The Heritage Foundation

Asian Backgrounder #136

May 26, 1995

May 26, 1995 | Asian Backgrounder on

Averting an Automotive Trade Wreck With Japan

(Archived document, may contain errors)

No. 136 May 26, 1995

AVERTING AN AUTOMOTIVE TRADE WRECK WITH JAPAN

You cannot expect Japan to force its citizens to buy a certain number of American products. That is authoritarianism at its worst and, if the table were turned, it is not something that would be tolerated in this country .... Not only is this bad policy and damaging to consumers, but it is a flagrant violation of GATT, which I strongly supported. This Administration is pushing the U.S. into a trade war. And a trade war between the United States and Japan will be lost by both sides. -Jack Kemp Former Congressman and Secretary of Housing and Urban Development

INTRODUCTION Japan and the United States are careening toward an automotive trade wreck. Presi- dent Bill Clinton has threatened Japan with a 100 percent retaliatory tariff on luxury auto imports unless Japanese automakers; accede to American demands. Both Japan and the U.S. are planning to file complaints against each other at the World Trade Organization (WTO). Most experts agree that Japan would win its case against the U.S. in the WTO, but the probable consequences for global trade and the Japanese-U.S. strategic partner- ship could prove devastating. Japan and the U.S. may be heading for a trade war-some- thing that would be disastrous for both sides. There is a better way to settle trade disputes with Japan: by liberalizing and deregulat- ing Japanese markets. The existing industry-by-industry approach to opening markets, even when successful, disrupts the broad economic and strategic partnership between Ja- pan and the U.S. A more constructive alternative is to negotiate a free trade and invest- ment agreement with Japan that could be implemented fully by the year 2000. President Clinton's insistence on employing unilateral trade sanctions before present- ing America's "nullification and impairment" complaint against Japan at the WTO clearly violates General Agreement on Tariffs and Trade (GATT) rules. Instead of sup- porting American efforts to open Japanese markets, U.S. trading partners are condemn-

ing the Clinton Administration's unilateral action. Clinton's "punishment first, trial later" approach undermines the WTO and the development of internationally accepted rules for open trade for which the United States fought during the Uruguay Round. As the world's largest exporter, American business will suffer the most if Clinton's actions abort the emergence of a rule of law for international trade. President Clinton and the Republican leadership in Congress should join with Japanese leaders to settle the automotive trade dispute and move rapidly to build a new Japan-U.S. economic partnership. To do this, the U.S. should: V Accept Japanese proposals that are consistent with free trade principles. American and Japanese negotiators are close to market opening agreements to liberal- ize motor vehicle and replacement parts imports. Ambassador Kantor should irrunedi- ately conclude an agreement based on the proposals Japan has tabled to assure for- eign automakers access to Japanese dealers and to deregulate the auto repair market and streamline vehicle certification and registration procedures. V Drop the American demand for "purchasing quotas" while continuing to en- courage Japanese automakers to facilitate original equipment parts imports. The Clinton Administration's insistence on "purchasing quotas" for American-made original equipment parts from Japanese automakers violates GATT rules. A "pur- chasing quota" is a victory for government-managed trade over free trade. V End the industry-by.-industry approach and negotiate a comprehensive free trade and investment agreement by the year 2000. Japan and the U.S. should move up the completion date for the free trade and investment agreement to which both countries agreed at Bogor, Indonesia, on November 15, 1994. Negotiating a free trade agreement would replace divisive industry-by-industry haggling with a more conciliatory approach. Consumers and workers in both countries would benefit from the resulting trade expansion.

TI-IE HIDDEN HAND: JAPAN'S AUTOMOTIVE TRADE PRACTICES

The "Big Three" U.S. automakers-General Motors Corporation, Ford Motor Com- pany, and Chrysler Corporation-dominated the American market until the 1970s. With little import competition, they emphasized style over quality and cost control. Mean- while, Japanese automakers, led by Toyota Motor Corporation, pioneered "lean produc- tion" to improve quality and lower costs. Japanese production innovations such as con- tinuous improvement circles, just-in-time parts delivery, and long-term relationships with parts suppliers and distributors, known as keiretsu, I revolutionized the industry. When the 1973 and 1979 oil price shocks occurred, Japanese automakers were ready with high-

