wall as to who will be the dominant and most influential economic power in East Asia.

Japan has not yet acquired great influence in America's backyard-Latin America-but the possibility is there. There are many convergent interests between Japan and Latin America. The southern hemisphere has minerals and oil that Japan needs. With its large consumer markets, it is an attractive outlet for Japan's exports. Tokyo's clout will be enhanced by its ability to refinance the debts of, say, Brazil or Argentina far more easily than Washington can, and its increasing amount of direct investment in Mexico. In addition, Japan will have increasing influence in the IMF and the World Bank, on which so much of Latin America's future depends.

U.S. and German interests could most easily diverge in Europe. In industry, finance and macroeconomic policies, Washington could be confronting a European Community heavily dominated by Bonn. There is little tradition in Germany for managing economic affairs with more than narrowly defined domestic welfare as a goal, and over time America could be confronting a more insular Europe and a more distant partner in the global economy.

Germany is not only the pivotal power in Europe as it approaches 1992, it is also the most important link with Eastern Europe and the Soviet Union. It leads all Western nations in trade with Poland, Hungary and the other Eastern-bloc nations. Bonn is also Moscow's biggest trading partner, and Germany has sponsored more joint ventures than any other OECD nation. Large German credits have already been extended to the U.S.S.R. and major training programs for Soviet technicians are in progress. Whatever the EC's role with East European nations and the U.S.S.R., it is likely that German influence will be paramount in those negotiations. Over time, as the problems in the East grow, we can anticipate escalating friction between Washington and Bonn over the amount of aid and relative contributions, the linking of aid to economic and political reforms, the framework for approving exports of sensitive technology to the East, and indeed the German commitment to a Western Europe with a strong orientation toward more open markets and close trans-Atlantic ties.

VIII

What of the relationship between Japan and Germany? Contrary to stereotyped perceptions, the two nations have never had close ties. Although Meiji Japan based much of its systems of law and medicine on the German model, political links between the two nations over the last two centuries have been almost nonexistent and trade relations have been fraught with friction. Even during World War II there was very little practical cooperation. Since 1945, each nation has been preoccupied with its own recovery, with its ties to the United States and with involvements in its respective backyard. To the extent there have been substantive bilateral contacts, most have taken place in multilateral forums like the OECD, the IMF or the annual summits of the major industrial democracies.

As the 1980s end, however, changes are occurring. Lured by the prospect of a unified European market, and worried by growing trade and investment frictions with the United States, Japanese firms have taken an intense interest in Western Europe and have been scrambling to increase trade and investment in the EC. Germany enjoys high respect in Japan for the quality of its labor force and the depth of its scientific and technological capabilities, and the Federal Republic is high on the list of Japanese targets. Moreover, many Japanese executives in business and government are expecting that Germany will eventually become the financial and industrial capital of a consolidated Europe, and they plan their longer-term strategies accordingly.

From a German perspective, however, Japan is seen as far less an opportunity than a threat. For years Germany has run trade deficits with Japan. Now Bonn's dominance in Europe itself may come under some pressure from a growing Japanese presence. The most visible battlefield may well be the automotive industry, where Toyota, Nissan and Honda are set to challenge Mercedes, BMW and Volkswagen, not just in the United States-a critical market for everyone-but in Europe as well, including, remarkably, West Germany. In addition, Japanese banks and securities companies are moving into the EC and into Frankfurt in force, creating new anxieties in many of Europe's financial boardrooms. And while mergers and joint ventures of all types between Japanese and German firms are likely to grow, particularly in industries needing skilled workers and advanced research capabilities, it is a good bet that Japanese penetration will increasingly bump up against political and social sensibilities in the Federal Republic, making for increasing tensions on a bilateral level.

All told, therefore, stronger ties between Tokyo and Bonn are apt to be very slow in coming. For the foreseeable future both are likely to remain much closer to Washington than to one another. Each will attempt to persuade Washington to join sides against the other. For example, Bonn-together with other European nations-would like to join with America to pry open Japanese markets, and German and other European technology firms may be leaning toward linkups with their counterparts in America to compete against the big Japanese conglomerates. Tokyo, on the other hand, wants help from the Bush Administration in pressuring Europe not to become a protectionist fortress.

In the end, however, it would be a major mistake to dismiss the pressure that Tokyo and Bonn could exert on the United States-in concert. The notion of a planned "gang-up" may be farfetched for political reasons, historical and current, but the pursuit of similar interests is a good possibility. This scenario would include resistance in Japan and Germany to all manner of American pressure to reduce their financial surpluses, to dismantle their "structural" obstacles to increased consumer demand for imports, or to follow America's lead in global economic institutions and in various regions of the world.

IX

American strategy toward Tokyo and Bonn must start with changes in domestic economic policy. It is an absolute prerequisite for the United States to be both economically competitive and capable of financing its defense needs. Progress on this score will vastly increase Washington's maneuverability with its key allies. Failure will make effective leadership from Washington impossible.

