Future historians may choose 1989 as the year the cold war between capitalism and communism ended and a new conflict began within capitalism. They may argue that it was in 1989 that America and the West turned from containing the Soviet Union to containing Japan. The new conflict arises from three historic shifts that have shaken the foundations of the postwar world: America's relative economic decline, the rising economic power of Japan, and the decline of the West's old common enemy of communism. Indeed, it is the dissolution of this threat that is sowing the seeds of a capitalist cold war.

If the old cold war was a competition driven by the race for military superiority, the quest for economic and technological domination will propel the new competition. The meteoric rise of Japan has made America increasingly insecure. What drives America to contain Japan, however, is not so much Japan's economic ascendance, but the failure of American leadership, which feeds national insecurity and xenophobia.

II

Few economic developments have generated as much raw emotion and intellectual confusion as the U.S. trade deficit that turned America almost overnight into the world's largest capital importer and debtor. One widely shared concern is that America's debtor status and dependence on capital from abroad have put the nation increasingly at the mercy of foreigners. America, it is argued, has lost its independence.

In particular many observers fear that foreign, and especially Japanese, investors who are now eagerly financing America's deficits will someday suddenly get nervous and pull out, causing a crash of the financial markets and a "hard landing" for the economy. These anxieties ignore a fundamental fact: In an increasingly interdependent world dominated by global market forces, an open economy with two-way capital flows (whether in deficit or in surplus) is vulnerable to the actions of foreign and domestic investors alike.

If Japanese investors lose confidence in the dollar, so will American investors-indeed, it is American investors who may lose confidence first. Market confidence does not respect national boundaries; a sudden collapse of confidence in the dollar would be worldwide. Foreign and U.S. investors would not act very differently. Both would attempt to shift out of dollar-denominated U.S. assets. Thus, capital withdrawal by foreigners will be accompanied by capital flight by Americans, or vice versa.

That is what happened during the dollar crises of 1970-73 and 1977-78, when America was the world's largest creditor country. Both episodes were characterized by American capital flight more than by foreign capital withdrawal. More recently, in October 1987, U.S. investors panicked and sold off American stocks, while Japanese investors remained net buyers. Thus during that debacle, Americans pulled the plug, not the Japanese.

Moreover, in 1986 and 1987 when the dollar came under sudden heavy selling pressures, Japan played a critical role in slowing its decline. In addition to large dollar purchases by the Bank of Japan to rescue the dollar from its occasional bouts of free fall, the Ministry of Finance used frequent moral suasion, and, in May 1987, even implicit capital controls to discourage Japanese financial institutions from joining the "dump the dollar" bandwagon.

Ironically, as it was injecting stability into U.S. financial markets, Japan also suffered a stock market crash in October 1987, and largely because American and other foreigners engaged in a frenzy of dumping yen securities. Thus Japan, as the world's largest creditor and a financial superpower itself, proved to be just as vulnerable to foreign influence as the United States, the world's largest debtor, is feared to be.

While the trade deficit and debtor status are not likely to threaten national security in the near future, they are already doing something much more worrisome-nourishing America's national insecurity. As a result, jingoism is on the rise. This growing national insecurity has already begun to shape U.S. economic policy in key areas: international trade, foreign direct investment, burden-sharing, Third World debt and the future of international financial institutions. In all these areas, the foreign capitalist nation that Americans seem to fear and resent most, and that therefore consumes most energy and attention of policymakers, is undoubtedly Japan.

III

As its trade deficits persist, the United States is gradually shifting from being the world's champion of multilateral free trade to one of its leading challengers. The response to a Congress searching in foreign lands for solutions to America's failures has been what U.S. Trade Representative Carla Hills calls the "crowbar." This crowbar, however, is not so much prying open closed markets as it is tearing apart the concept of multilateralism, and thus threatening the survival of the General Agreement on Tariffs and Trade (GATT) itself.