1 Keiretsu refers to the long-term linkages among a variety of companies in Japan to form a hierarchical organization. Keiretsu may be horizontal or vertical. A horizontal keiretsu is a group of very large companies with common ties to a major bank and united through cross shareholdings, trading relationships, and personnel sharing, e.g. The Mitsui Group. A vertical keiretsu is composed of a lead manufacturing company and hundreds of smaller suppliers and distributors dependent upon it, e.g. Toyota Motor Corporation. quality, fuel efficient cars that American consumers wanted. By 1980, Japanese automak- ers exported 1.8 million passenger cars, grabbing a 21.2 percent share of the American market away from Detroit. 2 Under political pressure from Congress and the Reagan Administration, Japan volun- tarily cut back its automobile exports to the U.S. in 1980, accepting a "voluntary export restraint" of 2.3 million autos to the American market. 3 This raised the prices of Japa- nese imports by limiting supply and left American and European automakers free to raise their prices as well. The result: additional profits from American consumers of between $5.8 billion to $10.3 billion annually, most of which went to Japanese automakers. 4 To circumvent the voluntary export restraint and insulate themselves from the threat of fur- ther protectionism, Japanese automakers; in 1982 established assembly operations in the U.S., beginning with Honda Motor Company in Marysville, Ohio. The output from these 5 "transplants" in 1994 was 1.8 million passenger cars, or 27.2 percent of U.S. production. Having adopted many Japanese production innovations, American automakers and parts suppliers once again are highly competitive in quality and cost. Although American automotive exports to Japan are growing, they remain low. Imports comprise only a 4.6 percent market share of Japan's 6.5 million unit motor vehicle market, with American automakers holding a 1.6 percent share. 6 In 1994, American motor vehicle exports to Ja- pan exceeded $2 billion or 103,000 units, up 75 percent in value or 70 percent in unit vol- ume over the previous year. 7 Of these exports, 56 percent were from Japanese trans- plants and 44 percent from the Big Three. 8 In comparison, motor vehicle imports com- prise 14 percent of America's 15 million unit market. In 1994, Japanese exports to the U.S. exceeded $26 billion or 1.8 million units.9 Likewise, imports comprise only 2.4 percent of Japan's $107 billion auto parts market. American parts suppliers hold only a 1.4 percent share of Japan's market. American auto parts exports to Japan in 1994 rose 31 percent from the previous year to $1.5 billion. In contrast, imports comprise 37 percent of America's $122 billion auto parts market, with Japanese parts suppliers holding a 12 percent market share. 10

Motor Vehicle Exports to Japan Although Japan eliminated formal border restrictions in the 1960s, it still uses a variety of measures to discriminate against foreign motor vehicle imports. The inability of for- eign automakers to secure established dealers remains an especially significant barrier to expanding vehicle exports to Japan.

2 American Automobile Manufacturers Association (AAMA) and Ward's Automotive Report. 3 Japan lowered the limit to 1.65 million autos in April 1992. 4 C. Fred Bergsten and Marcus Noland, Reconcilable Differences? (Washington, D.C.: Institute for International Economic Studies, 1993), p. 106. 5 American Automobile Manufacturers Association and Ward's Automotive Report, 1995. 6 Japan Auto Importers Association, 1995. 7 Office of United States Trade Representative, 1995. 8 Japan Auto Importers Association, 1995. 9 Office of United States Trade Representative, 1995. 10 Ibid. Japanese automakers incorporate virtually all of their affiliated domestic dealers into their own keiretsu. They often own equity shares in these dealers, arrange mortgage loans for showrooms, provide inventory financing, and even share personnel. Although exclu- sive dealership contracts are no longer permitted, I I dealers affiliated with one Japanese maker are usually unwilling to carry autos from other makers, domestic or foreign, be- cause of a fear of retribution. 12 Only 7 percent of Japanese dealers sell American brands while 79 percent of U.S. dealers carry Japanese makes. 13 Without established dealers, foreign automakers must make prohibitively expensive investments to create their own networks or settle for a handful of less successful dealers in Japan. Such exclusionary be- havior limits imports by preventing foreign makers from achieving economies of scale in adapting and certifying autos for the Japanese market. The result is higher prices for im- ported motor vehicles. C. Fred Bergsten, Director of the Institute for International Eco- nomics and Chairman of the APEC Eminent Persons Group, and Marcus Noland, Re- search Fellow at the Institute for International Economics, estimate that the tariff rate equivalent for non-tariff barriers to motor vehicle imports into Japan is 70.2 percent. 14 For many years, Japanese negotiators blamed low motor vehicle import penetration in Japan on the failure of the Big Three to offer products tailored to the Japanese market, particularly vehicles with right-hand drive and engines of less than 2,000 cubic centime- ters. While this was true in the past, American automakers, especially Ford, now have more varied product lines in Japan. The Big Three currently offer 102 products in Japan, of which 60 are right-hand drive and 55 have engines less than 2,000 cubic centimeters in size. 15

Auto Parts Exports to Japan American automotive parts manufacturers have two distinct complaints against Japan. First, keiretsu bonds between Japanese automakers and parts suppliers preclude their American competitors from entering the original equipment 16 parts market. Japanese automakers maintain close and long-term business ties to their parts suppliers through eq- uity investments and other financial, managerial, and technical cooperation. Contracts be- tween automakers and parts suppliers are structured to guarantee high-volume procure- ment and discourage automakers from switching suppliers. The keiretsu system has been a key factor in the success of Japanese automakers.

