The trade war and Japan

by Heizo Takenaka

We have evidence gained over a long period that free trade brings great benefits to the economy as a whole. Today, however, we are witnessing an escalation of protectionist policies that defy such evidence.

In March, the administration of U.S. President Donald Trump announced it was imposing tariffs of up to 25 percent on steel and aluminum imports to the United States (with some exceptions). Several countries and regions, including China, have taken retaliatory steps against the U.S. action. The U.S. in turn took such steps by its trading partners to the World Trade Organization, alleging they violate WTO rules. The U.S. action has developed into a tit-for-tat exchange of retaliatory measures.

The Trump administration is trying to build up a “political” episode in order to win votes among Americans unhappy with the status quo — by showing that he is different from any of his predecessors. Such moves will only intensify as the U.S. midterm elections in November draw near. The U.S. and China are the world’s largest and second-largest powers in terms of GDP and military strength. A trade war between such major powers will be a disturbance not just between the two countries but to the whole world.

How should Japan act in response to these developments? The impact they will have on Japan will not just be that of a trade war and as such need to be assessed from multiple vantage points.

First, Japan needs to watch out for the consequences of the trade war on its vehicle exports. Currently, most of the U.S. trade actions have China in mind as the primary target. That’s because the U.S. trade deficit with China accounts for roughly half of its overall deficit. The deficit with Japan accounts for around 12 percent of the total. The problem is that 80 percent of the deficit with Japan comes from automobiles and related trade. The chances are extremely high for the Trump administration — which lays emphasis on creating political episodes — to target the automobile trade with Japan.

Second, what’s notable in the ongoing trade war is that it has evolved into a currency war. While U.S. imports from China reach some $500 billion, China’s imports from the U.S. come to only about a third of that level. China will be at a disadvantage if the current exchange of retaliatory measures gets extended.

In that case, China will likely resort to a broad range of retaliatory action, including manipulating its currency exchange rate. In fact, the yuan’s rate against the dollar tumbled some 10 percent in late February compared with right before Trump’s inauguration. The fall came just before the Trump administration was to decide on the additional tariffs on steel and aluminum imports. The yuan’s decline in effect offsets about 40 percent of the 25 percent steel tariffs. A policy to drive the yuan’s value lower will have a big impact on Japan as well.

Third, the standoff between the U.S. and China has taken on the aspect of a broad fight over hegemony in high-tech business. The U.S. policy appears to have clearly changed around mid-June — when it included semiconductors and its production equipment as targets of its tariff hikes. Under its “Made in China 2025” agenda, China has declared that it will join the world’s leading manufacturing powers by 2025 — and is aggressively seeking to acquire American and other overseas firms. The U.S. government is clearly mindful of this. The trade war has evolved into a war over hegemony in the high-tech fields.

Are Trump’s policies that reject free trade and pursue extreme protectionism going to be a one-off phenomenon? Should we patiently wait for it to end — just like a passing rain — so that the problem will subside on its own? Behind the Trump phenomenon is a serious divide in American society. Therefore, it is likely that the situation that we’re seeing today will, to varying degrees, continue under any administration. It should also be noted that Trump, despite his seemingly wavering statements, has steadily implemented what he promised during the campaign, such as corporate tax cuts and building a wall along the border with Mexico.

What’s most worrying is Trump’s criticism of the WTO as a useless institution. This time, the U.S. took its complaints to the WTO. If the WTO does not rule in its favor, there’s a good chance the Trump administration may use it as an excuse to pull the U.S. out of the organization. Japan needs to bear that worst-case scenario in mind and quickly devise proactive measures to cope with the situation.

On the first question of automobile trade, Tokyo should emphasize that sanctions on Japan will only put the U.S. at a disadvantage. Japan annually ships some 1.7 million vehicles to the U.S., but the U.S. exports double the number of Japanese vehicles built in American plants. In a tit-for-tat exchange of tariff hikes, the damage to the American economy will clearly be larger.

On the second issue of currency war and the third question of the race for high-tech hegemony, what Japan can do to directly address them will be limited. What the government should do will be narrowed down to two things.

One is to assume that the global economy will be slowing down over the medium term due to the effects of protectionism and make all-out efforts to carry out structural reforms of the domestic economy.

The other is to take the lead promoting multinational free trade pacts. In that respect, the government can take credit for concluding an economic partnership agreement with the European Union and for orchestrating an accord among participants in the Regional Comprehensive Economic Partnership (RCEP), in the ministerial talks held in Tokyo in early July, to seek a broad agreement by the year’s end. The Japan-EU agreement covers 30 percent of the global population and the RCEP some 50 percent.

In the past, Japan was frequently accused by the U.S. of taking protectionist policies — and it experienced trade friction with the U.S. Today, however, Japan is expected to play a key role as the standard bearer of free trade.

Heizo Takenaka, a professor emeritus of Keio University, served as economic and fiscal policy minister in the Cabinet of Prime Minister Junichiro Koizumi from 2001 to 2005. He is a member of the government’s Industrial Competitiveness Council.