The irony of U.S. trade policy of the 1980s is that President Reagan, the postwar chief executive with the most passionate love of laissez faire, presided over the greatest swing toward protectionism since the 1930s. That tilt began even before Reagan's free-trade approach to the currency markets and a swollen dollar forced him to abandon a free-trade approach to the goods markets. Less than six months into his presidency, Reagan's trade representative forced Japan to "voluntarily restrain" automobile exports. A few months before Reagan's reelection in 1984, Japan was forced to voluntarily restrain textile exports to the United States as well. Those restraints remained in effect during Reagan's second term and his administration also initiated additional voluntary restraints on imports of steel and machine tools.

Finally in July 1986 Japan agreed to increase the share of U.S. semiconductors in its market to avoid American antidumping duties. This event was a watershed that marked a move from American reliance solely on restricting foreign imports to an enhanced approach that also included "affirmative action" for U.S. exports. Thus, the seeds of the late 1980s' version of "managed trade" were planted.

Japan escaped the antidumping duties in 1986, but ended up with tariffs a year later for violating the agreement on semiconductors; in April 1987 President Reagan imposed retaliatory tariffs on some Japanese imports. Thus Reagan earned the dubious distinction of being the first postwar president to impose economic sanctions on Japan. During his last year in office, Reagan moved further toward the new strategy of export protection by signing the Omnibus Trade and Competitive Act of 1988. His trade representative, meanwhile, diligently pursued old attacks on imports: quotas on textiles and apparel from China and Mexico and steel from several other countries; antidumping and countervailing duties against Japan, Canada, Singapore, South Korea and the Netherlands; and economic sanctions against Brazil and Japan. By the time President Reagan left office, the share of imports entering protected American markets had doubled from 12 percent to 24 percent.

The Bush Administration now is trying to create a new balance between free trade and managed trade by giving more weight to the latter. Within managed trade the new administration is also changing the balance of import restriction to export protection, with the latter aggressively pursued.

A three-track approach is used to achieve these new objectives. In areas where it believes the United States has a solid comparative advantage-agriculture, services, direct investment and intellectual property rights-the Bush Administration is still using a multilateral approach to trade negotiations under the GATT's Uruguay round. When it comes to specific sectoral interests-mostly in manufacturing, high-tech or low-tech-the administration is using a unilateral approach. Finally, the overall trade policy seems to be guided increasingly by "bloc-ism" and bilateralism.

Washington's pursuit of bloc-ism and bilateralism is only encouraging others to do the same. The free-trade agreement with Canada has raised talk of a similar agreement with Mexico and even Japan. It also has raised the specter of a "Fortress North America," forcing other nations to seek desperately to breach its ramparts or build their own somewhere else. America's trade posture has hastened the efforts of Japan and South Korea in the north, Australia and New Zealand in the south, to move toward constructing a Pacific bloc by enlarging the existing Association of Southeast Asian Nations into the Asia-Pacific Economic Cooperation. The Bush Administration has shown great interest in developing and participating in such a bloc. It proposed a "new Pacific partnership," and sent three top cabinet members to the new organization's November meeting in Canberra, Australia. The United States would be used by such a bloc as a buffer against feared Japanese domination, and the Asian partners would also use it as a gateway into a North American fortress.

Unilateralism is also increasingly shaping U.S. policy on both import restriction and export protection, and is directed mostly toward Japan. The Reagan Administration succeeded in moving U.S. trade negotiations with Japan from a "process oriented" policy to one that is "results oriented." Thus the earlier laundry-list approach and the later priority-list approach (such as the market-oriented sector-specific process) have been transformed into a policy of forcing Japan to participate in a bilateral cartel, the 1986 semiconductor agreement for instance.

The Bush Administration now is taking unilateralism a step further: a results-oriented policy aimed at fighting unfair foreign-read "Japanese"-trade practices. Its tools to implement this policy are the twin sticks of "aggressive reciprocity" and "retaliatory Super 301." To avoid being hit too hard, the Japanese government is coming up with numerous ideas to promote imports, the latest being the Ministry of Industry and Trade's plan to offer Japanese companies tax deductions on their imports.