11 In 1979, the Japanese FairTrade Commission issued administrative guidance to eliminate exclusive dealership arrangements. 12 A Japanese automaker can exert leverage over its dealers in several ways. Automakers throughout the world affect the profitability of their dealers by the allocation of new vehicles, frequently allocating more units of popular models to increase the sales volume and profit margins of preferred dealers. Moreover, Japanese automakers can exercise leverage over their domestic dealers through a maker's ownership interest and debt financing. 13 Office of United States Trade Representative, 1995. 14 Bergsten and Noland, Reconcilable Differences?, p. 184. 15 American Automobile Manufacturers Association, April 27, 1995. 16 There are two distinct auto parts markets. The "original equipment" market is comprised of automakers purchasing parts for building new vehicles. Ile parts "aftermarket" is comprised of repair garages and the public buying replacement parts after vehicles are sold in dealerships. Indeed, American automakers are adopting key aspects of the Japanese parts procure- ment system to increase their own competitiveness. For example, the relationship be- tween Ford Motor Company and Excel Industries, a window manufacturer, is strikingly similar to keiretsu ties between Toyota Motor Corporation and its suppliers. Optimal ve- hicle designs require the proper tradeoffs between glass-forming possibilities and early vehicle concepts. Excel's specialized glass knowledge must be applied early in the de- sign process to control costs and improve vehicle quality. To assure long-term coopera- tion, Ford has acqqired a minority equity interest in Excel and entered into an evergreen purchase contracJ7 that guarantees Excel 70 percent of Ford's glass business as long as Excel is competitive in cost and quality. 18 The second complaint is that a complex web of discriminatory government regulations prevents American auto parts makers from penetrating the Japanese parts aftermarket. These rules channel consumers toward dealers and certain independent garages that have a keiretsu relationship with Japanese automakers and their original equipment parts sup- pliers for repairs. 19 Consequently, "genuine"20 (Japanese made) parts distributed through a Japanese automaker's regional parts center or an affiliated wholesaler account for 80 percent of all retail parts sales in Japan. The most important of these regulatory barriers that discriminate against American and other foreign parts makers is Japan's rigid motor vehicle inspection system, known as the shaken. Vehicles must be inspected in Japan at the time of purchase. Once purchased, cars and trucks must be reinspected after three years, every two years thereafter for up to ten years, and then every year. Only certified garages and Ministry of Transport (MOT) Land Transport Offices can perform reinspections. The shaken forces Japanese consum- ers to make expensive and often unnecessary repairs. Inspection cost exceeds $1,200 even without a major repair. Rather than pay for costly repairs, the shaken system encour- ages Japanese consumers to trade in their motor vehicles before their third anniversary. Consequently, the average age of motor vehicles and the demand for replacement parts are lower in Japan than in other industrial countries. Only MOT-certified garages are permitted to perform shaken inspections or make many repairs to motor vehicles. Rigid certification requirements cover personnel, facili- ties, and service equipment. Most certified garages are owned and operated by dealers or otherwise affiliated through keiretsu ties to Japanese automakers or parts suppliers. Certi- fied garages usually stock only genuine parts made by Japanese original equipment parts suppliers.