The Bush Administration, to its credit, has pursued an aggressive trade policy. It seems willing to experiment with government-backed industry consortiums to enhance competitiveness, and it has identified the need for American firms to take a longer-term view of their investment strategies. It has also made revitalizing education a national priority.

These achievements, however, are totally undercut by fiscal and monetary policies. The failure of the administration and Congress to get a handle on the budget is likely to lead to growing budget gaps once again. It signifies a basic inability to govern and destroys the credibility of American economic policy at home and abroad. The frequently benign policy toward the dollar promises to aggravate the trade deficit next year, and the public bickering between the Treasury and the Federal Reserve about how to deal with the currency raises basic questions about whether the United States has a policy at all-let alone whether it has the ability to lead the way in global coordination.

Three initiatives could be pivotal for restoring U.S. economic health. A gasoline tax, for example, could generate $1 billion for every penny increase. An agreement with Japan and Germany to gradually get the dollar on its former downward course via market intervention and coordinated changes in interest rate policy could be the most important step to address the trade and financial imbalances that are growing again. And the movement from rhetoric to actual measures to encourage more savings and long-term investment is a sine qua non for a stronger U.S. economy.

Next, the challenges of Japan and Germany necessitate close coordination in Washington between defense policy and economic considerations. In the past, the United States could use its military position to influence its allies in trade or finance. At other times, it could subordinate business profits to broader political security matters. Today, neither is the case. Defense and economics are equally important. The two areas of policy have to be conceived and executed in tandem.

As a start, there is need to develop a better definition of what constitutes burden sharing, how military and economic considerations can be weighed together. Thinking here has to go beyond adding up military spending and foreign aid and comparing the totals. For example, Japan has worked hard to prop up the dollar at crucial periods. Should Washington include such support for American objectives in the equation of how much international burden and responsibility Japan is taking on?

Despite the economic weight and the growing assertiveness of Japan and Germany, the United States is still the overwhelming global power and has an excellent opportunity now to push its own view about the respective roles and responsibilities of the three nations in the future world economy. Tokyo and Bonn will define their own interests through their own processes, but neither is in a position to take initiatives outside their respective regions.

To succeed, however, the administration must know what it wants. It must have its own vision and goals for the future monetary system, including such questions as the role of the dollar, the yen and the deutsche mark. It must have at least a plausible internal plan of how to settle the trade imbalances. It must have a view of how to channel the enormous Japanese capital outflow. It must be able to define what the IMF and World Bank should be doing in the 1990s, or how to handle economic relations between the industrial democracies and the Eastern bloc.

The challenge is to find ways to increase the constructive involvement of Japan and Germany in future arrangements. The separation of the World Bank and the IMF, for instance, may have outlived its usefulness in the world of the 1990s and beyond. The regulatory structure for banking and securities trading around the globe has yet to be fully developed. The General Agreement on Tariffs and Trade (GATT), as structured, cannot accommodate the broad range of domestic polices that affect international trade. The coordination between the monetary authorities of the three key nations is already close, but it could become much closer via the granting of observer status in one another's key central bank meetings. New institutional arrangements are required to coordinate bilateral and multilateral initiatives toward Eastern Europe. In each case there is a chance to fully reflect Japan's and Germany's new powers and obligations.

In addition, Washington could broaden its efforts to press Tokyo and Bonn to move toward more open, flexible consumer-oriented societies. Regarding Japan, for example, the structural trade and investment issues have been dealt with only in a narrow bilateral framework, which is too highly charged by other items on the current agenda. The negotiations need a fresh look with regard to participants, the objectives and proper time frame. And the EC should be brought in to help the United States exert pressure and to inject the true multilateral global dimension.

A new look is also in order when it comes to emerging economic blocs. The administration, after some delay, has awakened to the dangers of a bloc mentality emerging in Western Europe, and is now pressing vigorously for outward-looking policies. However, these are early days in the EC's effort to unify its markets and Washington cannot afford to let up the pressure. On the other hand, the United States may be taking too relaxed an attitude toward the emerging Japanese push for some type of regional grouping in the Pacific Basin. Thus far, Secretary of State Baker has given the idea a strong endorsement in the form of a proposed "framework for discussion." But is this the stuff of well-meaning speeches or does the United States have a specific strategy to counterbalance Japan's economic influence?

X

As a new decade begins, economic momentum in Japan and Germany is gaining force, while America is struggling with debt, deficits, a shaky financial system and unprecedented social problems. There can be no question that these disparities will lead to growing tensions between the United States and its two key allies.

For Washington, getting what it needs from Tokyo and Bonn in the world economy will be exceedingly difficult no matter what is tried. Nevertheless, for the Bush Administration, the time to reexamine its strategy toward Japan and Germany, separately and together, is now-before the big problems arise.

1 In the case of Germany, in particular, "making room" for U.S. exports could mean importing more from its European partners, whose economies would, in turn, be stimulated to buy more American products.

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