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Japan, the Forgotten Protectionist Threat

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Everyone's worried about China today on the trade front. And they should be.

But let's not forget that China is only the most brazen player of one-way free trade out there. We ran a $273 billion deficit with China in 2010, but we also ran an $80 billion deficit with the European Union and a $60 billion deficit with Japan.

These rich-country trade deficits are in some ways more alarming than our deficit with China, because they are emphatically not the result of cheap foreign labor. In fact, nearly a dozen European countries now pay their manufacturing workers better than we do.

So let's look at Japan for a minute.

In the 1980s, Japanese industrial policy was the object of intense American interest, which has since waned due to the deliberately cultivated misapprehension that Japan is in economic decline (This illusion has been exhaustively debunked by the Tokyo-based Irish journalist Eamonn Fingleton; Japan is playing sick to get us off their back.) There was a flurry of books on the subject and for a while it seemed that America might acquire a serious industrial policy of its own (which never happened). But Japan remains much more relevant to America's situation than China, simply because Japan has wages comparable to the U.S., while China competes largely on the basis of a low-wage policy that is impossible for a developed nation to emulate. China is following Japan's old playbook anyway, so it is well worth examining Japan's trade history.

Japan's protectionism runs very deep in its political and economic system. The Japanese themselves certainly believe their economic success has been due to protectionism. No one in Japan of any standing in business, government, or academe believes that Japan's success has been due to free trade. In the words of economic historian Kozo Yamamura:

Protection from foreign competition was probably the most important incentive to domestic development that the Japanese government provided. The stronger the home market cushion...the smaller the risk and the more likely the Japanese competitor was to increase capacity boldly in anticipation of demand growth. This can give the firm a strategic as well as a cost advantage over a foreign competitor operating in a different environment who must be more cautious.

The cultural roots of Japan's repudiation of free trade are extraordinarily deep--as deep, say, as the roots that make America a capitalist culture. This was, after all, a nation which literally sealed itself off from the outside world for two centuries (1635-1853). This act is regarded by most Westerners as merely odd, but it was, in fact, profoundly consistent with the enduring character of Japanese civilization.

Japan's forcible opening to the modern world in 1853, when U.S. Commodore Matthew Perry sailed his famous "black ships" into Tokyo Bay demanding trading rights, added a new element to Japan's existing authoritarian social order: the need for economic and technological sophistication sufficient to defend its existence as an independent nation. Japan promptly set about engaging the modern world on terms congenial to its own political priorities--not those of outsiders.

The key slogan of the day was fukoku kyohei, "rich country equals strong army." Thus private economic interests have never, except perhaps for a brief liberal moment in the 1920s, been allowed to be the primary drivers of its national economy. Instead, private interests have been subordinated to the national economic interest under a system most succinctly describable as state capitalism. And protectionism is an innate part of that system.

Japan in 1945 was economically crushed, its cities smoking ruins, its empire gone. It was poorer even than some African nations untouched by the B-29. It seemed so far behind the United States that there was no plausible way ever to catch up. It was widely expected that Japan would end up an economic also-ran like that neighboring island chain, the Philippines. And within the economic ideology America was promoting to Japan at the time, free trade according to comparative advantage, there seemed to be no way out, as Japan had comparative advantage only in low-value industries.

History records a fascinating exchange on this topic, which encapsulates the entire postwar free trade debate. In 1955, when the U.S. and Japan were negotiating their first post-occupation trade agreement, the head of the American delegation, C. Thayer White, told the Japanese to cut their tariff on imported cars because, in his words:

1. The United States industry is the largest and most efficient in the world.

2. The industry is strongly in favor of expanding the opportunities for world trade.

3. Its access to foreign markets in recent years has been limited by import controls.

4. Although the United States Government appreciates that it is necessary for some countries to impose import restrictions for balance of payments reasons...it would be in Japan's interest to import automobiles from the United States and ex-port items in which Japan could excel.

Upon Ricardian comparative-advantage principles, White was, of course, 100 percent correct. But the Japanese trade negotiator, Kenichi Otabe, replied that:

1. If the theory of international trade were pursued to its ultimate conclusion, the United States would specialize in the production of automobiles and Japan in the production of tuna.

2. Such a division of labor does not take place...because each government encourages and protects those industries which it believes important for reasons of national policy.

Needless to say, Japan did not choose to become a nation of fishing villages!

Instead, its rulers drew the same conclusion that Alexander Hamilton had drawn 150 years earlier and Henry VII 300 years before that, opting for protectionism and industrial policy. They closed Japan's markets to foreigners in industries they wished to enter, only welcoming foreign goods insofar as they helped build up Japan's own industries. They applied administrative guidance to key industries and rigged Japan's banking system and stock market to provide cheap capital to industry.

Tokyo instead protected its fledgling automobile industry in the 1950s, limiting imports to $500,000 per year. (In the 1960s, prohibitive tariffs replaced this quota.) Japan only allowed foreign investment insofar as this transferred technology to its own manufacturers. Today, it produces over two-and-a-half times as many cars as the U.S., mostly for export.

As Japan has historically been the economic leader for the whole of Confucian Asia (Japan, Korea, China, Taiwan, Vietnam, Hong Kong, and Singapore), its protectionist policies have been shared with nearby nations to a huge extent. The ultimate basis of these policies is an attitude towards economics that sees the economy not as an end in itself, but as an instrument of national power. As Harvard Asia specialists Roy Hofheinz and Kent Calder have written, "For more than a century, nationalist sentiments...have been a basic driving force underlying East Asian economic growth." Even today, Chinese industry is 30 percent owned by the state. Over a dozen strategic industries have been slated to remain under outright government ownership and control, including information technology, telecommunications, shipping, civil aviation and steel. Laissez faire this is not.

In relation to its neighbors, Japan has employed something called the "flying geese" strategy, christened thus by the Japanese economist Akamatsu Kaname in the 1930s. Japan breaks into an industry, wipes out existing Western competitors, then successively hands the industry down to less sophisticated neighboring economies such as Korea, Taiwan, Thailand, Malaysia, and Vietnam as they mature. This pattern has held for goods from garments to televisions for five decades. Japan's withdrawal from labor-intensive goods in the 1970s opened up space for Taiwan, South Korea, Singapore, and Hong Kong, and their ongoing withdrawal from these goods is opening up space for China.

Among other things, this nicely illustrates how rational protectionism is a dynamic, not a static, strategy, and does not consist in defending every job and every industry.