17 An evergreen contract has no termination date and thus will stay in force as long as all contracting parties meet their obligations. 18 Jordan D. Lewis, Partnershipsfor Profit.- Structuring and Managing Strategic Alliances (New York: Free Press, 1990), pp. 110-114. 19 For a detailed discussion of import-excluding effects of certification and inspection regulations, see "Barriers to Access to the Auto Parts Replacement Market in Japan (Docket No. 301-93)," Comments of Tenneco Automotive to the United States Trade Representative, December 1, 1995. 20 Genuine parts are manufactured by original equipment parts suppliers under a contract with an automaker. In contrast, non-genuine parts are made at the initiative of auto parts makers. The major distribution channels of non-genuine parts distribution that exist in other in- dustrial countries are blocked in Japan. Since certified garages must provide full service, specialized repair garages, like Midas Muffler or Brako in the U.S., are effectively pro- hibited from entering the Japanese market. Moreover, certified mechanics may work only at certified garages. Thus, gas stations and other outlets which could supply non- genuine parts cannot hire certified mechanics to perform simple repairs and parts replace- ments. Unable to make most repairs, gas stations and other outlets do not carry foreign non-genuine parts. Under Ministry of Transport regulations, if repairs to the motor, transmission, drive train, brakes, steering, shock absorbers, and other parts deemed critical to safety are not performed in a certified garage, they must be inspected at an MOT Land Transport Of- fice within fifteen days. As a practical matter, Japanese consumers invariably choose to have such repairs done at certified garages which stock only Japanese-made genuine parts. Finally, Ministry of Transport regulations mandate that a vehicle owner submit to a new inspection and pay additional taxes when repairs or parts replacement cause even a slight change in a vehicle's shape or size. Repairs that can alter a vehicle's size by as lit- tle as one centimeter necessitate an inspection costing as much as $500. Since installing some non-genuine parts (for example, replacing shock absorbers), even though perfectly safe and functional, may slightly alter a vehicle's dimensions, Japanese consumers are en- couraged to purchase only genuine parts made by Japanese parts suppliers. The web of Japanese regulations harms Japanese consumers as well as American auto parts suppliers and their workers. A 1991 joint study by the U.S. Department of Com- merce and the Japanese Ministry of International Trade and Industry found that 68 unin- stalled parts were on average 340 percent more expensive in Japan while 66 installed parts were 198 percent more costly. 21 In a speech on March 30, 1995, Ambassador Kan- tor noted evidence of wide price differentials between replacement parts in Washington, D.C., and Tokyo. For example, a set of shock absorbers costs only $228 in Washington compared to $605 in Tokyo, a difference of 265 percent. Likewise, an American con- sumer pays $82 for a muffler and tail pipe that cost $200 in Japan, a difference of 244 percent. 2

THE JAPANESE-U.S. AUTOMOTIVE TALKS

The United States and Japan have pursued various negotiations to open the Japanese market to foreign automakers and automotive parts suppliers. The Reagan Administra- tion initiated the Market-Oriented, Sector Specific (MOSS) negotiations in 1985-1986 to encourage Japanese automakers to develop long-term business relationships with Ameri- can parts suppliers. Continuing with this policy under the Structural Impediments Initia- tive (SSI) in 1989-1990, the Bush Administration agreed to a Market-Oriented Coopera-

21 Department of Commerce/Ministry of International Trade and Industry Automotive Parts Price Survey, June 27, 1991. Installed parts refers to parts placed into the motor vehicle by the vendor at the time of purchase; uninstalled parts are carried out of vendor by the consumer. 22 Speech before the Economic Strategy Institute, March 30, 1995. tion Plan that was intended to facilitate long-term business ties and increase the purchase of American-made parts. During his ill-fated January 1992 trip to Japan, President George Bush "accepted" an agreement from Japanese automakers, brokered by the Japa- nese government, to set "voluntary" targets for purchasing $19 billion of parts from American suppliers by 1994. The Clinton Administration has made automobiles and auto parts a high priority. On July 10, 1993, President Clinton launched a new set of talks called the United States-Ja- pan Framework for a New Economic Partnership. Negotiations were suspended on Feb- ruary 11, 1994, when then Japanese Prime Minister Morihiro Hosokawa rejected Clin- ton's demand for "quantitative targets" for American exports to Japan. The Framework talks were resumed on May 24, 1994, after the Clinton Administration softened its de- mand from "quantitative targets" to "objective indicators." On October 1, 1994, the United States and Japan reached significant agreements on several outstanding issues, in- cluding telecommunications, medical technology, flat glass, and insurance. However, be- cause auto and auto parts remained unresolved, the Office of the U.S. Trade Repre- sentative initiated a Section 301 investigation into the negative impact of Japanese gov- ernment regulations on American automotive parts suppliers.

Section 301 and the World Trade Organization Section 301 is a controversial section of American trade law that authorizes the Presi- dent to impose unilateral sanctions on other countries when the USTR determines that they have engaged in unjustifiable or unreasonable trade practices. 23 Enacted as part of the Trade Act of 1974, Section 301 has been modified significantly by the Trade Agree- ment Act of 1979, the Trade and Tariff Act of 1984, and the Omnibus Trade and Com- petitiveness Act of 1988. Section 301 defines an "unjustifiable" trade practice as one that violates GATT or other trade agreements or otherwise nullifies or impairs expected U.S. benefits under those agreements and burdens U.S. commerce. An "unreasonable" trade practice is defined as "not necessarily in violation of or inconsistent with" U.S. legal rights but "otherwise deemed to be unfair and inequitable." An interested party may file a petition seeking an investigation of an allegedly unjustifiable or unreasonable trade practice with the Office of the USTR. If the petition is found to be credible, the USTR must initiate an investigation and seek consultations with the appropriate foreign govern- ment. The USTR may also initiate an investigation on its own authority. If the USTR can- not reach a satisfactory resolution of the allegedly unjustifiable or unreasonable trade practice with the foreign government, there must be a hearing on the petition. 24 If an alle- gation is determined to be valid, the President must impose retaliatory trade sanctions in unjustifiable cases 25 and may impose them in unreasonable cases.

