The U.S.-Japan Economic Relationship: Essential in a Changing World

March 27, 2008

Speaker
David H. McCormick, Under Secretary of Treasury for International Affairs

Presider
Fernando Gonzalez, Vice President, American International Group, Inc.

Under Secretary of Treasury David McCormick reflected on the economic challenges, regional and global, that confront the U.S. and Japan today.

"The economic success of the Asia-Pacific region owes much to the open trading regime promoted by Japan and the United States," Mr. McCormick said. "And there's no doubt that this relationship has had its moments of tension over the last 60 years; but through the strength of our mutual interest and our shared values, it has grown and flourished and matured."

However, he said, it's also clear that the economic relationship between the U.S. and Japan "has not achieved its full potential in many ways," whether in terms of bilateral trade and investment, energy and the environment, or global trade.

"To get a sense of how much the challenges confronting Japan and the U.S. have changed, one needs to only go back a single generation," he continued. "In the 1980s the U.S. and Japan economies overwhelmingly dominated the Asia-Pacific region, accounting for 84 percent of the area's GDP," and trade in manufactured products--steel, automobiles, semiconductors--was the focus of U.S.-Japan economic issues. "The Asian tigers at that time, Korea, Taiwan, Hong Kong and Singapore, were growing rapidly, but still relatively small. China--and this is remarkable when you think about it--but China was at that time just beginning its turn towards a market economy."

The U.S.-Japan share of Asia-Pacific GDP has fallen to 75 percent, and further declines are expected; nevertheless, Mr. McCormick urged, "we should also be absolutely clear, the rapid growth of these Asian economies is a validation of the open economic system that the U.S. and Japan have fostered."

With the bursting of the 1980s bubbles in Japanese equities and real estate, Japan endured the prolonged period of deflation and financial crisis often referred to as the lost decade, and "U.S. worry about Japan's economic weakness and its effects on the global economy after the Asian financial crisis displaced worries about Japan's strength," he said. Reform has brought renewed strength to the banking sector, but deflation and weak consumer spending continue to plague the Japanese economy. It is "fair to say, as many of my friends in Japan would acknowledge, that beyond discussion, more action in the area of reform needs to happen faster."

"Our joint focus on the bilateral relationship has sometimes come at the expense of our two countries presenting a common and forceful front on issues of international significance," including Doha Round trade negotiations and development of an Asia-Pacific free trade area, Mr. McCormick said.

Policies on foreign direct investment represent another issue with international implications, he indicated. Inbound FDI represents only 3 percent of GDP in Japan, versus more than 28 percent in the U.S. American openness to FDI has brought many benefits, including healthy competition, which spurs innovation even as it brings lower prices and a greater variety of goods and services to American consumers, and jobs that are "on average about 25 percent to 35 percent better paid than American-based jobs," he said. "The Fukuda government has ambitiously pledged to double incoming foreign direct investment by 2010, and this is a great step, in our view, and would spur an increase in productivity and domestic demand growth."

"The most immediate challenge to maintaining open investment regimes," Mr. McCormick declared, "comes from the rapid growth and increasing importance of state-owned sovereign wealth funds as international investors," due to the risk that their activities "could provoke a new wave of investment protectionism," especially in situations where transparency and communication are inadequate. To help address these issues, the Treasury Department has proposed that the IMF develop a set of best practices for sovereign wealth funds and that the OECD develop a parallel set of principles for countries that receive FDI; these are initiatives in which "Japan has been, and should continue to be, an important ally."

The need for currency reform in China represents another area where U.S.-Japan cooperation continues to play a critical role, Mr. McCormick observed. And finally, "and I think this has evolved over time and become much more clear," Japan and the U.S. "share common commitment and capabilities" on energy, the environment, and climate change. This includes support for a multilateral, U.S.-Japan-UK fund to boost the use of clean technologies in developing countries, and President Bush will ask Congress to approve $2 billion in contributions to this fund over the next three years, he said.

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Do you see the private sector in Japan providing real-life support for financial reforms?

The consensus view is that there is a commitment to reform, but that the agenda has slowed in the last couple of years, responded Mr. McCormick.

What are the principal constraints on the flow of FDI into Japan?

"Coming from the business world, I think Japan is a challenging market to gain access to for lots of reasons, some of which are regulatory, but some of which would also be cultural and sort of understanding the market," Mr. McCormick replied. It is "particularly important for the U.S. and Japan to come together" to push back against the forces of protectionism, he added.

Can you imagine in the next 25 or 50 years that Japan and China will be the biggest trading partners, and the biggest militaries in Asia?

"As the relationship between Japan and China strengthens, inevitably that brings enormous benefits to our relationship with Japan, our relationship with China and our position in the region," Mr. McCormick said. "So, I think the strengthening of that relationship, as the Japanese leadership is pursuing through this high-level dialogue, is very much akin to what we're doing with the Chinese as well and not unlike what an ongoing dialogue we have with the Japanese." However, "how that sort of plays out in terms of what they do in their respective militaries, I wouldn't want to speculate."

You have spoken about turmoil in the financial markets--could you explain what is happening now, and what will be the strategy to escape from this?

"As you might imagine, this is sort of front and center I think in everybody's mind in the Treasury Department these days," Mr. McCormick answered.

Near term, the Fed has taken "a whole series of actions on the liquidity front and the monetary policy front." Congress has adopted a stimulus package "passed in record time by both parties," and programs like the Hope Now alliance are working to help homeowners stay in their homes.

The Secretary of the Treasury "just recently rolled out the findings of the President's working group, which had a whole series of very specific recommendations on what we need to do about mortgage origination and credit rating agencies and how financial institutions need to think about risk management and off-balance-sheet entities and so forth. And that won't change the current situation. That will ensure that we address some of the regulatory challenges that led to the current situation. So, that's important and it's timely, but that's not going to change where the economy is tomorrow," he said.

"Then there is a third set of questions and a potential policy response, which are much more systemic and structural, where you step back and say are our regulatory systems set up in a way that's appropriate for dealing with the global economy as it exists today, are we integrated across economies and so forth. And there has not been a whole lot said about that and a whole lot of thinking done on that yet, but I think that will be a focus for future policy makers as they reflect on what's happened," Mr. McCormick added.

You mentioned IMF guidelines on sovereign wealth funds. Is the consensus among sponsoring parties broad enough to avoid an impression of ganging up on certain countries such as China?

"The IMF has begun to coordinate a process by which all the key players, both sovereign investors as well as recipients of sovereign investment--and by the way, many countries are both--can come around the table and work together on this," and expectations are that the guidelines will be "in final form by the fall meetings in October, if not sooner," responded Mr. McCormick.

"The case that we try to make to our friends, who are sovereign investors, is that there is a long and distinguished track record of stable commercial investment," he said. The aim is to assure "that this track record of behavior becomes replicated" even as the funds grow dramatically, both in number and in resources. "I'm guardedly optimistic we're making progress here."

--Katherine Hyde