Japan: Nudging an Underachiever into a Greater Global Role

What a difference a decade makes. In the late 1980s, Japan was highly visible in Washington—its strong economic performance the object of either admiration or unease—and seemed on the verge of becoming a more major player in regional and global affairs. Today Japan attracts little attention in Washington—a victim of almost a decade of economic stagnation and unfulfilled expectations on the security and diplomatic side.

Still, Japan remains the second largest economy in the world and one of the handful of very affluent advanced industrial economies. From an American perspective, Japan remains an important trade and investment partner and a key strategic regional ally linked by a formal security treaty. Nevertheless, political and economic trends could complicate American foreign policy toward Japan in the new administration.

Macroeconomic and Financial Problems

From 1992 through 1999 Japan’s average annual real GDP growth was just under 1 percent, and the period ended in recession (with five consecutive negative quarters in 1997-98 and two more in the second half of 1999). Growth may finally be returning, but Japan’s problems are far from over, and the new administration could well face a Japan whose economy continues to stumble.

First, the recovery may not materialize—or may be short—lived. Having ramped up fiscal deficits to jump-start the economy since 1998, the government will be eager to reduce them before the ballooning public debt becomes potentially dangerous. Concern over rising debt could lead the government to raise taxes and cut spending too quickly, before a solid private-sector recovery is under way. A modest recovery followed by renewed recession or stagnation is a distinct possibility.

A renewed financial crisis is also possible. Since 1998, the Japanese government and the financial sector have begun to address the enormous nonperforming loan problem. Some bad debts have been written off; a handful of financial institutions have been nationalized, cleaned up, and sold back to private-sector owners; other banks have been recapitalized with government funds; and several large banks have merged. But these steps do not come close to cleaning up the problems. Meanwhile, the decline in real estate prices that has soured so many bank loans continues unabated, and a recurring recession would create more nonperforming loans.

Finally, the longer-term prospects of the economy remain uncertain. Demographic trends—a low birth rate that will cause a population decline beginning in 2008—are already shrinking the working-age cohort and within a few years will set off a social security funding crisis that dwarfs that of the United States. Meanwhile, government debt, already more than 100 percent of GDP, will keep climbing. And deregulation to underwrite a more robust private-sector renewal continues at a snail’s pace. Even if none of these problems leads to serious recession or financial crisis in the next decade, an underperforming economy with only marginally positive growth is highly likely.

A growing, robust Japanese economy is very much in the interest of the U.S. government. Weighing in at 9 percent of global GDP (at purchasing-power-parity exchange rates), Japan’s economy has a small but measurable impact on global economic performance through trade and investment linkages. Japan is also the world’s largest gross and net global lender, with the Japanese owning some $2.6 trillion in gross overseas assets and $1 trillion in net assets. Serious macroeconomic or financial problems in Japan could thus disrupt global financial markets—through either sudden capital flight or capital repatriation to meet obligations at home.

For all these reasons, Japan’s macroeconomic and financial health should matter greatly to the new administration. Monitoring both should be the first objective—though the paucity in the U.S. economy of working-level expertise on the Japanese economy makes that task harder.

The bigger issue is what to do should serious economic problems in Japan recur. The bad news is that the U.S. government has little leverage here. The administration can speak out in favor of more sensible policies, but absent a true economic crisis, the record of the past decade suggests that its comments will fall on deaf ears. Washington can also nudge along deregulation and encourage a more open market for inward direct investment to help spur a private-sector recovery, but no amount of American advice or encouragement can persuade or force Japan to do what it is reluctant to do.

Trade: A Vanishing Issue?

During the past several years, once highly visible U.S.-Japanese trade issues have virtually disappeared. One reason for that change has been the sudden surge of foreign direct investment into Japan since 1998—including the acquisition of several Japanese firms by American or other non-Japanese corporations, a development unthinkable just a few years ago. Still, specific market access problems remain, and U.S. government officials involved in trade negotiations have seen little change in the defensive, obstinate negotiating behavior of their Japanese counterparts.

More open trade and investment is an obvious benefit for Japan, and leadership in moving negotiations forward in a new world trade round would be a natural step for the Japanese government—or so Americans unfamiliar with the historical, political, and social setting of Japan seem to believe. But incoming administration officials need to recognize that extensive consultations with Japan will be a necessary, and probably frustrating, part of the effort required to get the next world trade round on track. Japanese objections on agriculture and other issues helped sink prospects for the new round at the 1999 WTO meeting in Seattle.