23 For a discussion of Section 301, see Thomas 0. Bayard and Kimberly Ann Elliot, Reciprocity and Retaliation in U.S. Trade Policy (Washington, D.C.: Institute for International Economics, 1994), pp. 24-32. 24 Hearings and determination must be completed within six months for intellectual property rights petitions, twelve months for subsidies code and bilateral cases, and eighteen months for GATT and other trade agreement violations cases. 25 Loopholes allow a President to avoid "mandatory" retaliation if a foreign government is taking satisfactory measures to eliminate the unjustifiable trade practice, if retaliation would harm national security, or if retaliation would harm the U.S. economy significantly. The policy undergirding Section 301 "'DISPUTETIMEL"INE-.:."-:@:::'"'"""' was labeled "aggressive unilateralism" .. ........ holar by Jagdish Bhagwati, a Visiting Sc at the American Enterprise Institute and "g,dy-'effirnehf. h-66 T Arthur Lehman Professor of Econom 26 ics at Columbia University. Since omp 1985, the U.S. has urged its trading ffii.Noanesek ra MT,,:prac partners to remove barriers to Ameri- can exports and investment under the @g----Qu apan etC,6n-tU1tAfion's..p,.1 !W.. T threat of retaliatory trade sanctions. This policy is unilateral because the U.S. government alone decides what . .... ... @P: I (@,rn P, "PaIr ...... ...... . .... foreign trading practices are unfair and ........ ........ '"MR.1, ,Q,,gra, -cons it W?'JiA0.Ah`?-J th @ . T-, .. , f@ihd_iresq utto.... 'e", i f i because it requires its partners to liber- or; ob: e ..... ....... .ays; S 6 @lsi e g n ay.,! a s & @ 1@:-'fi -:@ ........... . alize without any reciprocal conces SO ement-@ ody.@ sions. jag pen en. Establishment of the Dispute Settle- k $ ment Body in the WTO has changed . . .... .. ..... pjw*--m- 9& the economic and political environment . . . . ......... Qi- surrounding the Framework automotive i-ane.- @3 . ...... .. . .. ........ talks. One of the chief objectives of wur irnon @i ,gen American negotiations in the Uruguay Round was to devise an effective dis- q!Y_ :'.'N: NO: u - V` ;C'N: i T` i pute settlement mechanism. The U.S. government complained that the pre- . .. ... b; r-@'l 055-i.-Sti ,06"1 Uruguay Round GATT dispute panels op.,@pbanel.'-` took too long, allowed any country (in- ere-: iva;-c dn"@ehsm:again . cluding one found in violation) to block K::. them and prevent retaliation, and failed ..9,N M. yiiappea i:; . . .... A 99' A 6... . ....... to ensure compliance with their deci sions. The new VY70 Dispute Se ..@ppp., a 0. ..y,: @a&@ ttle- JU 9@ ment Body expedites decision-making, OP institutes an appeal procedure, and re- . ..... . . Acem r-`,1,995A;Adtdi2 quires a consensus of all WTO mern -.'@-@Ifjipanls-,- bers to block panels and prevent retali- T16dh'&4h-;v a ton-d W ation. Under this new system, the U.S. ..... ........ `J5 .1th'016rhed id government may continue to use Sec- .":,@-a e@!perio-.01mo:M .. . ..... .... angeKJfJ.a'k tion 301 to bring cases before the WTO e:'ad11:n::-: hen . .....I. ..... tAY'". e;4 n and implement retaliation if foreig e - . . . ... .......... h . . .. .... .. governments fail to comply wit WTO . ..... .. . .. .W1 U R mment rulings. However, the U.S. gove . ... ... may no longer impose retaliatory trade . ... .... .... ...

