Japan and China: A Civil Trade War

In April 2001, Japan — for the first time ever — imposed tariffs on imports from China. The tariffs covered shiitake mushrooms, scallions and igusa rushes, used in making tatami mats. With an Upper House election looming, the ruling Liberal Democratic Party was prepared to do just about anything to placate its many rural constituents.

In response, China slapped 100% tariffs on imports of Japanese cars, mobile phones and air conditioners, thereby pressuring Japan’s exporters to battle Japan’s farmers.

Sounds like a nice little trade war, doesn’t it? Well, just don’t believe headlines in the mainstream press. Japan and China are not on the verge of any catastrophic trade war. If you dig a little deeper, this trade “war” turns out to be more of a civil war — within Japan itself.

In most industrialized countries, multinational companies and exporting firms based there argue in favor of free trade. Why? They are anxious to break down foreign barriers to exports of their own products — or to be able to access low-cost inputs from abroad for their domestic production.

That process, however, has been delayed in Japan. In part, this occurred because Japan’s exporters benefited from protectionism themselves. But now, the costs of protectionism have started to outweigh the benefits.

Simply put, in today’s competitive markets, Japan’s more efficient industries can no longer afford to pony-up at the government bar to subsidize their laggard — and inefficient — domestic brethren. So the internal fight long seen in other countries is finally unfolding within Japan.

Imports from China now have an enormous impact on Japan. Trade between Japan and China in 2000 jumped by 29.5% from the year earlier, reaching a record 10% of Japan’s total trade. Japan’s trade deficit with China rose 27.4% last year to $24.93 billion.

Since 1975, Japan’s imports from China have risen by nearly 1,200%. In the last five years alone, Japan’s imports from China have risen by 76%. They now account for 15% of Japan’s total imports. Other East Asian nations wonder how China has managed to do so well while they continue to chalk up big trade deficits.

One clue is that many of China’s exports to Japan actually come from Japanese multinational corporations. They have transferred production overseas to skirt high costs at home. This is true particularly in the textile, consumer-electronic, agricultural and retailing industries.

Throughout the post-war period, Japan’s competitive exporters and consumers have effectively subsidized inefficient domestic industries. Regulations and high domestic prices have, in effect, been a transfer of resources from the efficient to the inefficient in Japan. Now that the economy has tanked, neither efficient firms nor consumers can afford the burden.

Indeed, the irony is that innovation even in sluggish industries is being stymied by the insistence of the Old Guard to maintain the status quo. For example, some of the China-grown agricultural products subject to newly erected tariffs were originally cultivated at the behest of Japanese trading companies, complete with Japanese seeds and spores.

And clothing retailer Uniqlo has become enormously popular in large part because of the division of labor it has carved out between its Japanese and Chinese operations. The company produces high-quality clothing in China, thanks in large part to Japanese manufacturing techniques exported to China. The products are then imported into Japan, where consumers line up to buy them.

The same pattern holds true for towels and other textile products that some Japanese manufacturers have moved over to China. Many firms that have remained at home cannot compete with the imports from China, and are chiming for protection.

A classic trade-related debate has thus ensued in Japan. Just who should be protected: Consumers? Japanese firms producing in China? Or Japanese firms that have remained at home but can no longer compete?

There are many dimensions to the current China-Japan trade dispute. The Ministry of Economy, Trade and Industry (METI) and the Foreign Ministry, for example, are both opposed to Japan invoking obscure trade rules to limit imports from China. METI wants to modernize Japan’s economy. The Foreign Ministry doesn’t want a petty fight with China. But politics has thus far ruled the day.

But the important story surrounding this dispute is the way that some Japanese constituents have been battling other Japanese constituents. This is classic “free trade politics” that is very new to Japan — and it’s a healthy sign of reform. To get it resolved successfully, it’s undoubtedly better to leave China out of it.