Japan's trade deal with the US is a $50 billion question

  • China and the European Union cannot take all the exports Japan will have to direct away from the United States.
  • Tokyo's record-high spending on welfare, military and infrastructure won’t do much to soften the serious blow of falling exports.
  • Japan’s slow and gradual trade adjustment is unlikely if the U.S. wants a meaningful rebalancing of trade accounts.
U.S. President Donald Trump (R) meets with Japanese Prime Minister Shinzo Abe in the Oval Office of the White House on June 7, 2018.
Getty Images News | Getty Images
U.S. President Donald Trump (R) meets with Japanese Prime Minister Shinzo Abe in the Oval Office of the White House on June 7, 2018.

For Japan, exports are not just the key engine of economic growth. They are the foundation of the country's growth model and the essential dynamic component driving its business cycle.

Last year, net exports contributed one-third of Japan's GDP growth. In the first nine months of this year, they accounted for nearly a quarter of aggregate demand, and they will probably match their last year's contribution when all the 2018 numbers are in.

Japan's $117.6 billion worth of goods sales to the U.S. in the first 10 months of this year are virtually on par with Tokyo's exports to China. The big difference is that, with those sales, Japan is generating a $56.2 billion trade surplus with the U.S., while running, over the same period, a whopping $23.3 billion deficit with China.

Two years late, Washington finally seems to have decided that Japan's systematic and excessive trade surpluses with the U.S. must come down — and that formidable barriers to Japan's markets have to be removed. Trade negotiations with Tokyo are scheduled to begin on January 20, 2019, with tariff-free exports of American manufactured products and agricultural goods at the top of Washington's wish list.

Is the US serious about its Japan trade?

A more balanced trade in motor vehicles — which account for 75 percent of the U.S. trade deficit with Japan — is also being sought. The United Auto Workers union is calling for quotas on Japanese vehicles and parts, with any quota increases subject to the growth of U.S.-made automobile exports to Japan.

The writing, finally, may be on the wall, even though Japan could be allowed some time to adjust to the new trading regime, especially in agricultural matters. But the Democrats are already warning the U.S. negotiators to tighten up the enforcement instruments and procedures.

And here is an interesting aside to the trade story from President Donald Trump's administration: Results of an opinion poll in Japan, published last Wednesday, showed that only 39 percent of respondents thought that the U.S.-Japan relations were "good" — down from 56 percent in last year's poll. Nearly 40 percent thought the relations were "bad," which was almost double from last year's 23 percent.

There is an unmistakable moral to those findings for America's worldly pundits, including some of those in the highest offices, calling for commitment and respect to friends and allies. Yes, but a rising hostility is what America is getting from a country whose security is unconditionally underwritten by the United States, and whose economy has flourished, and continues to grow, thanks to unlimited access to American wallets.

Still, what we are seeing in Japan now is a Kinderspiel, child's play, compared to Germany's extraordinary vilification of America and its leadership — another country that freeloads under the American security umbrella and continues to accumulate huge amounts of wealth as a result of $50 billion to $60 billion in annual trade surpluses with the U.S.

And here is what America's benevolence is getting in return: Former German Chancellor Gerhard Schroeder asked the government, in a Sunday interview, not to take American advice about with whom it should not trade. Schroeder then recalled, as an apparent badge of honor, his refusal to follow the U.S. in its invasion of Iraq in 2003.

There is no need to take partisan or bipartisan sides in the ongoing trade debate. The simple truth is that U.S. friends and allies are questioning Washington ties as soon as the issues are raised about defense burden sharing and squaring their systematically and outrageously unbalanced trade accounts with the U.S.

Having made that long detour, let's go back to Japan's export problem.

China and the EU can't help

Assuming that the U.S. is really serious about narrowing its huge trade gap with Japan, it seems that Tokyo would have to promptly redirect some $50 billion of its overseas sales to Asian and European destinations.

The key question here is whether China would be willing to take tens of billions of dollars worth of Japanese exports on top of the $133 billion it took last year, and probably a similar amount it will take by the end of this year.

That looks unlikely as a result of China's continuing progress on import substitution and a moderating growth of its domestic demand. Lingering political and security problems are also an obstacle to a greater economic integration of the two estranged Asian neighbors.

China is bristling at Japan's National Defense Program Guidelines published last week because, Beijing claims, its intent of power projection is inconsistent with the country's Constitution, which says that "land, sea, and air forces, as well as other war potential, will never be maintained." Beijing notes, with apparent alarm, that the program carries a price tag of 27.47 trillion yen ($243 billion), and it finds particularly objectionable modifications of Japan's helicopter destroyers to allow short takeoff and vertical landing of fifth generation stealth fighters.

Ironically, Japan seems to be acquiring 42 F-35B and 63 F-35A airplanes, and two Aegis Ashore missile systems, as part of the new trade deal with the U.S.

China and Russia know that all that sophisticated military hardware is pointed at them, and they are very unlikely to come to the rescue of the Japanese economy by taking more of its exports.

And neither is the European Union likely to allow Japan to unload more exports in addition to $80 billion it will take by the end of this year.

In fact, Japan may end up having big problems with the EU if the Renault-Nissan-Mitsubishi debacle is allowed to destroy Europe's largest industrial alliance with Japan. "Yellow-vest" protests have put the French government on the back foot, but Renault, a true French institution, and the country's formidable elite, are fizzing with fury at the way the industrial alliance, and the car maker's chairman, are being treated by the Japanese.

Stay tuned. China is showing the way here with its response to the jailing of a Huawei executive in Canada. Ottawa is now appealing to its allies for help to free its citizens Beijing has detained.

Investment thoughts

Japan will not be able to redirect some $50 billion of its U.S. exports to other trade destinations. That will pose a serious problem for Japan's structurally impaired and export-driven economy.

Tokyo's announced — and totally unaffordable — fiscal measures won't soften the blow. A replay of public investments in proverbial "roads and bridges to nowhere" is a blind alley. Large welfare spending for an aging society and huge military outlays are also one-off non-market expenditures with little, if any, consequences for growth dynamics.

Sadly, Japan keeps kicking the can down the road instead of coming to grips with its existential problems of society, economy and peaceful neighborly relations.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.