26 See Jagdish Bhagwati, "Aggressive Unilateralism: An Overview," in Bhagwati and Patrick, eds., Aggressive Unilateralism: America's 301 Trade Policy and the World Trading System (Ann Arbor: University of Michigan Press, -F 4 "op

1990). sanctions unilaterally in disputes arising under the WTO, although it remains free to act unilaterally in disputes outside of the VITO's scope.27

Clinton's Framework Negotiations The Clinton Administration's first goal in the Framework negotiations is to press Ja- pan to end exclusionary motor vehicle distribution practices and encourage Japanese dealers to sell foreign cars and trucks. American negotiators are asking the Japanese Fair Trade Commission (JFTC) 28 and Japanese automakers to reaffirm publicly that Japanese auto dealers may carry more than one automaker's product. The Americans want the JFTC to establish an ombudsman's office to investigate allegations of dealer coercion and the Ministry of International Trade and Industry to encourage major dealers to con- tact foreign automakers. The Americans also demand that Japanese automakers designate a high level executive as a contact to resolve problems and ensure that their dealers feel free to carry foreign vehicles. In addition, the Clinton Adniinistration is pressing Japanese automakers to commit to new "voluntary" targets for purchasing American auto parts when the Bush quotas expire this year. Ministry of International Trade and Industry officials feel the "voluntary" tar- gets were a mistake and want to prevent such numerical targets from becoming a prece- dent, particularly in next year's semiconductor agreement talks. Therefore, the Japanese government has refused to negotiate about what it regards as the business decisions of private companies. Despite pressure from U.S. Ambassador to Japan Walter Mondale, Japanese automak- ers adamantly oppose the renewal of such targets. According to the Japanese Auto Manu- facturers Association, "The Administration's demands are for quotas, pure and simple.... In a free market system,-you can't demand that companies buy supplies according to gov- emment expectations."ZY Japanese automakers may be willing to increase their purchases of American-made parts without targets to cope with the rising yen. On May 10, 1995, an unnamed Toyota executive announced that his company is studying a plan to an- nounce new and higher auto parts purchases if the U.S. agrees to treat them as purely vol- untary. 30 However, Japanese automakers are under tremendous government pressure not to make any concessions. 31 As for replacement auto parts, the Clinton Administration is emphasizing deregulation rather quantitative targets. On November 11, 1994, it tabled deregulation proposals cov- ering the automotive sector. The U.S. negotiators want Japan to:

27 Jeffrey J. Schott, The Uruguay Roun& An Assessment (Washington, D.C.: Institute for International Economics, 1994), pp. 125-132. 28 Like the Federal Trade Commission and the Antitrust Division of the U.S. Department of Justice, the Japanese Fair Trade Commission administers competition law. 29 "Kantor Announces Resumption of Auto Talks, Saying He Wants Speedy Result," Japan Digest, March 24, 1995, p. 3. 30 "Toyota May Break Ranks, Announce New Parts Purchase Targets Through 1998," Japan Digest, May 10, 1995, pp. 3-4. 31 "Report Suggests Automakers Would Deal, But Hashimoto Is Blocking It," Japan Digest, April 20, 1995, pp. 1-2. V "Accept equipment standards... that are the functional equivalent of Japanese standards, and remove standards that serve no important environmental or safety pur- pose; V "Eliminate the requirement that repairs by non-certified garages ... be inspected at MOT Land Transport Offices; V "Ease the regulations that independent repair shops and mechanics must meet to be certified to perform all motor vehicle repairs and shaken inspections; and V "Revise and liberalize regulations regarding repairs for motor vehicles, [for ex- ample]: [e]liminate the Road Transport Law which requires overhaul inspection of vehicles when only minor changes are made. 32 Recent sharp exchanges between Kantor and Hashimoto have exacerbated the automo- tive trade dispute with Japan. In a March 17, 1995, letter, Hashimoto warned Kantor that the U.S. would violate international trade law if it "requests the Japanese auto companies to increase their purchase of particular auto parts in a defacto coercive or discriminatory manner."33 Hashimoto threatened to challenge any U.S. retaliation under Section 301 as a violation of GATT. In a March 19 letter, Kantor responded by threatening "a broad in- quiry into Japan's lack of effective adherence to the market opening objectives of the VVTO.9934 Kantor further demanded an preement by Japanese auto makers to purchase 46 a minimum amount of foreign parts."3 On April 12, the White House National Economic Council warned Japan that the Clin- ton Administration had decided to impose punitive tariffs of up to 100 percent on up to $9 billion of Japanese imports unless Japan agreed to an acceptable automotive market liberalization plan by May 5. the last day of trade ministerial talks in Whistler, British Co- lumbia. The retaliation list would be published later, allowing thirty days for public com- ments and last-minute negotiations before imposing trade sanctions. 36 The Clinton Administration apparently is willing to risk a major confrontation with Ja- pan over the automotive market. With a high yen undermining the competitiveness of many Japanese companies, Administration officials believe the rising value of the yen will force the Murayarna government to liberalize imports. Subcabinet level automotive talks between the Americans and the Japanese broke off on April 18 without reaching any conclusion. Japanese negotiators rebuffed the American demand that broad-based de- regulation of the Japanese automotive sector must be'the basis for any solution. In a last-ditch effort to reach a settlement, Ambassador Kantor and Minister Hashi- moto negotiated off and on for three days at the Quad (Canada, European Union, Japan, and United States) trade ministers meeting in British Columbia. Japanese negotiators ta-

