NEW YORK – On his recent trip to Japan, U.S. President Donald Trump sounded more like a 1980s trade negotiator than a 2010s statesman. He urged Japan to invest more in the United States, buy more military equipment and import more liquefied natural gas, and generally pressed for other measures that he thinks will reduce his country’s trade deficit with its main Pacific ally.
But Trump is focusing on the wrong things. Japan’s trade surplus with the U.S. is mostly not about protectionism or aggressive Japanese policy — it’s about macroeconomics. And it might not need to be remedied.
The bilateral trade deficit is certainly real. Japan continues to export much more to the U.S. than it imports:
Why does this deficit exist? In the past, Japan was a very protectionist nation. In the 1980s, Japanese bureaucracies got very creative with reasons not to allow foreign products into the nation — the classic example involved banning foreign skis because they were supposedly unsuited to the country’s unique snow.
But much has changed since the 1980s. First, Japan’s government gradually realized that restrictions like this were likely to harm Japanese companies. Maintaining different standards than the rest of the world tends to keep Japan, Inc. penned up within the small Japanese market — a danger known as “Galapagos Syndrome.” That realization, plus a series of successful trade talks with the U.S. in the 1990s, made Japan much more open to American products. Nowadays, for example, Japanese people vastly prefer American iPhones to domestic brands — this would probably be inconceivable in the 1980s.
Japan-U.S. trade has also changed a lot. As many commentators were quick to point out when Trump called for more Japanese factories in the U.S., this shift has already mostly happened. Japan is the second-largest source of U.S. foreign direct investment after the United Kingdom, pumping hundreds of billions of dollars a year into the economy and employing huge numbers of American workers. Most of the Japanese brand cars sold in the U.S. are made in North America. Some of that is in Mexico, but much — for Nissan, around three-quarters — is made in the U.S. According to Cars.com, the Toyota Camry is the most “made in the U.S.” car.
There are some areas where further trade negotiations might open up the Japanese market a bit more. Some nontariff barriers do still exist — for example, in the way that Japan approves cars for import. Additional efforts to harmonize product standards would be beneficial. And Japan should drop many of its trade barriers in agriculture — the last area where the country is actively protectionist — and replace them with a system of subsidies like those used in the U.S. But these measures are unlikely to solve the issue of the bilateral trade deficit.
The real reason for the persistent deficit is probably macroeconomic. A basic fact of international trade is that a trade deficit has to be matched with a current account deficit — in other words, if the U.S. buys more goods and services from Japan than vice versa, it must pay with IOUs. Financial assets are the IOUs — that’s why a trade deficit can just as easily be seen as an imbalance of financial investment. When Japan buys U.S. bonds, stocks or car factories, and the U.S. fails to do the same in Japan, it pumps up the trade deficit.
Japan’s government has been a big buyer of U.S. bonds, sustaining its purchases of Treasuries even as China has sold some of its own holdings. Should the U.S. demand that Japan sell off some of these holdings? That would probably reduce the bilateral trade deficit: The yen would strengthen against the dollar, prompting Japanese people to buy more cheap U.S.-made goods and discouraging Americans from purchasing expensive Japanese ones.
But Japan dumping U.S. bonds could also lead to higher interest rates in the U.S. If the Federal Reserve were unwilling to step up and fill the gap by easing monetary policy — and there are signs that the Fed is dead set on tightening — that could slow the U.S. economic recovery.
A far better strategy for reducing trade deficits would be to get the Fed to hold off on its tightening plans. Monetary easing would put pressure on the dollar to depreciate, not just against the yen but against many other currencies as well. Since there’s little sign of inflation, this also seems like a safe move. If that doesn’t solve the bilateral trade deficit, encouraging American companies to do more direct investment in Japan would be an additional measure.
In other words, Trump and his team need to recognize that the 1980s are over. Japan is a good trade partner, an important ally and a key source of investment into the U.S. Monetary easing, rather than aggressive jawboning, is the best approach to the imbalances that remain.
Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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