The latest U.S. policy invention tailored for Japan is the so-called Structural Impediments Initiatives talks. Among other things, these talks seek to have the Japanese adopt Western, or more precisely, Anglo-Saxon, values and habits: saving less, eliminating inefficient mom-and-pop stores and breaking down long-term relationships among various business groups. Washington believes removal of these "structural impediments" will open Japanese markets to American businesses and reduce the trade deficit with Japan. Congress wants results by March 1990.

Leery of adverse domestic reaction to yet another round of unilateral U.S. pressure, the Japanese government is using the talks to demand that the United States adopt a set of "Eastern" values to enhance American competitiveness. Save and invest more, Japan is telling the United States, discourage corporations from pursuing short-term profits, encourage them to improve commercial application of available research and technology, and spend more resources on training and education of the workforce.

This approach, however, has had little success in tempering their domestic backlash to the mounting U.S. pressure. Japanese public opinion is increasingly turning anti-American, and the mood is one of growing resentment, frustration and contempt. America's posture is also strengthening the hand of the rightist admirers of Imperial Japan and the reactionary advocates of militaristic nationalism. Japanese reactionaries, in turn, have only reinforced American enthusiasm for opening Japanese markets with aggressive reciprocity and managed trade. These policies are gaining ground in the United States among academic economists, liberal think-tank analysts and prominent statesmen, thus giving Congress the intellectual ammunition it needs to push the administration further down the pernicious path of protectionism.

IV

Advocates of managed trade with Japan essentially argue that Japan is not a typical liberal democratic capitalist country with respect for the principles of free trade. "Fair trade," these critics argue, is also not possible because Japan is intrinsically unfair, or its notion of fairness is simply different from that prevailing in the Western capitalist democracies. While numerous arguments are used to support this position, two in particular are normally put forward.

First, it is argued that the dollar's fall, the yen's rise and Japan's macroeconomic stimulus have done little to reduce the U.S. trade deficit, the Japanese trade surplus and, more critical, the U.S. bilateral deficit with Japan. Second, the failure of macroeconomics to reduce the trade imbalances is no surprise because the problem is structural and cultural: Japan keeps its markets closed through various unfair trade practices, and its economy does not respond to exchange-rate changes and usual market forces.

The view that exchange-rate changes have done little to affect the pattern of trade and trade imbalances is widely held-and wildly wrong. Facts simply do not support such assertions as: "Almost four years after the radical corrective step of endaka [strong yen], Japan's trade is becoming more unbalanced, not less."1 During the three years from 1986 through 1988:

-Japan's volume of merchandise exports recorded the slowest growth among the Group of Seven (G-7) leading industrial countries, 1.5 percent per year, while U.S. growth was the fastest, at nearly 15 percent. In 1988, the dollar value of U.S. exports soared 30 percent, and the portion going to Japan surged to 34 percent.

-The annual growth in Japan's volume of merchandise imports was the highest among the G-7 countries, at 12 percent per year. Its imports of all manufactures soared 22 percent, again by far the highest rate within the G-7. By 1987, Japan already was importing more manufactures from America than West Germany and France combined, and its purchase of U.S. manufactures jumped by 35 percent in 1988.

As a result of these shifts in trade patterns, Japan's trade surplus narrowed to three percent of GNP in 1989 from its 1986 peak of 4.8 percent. The U.S. trade deficit took longer to respond to market forces. It seems to have fallen last year to two percent of GNP from its 1987 peak of 3.5 percent. In dollar terms, the U.S. trade deficit narrowed in 1988 for the first time in the decade, dropping nearly $35 billion to total $125 billion, and appears to have declined further last year to about $115 billion.

What drives Washington's trade politics, however, is not the overall trade and current account balances, but the U.S. bilateral trade deficit with Japan measured in dollars. This deficit has narrowed little from the 1986 level of $55 billion. What is the reason for the apparent stubbornness of this deficit?

The answer lies not in any invisible Japanese unfairness, but largely in the arithmetic of adjusting a large initial imbalance. With total U.S. exports in 1986 one-third the total of imports, exports needed to grow more than three times as fast as imports to narrow the deficit. Even if U.S. exports grew twice as fast, the trade deficit still would have widened. In 1987 American exports to Japan grew faster than imports, but not fast enough to prevent a further widening of the deficit. In 1988, however, U.S. exports did rise more than three times as fast as imports, and the trade deficit fell.