32 "U.S. Tables Comprehensive Proposal for Deregulation in Japan," Inside U.S. Trade: Special Report, November 18, 1994, pp. S3-S4. 33 "Kantor Warns Japan of Broad Trade Challenge Over Auto Dispute," Inside U.S. Trade, March 24, 1995, pp. I and 17. 34 Ibid. 35 Ibid. 36 David E. Sanger, "U.S. Plans to Threaten Japan with Tariffs in Trade Dispute," The New York Times, April 13, 1995, pp. A I and D7. bled new proposals on replacement auto parts and motor vehicle imports. For the parts af- termarket, Japan offered to reduce the scope of the critical parts list, ease shaken inspec- tion requirements, and simplify garage certification requirements but did not address American demands to separate auto inspection from repair facilities and permit specialty garages. Japan rejected U.S. demands that Japanese automakers designate an ombudsman to ensure that affiliated dealers are free to carry foreign autos. However, both sides re- main far apart on American insistence that Japanese automakers issue specific goals for purchasing American-made parts. 37 With no movement on this key item, Ambassador Kantor broke off automotive talks with Minister Hashimoto on May 5. On May 6, following the collapse of the automotive talks, Kantor met with Chairwoman Laura Tyson and the other members of the National Economic Council and submitted recommendations to President Clinton before he left for the Moscow Summit. On May 10, Kantor announced that, under Section 301, he had determined that Japan has engaged in "acts, practices, and policies" with respect to the af- termarket for replacement auto parts "that are unreasonable and burden and restrict United States commerce." Kantor proclaimed that the U.S. government had notified the World Trade Organization of its intention to file a broad-based complaint against Japan within 45 days. The U.S. will charge under Article XXIII of GATT that Japan's domestic regulations and keiretsu business structures "nullified and impaired" the expected bene- fits which should have accrued to the U.S. as a result of GATT. On May 16, Kantor finally announced the preliminary list of trade sanctions. The tariff will rise from 2.5 percent to 100 percent on thirteen models of Japanese luxury passenger cars. 38 In 1994, Japanese automakers exported 209,520 of the affected vehicles to the U.S. with a value of approximately $5.9 billion. These exports represent 12.5 percent of Japan's total vehicle exports to the U.S. by unit volume and 20 percent by value. The fi- nal decision on imposing these sanctions will be made on June 28, but the higher tariff will apply retroactively to all vehicles imported after May 19. 39 The Clinton Administration's apparent strategy is to inflict enough financial pain by "driving brands off the market" to force Japanese automakers to defy the Ministry of In- ternational Trade and Industry and agree to parts purchasing targets. 40 Indeed, Nikko Re- search Analyst Noriyuki Matsushima noted that the sanctions would cause Japanese automakers to "plunge deeply in the red in exports .... These cars have been their main source of profits and have been making up for the losses coming from their lower-class cars."41 Foreign reactions to these sanctions were negative. In Tokyo, Minister Hashimoto ac- cused the Clinton Administration of imposing "numerical targets ... under the threat of unilateral actions, which is nothing but government intervention in private business ac-

37 "U.S., Japan Try to Settle Voluntary Parts Plan Issue," Inside U.S. Trade, May 5, 1995, pp. 1, 18-19. 38 Acura Legend, Acura 3.2 TL, Lexus LS 400, Lexus SC 400, Lexus SC 300, Lexus GS 300, Lexus ES 300, Infiniti Q45, Infiniti J30, Infiniti 130, Mazda 929, Mazda Millenia, and Mitsubishi Diamante. 39 Statement of Ambassador Kantor, Office of United States Trade Representative, May 16, 1995. 40 "Kantor Makes Sanctions Effective Saturday: Both Praise and Rebukes," Japan Digest, May 17, 1995, p. 1. 41 "Sanctions' Real Impact on Makers, Dealers Is Unclear," Japan Digest, May 17, 1995, p. 2.

JAPANESE LUXURY CAR IMPORTS HIT BY. SECTION 30.1. SANCTIONS

Make-,&--ModOd U.S.: taleii-In-.1994- :BasiB.Sfitker-Pr1ce:1n 1995

Honda Acura Legend - ..35,709 130,890 Acdra.3.2- introduc'ed'irf 1.9.95... -$27,900

Toyota.- -LexusLS 400.. -:22-443 $5T 680'., Lexu@-:SC 400 - .7,392 $48:,880.. leixus-GS 300 13,939 .$43j 80 Lexus SC 300 4,537 $41,380 ...Lexus-ES.300. 39,108 $31,986-@ -

Nissan - I fi $52,850 n initi-Q45. 11,949 Infiniti J30- .22,71.8'' - $39,000 Infiniti .130 Int.roduced.in. 1995 $31,00Q...