If the new administration makes the WTO round a major priority, bilateral trade negotiations may recede in importance. The Japanese government will no doubt keep up its recent effort to push bilateral disagreements into the WTO dispute resolution process, an approach that the administration should second when appropriate. But not all bilateral issues fit within the still-imperfect framework of the WTO, so some negotiations will have to continue at the bilateral level. These negotiations are often tense, and progress is glacial. Incoming officials often hope for a magic solution, but none exists.

A Changing Security Alliance?

The cornerstone of American security policy in the Pacific over the past half century has been the U.S.-Japanese security alliance. A decade after the end of the Cold War, the alliance remains central to American regional strategy—permitting a continuation of forward troop deployment to cope with tensions throughout the region. The alliance has also served Japanese security interests, and Japan’s role in it has expanded modestly over the 1990s. But the next administration will face some new challenges here as well.

The generation of Japanese political and bureaucratic leaders who lived through World War II and the occupation—and who believed strongly in the benefits of a close alliance with the United States-is passing from the scene. Many in the next generation have bridled at the enormous inequality of a nonnuclear Japan, with strictly defensively postured military forces, paired with a powerful, nuclear-armed United States. Over the next decade, debate in Japan about security policy will be more open. The value of the bilateral security treaty will come under question, as much because of simple national pride as because of careful calculation of security costs and benefits.

One increasing security-related concern in Japan has been the continuing presence of American military bases. The problem has been acute in Okinawa-the one location in Japan where U.S. bases are a nonnegligible presence. During the past several years, debate has intensified over whether to move the Futenma air base, located in a heavily populated area where its noisy operation is particularly intrusive. Opposition to American bases could become more serious in the next several years, even if the Futenma base is relocated.

Changing attitudes also provide new opportunities to engage the Japanese government on issues once considered too sensitive to raise. Revision of Article 9 of Japan’s constitution, which prohibits use of military force, is in the early phases of serious discussion by Japanese politicians. Eventual revision (or even reinterpretation) that permits Japanese armed participation in United Nations peacekeeping operations or other collective military action is finally a possibility, though still sufficiently controversial that the next administration is best advised to remain silent on the issue. However, bilateral discussion about Japan’s role within the security alliance—from action by the Japanese military in the vicinity of Japan, to anti-piracy, sea-lane protection—should proceed regardless of the state of play on constitutional revision.

But the budgetary environment for defense in Japan will grow less hospitable over the next several years. The inevitable overall fiscal austerity as the government begins to cope with its rising debt burden will be a serious constraint on security policy. Financial support for American bases in Japan, new weapons acquisition, and funding for joint research and development with the United States on theater missile defense will all face serious questioning and possible cuts.

Japan’s Regional and Global Role

For the past half century Japan has kept a low profile in regional and global affairs. For more than a decade Washington has encouraged a more active role for Japan, using rhetoric about a global partnership or bilateral dialogue on the Common Agenda. It remains in the interest of the U.S. government to nudge Japan to become more prominent in regional and global economic, social, political, and security affairs. Doing so, however, will require that Washington tolerate a more independent voice from the Japanese government, one that will more often disagree with American initiatives.

On regional political and security issues, Japan is a critical partner. What happens on the Korean peninsula, or even as far away as Indonesia, often has larger and more immediate ramifications for Japanese security and economic well-being than for the United States. Even with constitutional constraints on its military role, the Japanese government is in a position to provide diplomatic and financial support for a variety of peace-building measures. Engagement with the Japanese government on regional issues, therefore, is important-diplomatic and financial support will not be as readily forthcoming should the Japanese government conclude it has not had a voice in shaping policy.

One area of particular concern will be Japan’s regional economic role. As part of the general drift in attitudes away from the close embrace of the United States, the Japanese government has periodically toyed with the idea of closer ties with other parts of Asia as an alternative. For Japan to be more active regionally is not necessarily a bad development, but it could take a form that creates a new problem for the next administration. An Asian Monetary Fund that provides a strictly regional fund to help members resist currency fluctuations, for example, would undermine pressures from the International Monetary Fund or U.S. government for important economic reforms in Asian developing countries. Thus, while encouraging a more active and engaged Japanese government in Asia-Pacific Economic Cooperation and other regional forums, the administration needs to guard against the “Asia versus United States” tendency in policies pursued by the Japanese government. Here as in other realms, the United States will face the difficult challenge of encouraging Japan to do “more”—without any assurance that the two countries will agree on how “more” should be defined.