American exports to Japan also rose faster than exports to Western Europe, 35 percent versus 25 percent, and yet the deficit with Western Europe fell by $13 billion while the deficit with Japan fell by only $5 billion. Why? Largely because the 1987 U.S. deficit with Japan was much larger than the deficit with Europe. The deficit with Japan required an even faster growth in U.S. exports to achieve a reduction similar to the deficit reduction with Europe. A 35-percent growth in U.S. exports to Japan simply was not enough.

The apparent refusal of this bilateral deficit to decline significantly has convinced many that exchange-rate changes and market forces do not work when it comes to trade with Japan. In 1987, however, the United States ran a $110-billion trade deficit with countries other than Japan. The United States had a trade surplus with these countries, except for the OPEC nations, in the beginning of the 1980s. The conclusion should be clear: The U.S. trade deficit is mostly made in America.

Washington also fails to distinguish the issue of market access in Japan from that of reducing the U.S. deficit. While there are areas where Japan can and should open its markets, American access to those markets may have little effect on the trade deficit with Japan. During the 1980s, Japan opened its markets more than any other G-7 country, and yet it has experienced the biggest trade surpluses in its history. America, meanwhile, closed its markets more than at any other time in the postwar period, and yet could not prevent the largest trade deficits of the century.

Unfair trade practices and protectionist barriers to imports have little medium-term influence on a nation's overall trade balance. But Washington's blame-thy-neighbor policy prevents it from recognizing the obvious about Japan. A country that imports more goods from America than any other except Canada; that purchases more U.S. manufactures than West Germany and France combined; whose imports grew faster than those of America in the 1960s (18 percent versus eight percent), at the same rate as America in the 1970s (seven percent) and for the last three years at the highest rate of any G-7 country cannot, by definition, have closed markets. By contrast, a country moving toward managed trade is surely closing its markets-and apparently its mind.

V

Many Americans also worry about the recent surge in Japanese direct investment. As Japanese investors acquire and establish plants, and buy prized pieces of real estate at an accelerating rate, American anxiety grows. The complaint in this case is not that the Japanese have too little liking for American goods, but that they have too much love for American assets. The media obsession with the Japanese acquisition of, or equity stakes in, big-name U.S. companies, banks and buildings prevents it from providing some basic facts and a more balanced picture.

Japan has so far bought very little of America-$50 billion by the end of 1988 in one count, but certainly no more than $100 billion, of corporate assets totaling $7.9 trillion. Japan only owns half as much in the United States as Britain, and the British have invested much more heavily and aggressively than the Japanese. In 1980 America owned more of Japan than Japan owned here. In manufacturing investment, the balance did not shift against the United States until 1987. Even last year, Japan made net payments to American investors as they earned higher profits there than the Japanese did in America.

Another myth is that while Japan is allowed to invest freely in the United States, Americans are kept from doing the same there. Facts tell a different story. The Japanese government used to be more restrictive, but did not do a great job keeping out Americans. Until 1981 America had more investment in Japan than Japan had here. Once Japanese investment laws relaxed, however, market forces themselves put up a new barrier: price. Japanese assets are no longer cheap. Even now foreign investors are rushing to Japan. In 1988 alone, foreigners established, joined and to a lesser extent acquired 355 companies per month in Japan; Americans did so at a rate of 55 companies per month.

Finally, there is the tension over burden-sharing. While other NATO allies suffer some criticism, once again the main target is Japan. Japan is accused of free riding to economic supremacy on the back of an America overstretched by the double burden of defending the free world and developing the Third World.

Last year, however, Japan pledged to pick up the lion's share in "the mini-Marshall plan" for the Philippines, and to add $35 billion to its earlier, and almost completed, $30-billion external surplus recycling plan. Yet in November President Bush signed burden-sharing legislation that calls on Tokyo to boost its foreign aid and military spending to a share of GNP equal to the NATO average by 1992, to channel aid to those areas of the Third World where the United States has foreign-policy interests, and to provide 100 percent, as opposed to the current 40 percent, of the direct costs of maintaining U.S. military bases in Japan.