Mazda 929- 9,206 $36,235 Millenia 24,423 $26,435

Mitsubishi Diarnante 18,096 $28,720.

Sources: Office of the United States Trade'Representative, Ward's Automotive R eports'.

tivities, and poses a serious threat to the free trade system."42 Hashimoto warned that Ja- pan may retaliate against American products if the sanctions are implernented.43 Pri- vately, Japanese officials charged that a weakened President Clinton is taking a hard line against Japan solely for political reasons. 44 European Union Trade Commissioner Leon Brittan noted that these "measures, if implemented would be contrary to U.S. obligations under the WTO."45 WTO Director-General Renato Ruggiero bluntly warned, "In reality, what is now at stake is not the functioning of the World Trade Organization, but the credi- bility of the engagements freely entered into by these parties."46

42 David E. Sanger, "100% Tariffs Set on 13 Top Models of Japanese Cars: $5.9 Billion Sales," The New York Times, May 17, 1995, p. Al. 43 Martha M. Hamilton, "U.S. Targets Japan's Luxury Cars," The Washington Post, May 17, 1995, p. A28. 44 Sanger, "100% Tariffs." 45 "Kantor Makes Sanctions Effective Saturday." 46 "Ruggiero Demands Respect for WTO Rules," Financial Times, May 17, 1995, p. 8. The American complaint and the Japanese counter-complaint will pose a serious chal- lenge to the AFTO's untested Dispute Settlement Body. Of these two cases, the outcome of the American complaint is more difficult to predict. The Japanese will argue narrowly that America's unilateral imposition of trade sanctions violates GATT provisions that WTO members must present their allegations of trade infractions and win authorization from the Dispute Settlement Body before imposing trade sanctions. University of Michi- gan law professor John Jackson described the Japanese case as a "cold, flat-out easy case."47 On the other hand, rather than charge Japan with a specific violation of GATT rules, the U.S. will accuse it of "nullifying and impairing" the expected benefits in auto- motive trade. The American case will plow new legal ground for a dispute-settlement panel, especially since the allegedl unfair practices were in place well before the Uru- guay Round was ratified in 1994. 41 Professor Jackson feels the U.S. may well win its case, but how the WTO panel will rule is not certain. 49 On May 17, Japan followed through on its threat by taking the first step toward bring- ing its own complaint against the U.S. before the WTO. Japan is charging the U.S. with three violations. First, Japan will argue that the American sanctions violate Article I of GATT by denying Japan Most Favored Nation treatment and Article II of GATT by rais- ing tariffs above those bound in the American schedule of tariff concessions. Japan will argue also that the American sanctions violate Article XXIII of the WTO Dispute Settle- ment Understanding, which "prohibits any contracting party to make a unilateral determi- nation on remedial measures. ,50

THE DEMISE OF JAPAN, INC.

The U.S.-Japanese trade dispute must be seen against the backdrop of the economic cri- sis in Japan. Understanding this crisis can help provide an answer to the U.S.-Japan trade dispute. Japan is enduring a financial crisis caused by monetary mismanagement, excessive regulation, and protectionism. Unless Japan adopts a more expansive monetary policy, radically deregulates its domestic markets, and liberalizes its international trade prac- tices, the Japanese economy will wither and perhaps trigger a world-wide recession. While burdensome regulation and protectionism did not cause the current financial crisis in Japan, they aggravate the economic downturn and impede a quick recovery. Deregula- tion and trade liberalization would ameliorate this crisis and might keep the Japanese re- cession from spreading to the U.S. and other economies. The current financial crisis began with a monetary overreaction to an external shock. The Bank of Japan's overly lenient monetary policy spurred Japanese banks to expand credit rapidly. Between 1985 and 1990, outstanding loans at all Japanese banks grew an average of 17.2 percent, 51 compared to an average nominal gross domestic product

47 Bob Davis, "U.S. LaunchesTrade Offensive AgainstJapan," The Wall StreetJournal, May 11, 1995, p. A-2. 48 Some legal scholars think the "nullification and impairment" clause may be prospective only. Long-standing trade practices that do not directly violate GATT (1994) may not be within the jurisdiction of the Dispute Settlement Body. 49 Davis, "U.S. Launches Trade Offensive." 50 "Japan to Challenge U.S. in WTO with Violation of MFN, Bound Tariffs," Inside U.S. Trade, May 17,1995, p. 2.

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