Such dicta can only threaten, not promote, global stability and prosperity. Japan now spends only 0.3 percent of its GNP on foreign aid, but already has replaced the United States as the world's top donor nation. The average NATO burden for aid and defense is likely to be around three percent of GNP by 1992. As Japan spends one percent of its GNP on defense, it in effect is being asked to spend two percent of GNP on foreign aid, or $80 billion by 1992. Last year, all donor governments combined spent less than $50 billion. Even if Japan could come up with the money, it is unlikely that developing countries could effectively utilize such a sudden surge in resources.

VI

American leaders have complicated Japan's efforts to increase its share of the burden in two other related areas: Third World debt and international financial institutions, notably the World Bank and the International Monetary Fund. For more than six years the U.S. government tried to solve the debt problem by forcing the savings-poor, overindebted countries to service their debts fully by doling out their savings and going deeper into debt. Last year, however, Washington finally accepted the idea that countries that have too much debt need to reduce their debt, not increase it. In March, Treasury Secretary Nicholas Brady announced a plan to have commercial banks "voluntarily" reduce their old loans and offer debtors new money. In return, creditor governments and international institutions would partially guarantee the restructured old claims of those debtors who reformed along IMF guidelines. While the plan represented a step in the right direction, its flaws-some of which are increasingly proving to be fatal-resulted from operational details carefully crafted to avoid an unsympathetic Congress, and to shift the full financial burden of the plan to the international financial institutions and Japan.

The countries eligible for debt reduction include Venezuela, the Philippines, Costa Rica and Mexico. With the debt problem entering its second decade, three of those four countries so far have signed agreements with the banks. Mexico, the front runner that was supposed to benefit most from the Brady Plan, was forced to sign on for marginal debt reduction, and is still waiting for the agreement to translate into financial relief. Venezuela, the country that influenced the timing of the Brady Plan with deadly riots against its economic austerity program, is yet to sign an agreement. Thus even under the Brady Plan, Washington continues to do its part to transform a short-term crisis of finance into a long-term crisis of development.

This crisis weakens not only the Third World, but also the financial integrity and policy effectiveness of the international financial institutions. Washington's budget deficit, meanwhile, has made the United States-the only nation with veto power in those institutions-a political leader in financial arrears. That deficit also has prevented Japan from assuming a greater role in the international institutions. The refusal of Congress to appropriate new funds for an overdue increase in IMF quotas prevents Japan from becoming that institution's second largest financial backer; it is currently the fifth. Japan has been the only country to offer money for the Brady Plan, and has allocated more money for the plan than the IMF itself. The United States, on the other hand, has yet to put up one cent.

Thus while Washington accuses Japan of unfair trade practices, it seems that the United States is engaging in unfair leadership practices. The irony is that as American budget politics effectively prevent Japan from assuming a greater share of the burden in places where it should, Washington insists Japan raise its share in places where it should not.

VII

The foregoing leads to a simple conclusion: America's "Japan problem" is not the trade deficit, or direct investment, or burden sharing, but the economic ascendance of Japan at a time when America has lost confidence in its ability to compete on a level playing field. This loss of self-confidence and the failures of American leadership have produced a national insecurity that is being translated into a hostile rhetoric, and, too often, absurd policies.

America's role in the post-cold war world threatens to become dangerously destabilizing if this insecurity continues to influence the formulation of U.S. economic and foreign policy. Nothing could threaten global peace and prosperity more than the attempts of an increasingly insecure America, still the world's number one economic and military superpower, to contain the economic ascendance of a militarily and politically vulnerable Japan.

The most effective antidote to such a temptation is the economic renewal of America. This renewal must be motivated by the desire to become the senior leader in a new age, to work against the forces of instability and to look for new partnerships in the changed architecture of the globe. But America's economic health cannot be restored if its leaders cast wary stares across the Pacific and fail to see the economic problems arising within their own borders.

1 James Fallows, "Containing Japan," The Atlantic Monthly, May 1989, p. 44.

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