577 April 24,1987 U.S JAPAN TRADE WARr THE OPENING BATTLE INTRODUCTION For the first time since World War II, the U.S. has retaliated against Japan for alleged unfair trade practices. S ecifically, the Reagan Administration charges that Japan has not complied with a bilater August 1986 a eement, which would prevent Japanese businesses from sellin certam semicon uctor computer chips in third countries for less charge, the Reagan Administration mainta i ns that the Ja anese government has failed to retaliate against these alle ed ractices, the Administration has placed 100-percent tariffs out of the U.S. market 8 ar than their cost of pro d uction, a practice known as "dumping In addition to the dumping p ermit U.S. firms to win more than a 10 percent share o F the Japanese chip market. To on some $300 million wor A? o Japanese imports, effectively keeping many of these goods Agonizingly Slow Japanese. This trade policy makers dealing with Ja anese trade t h e dilemma faced by U.S have been a onizingly slow to open their markets to 5 .S. goods B rustrates Americans and prom ts demands that Washington do "something" to force the Japanese to move more quickly. he typical view is that only by getting tough will the U.S. open the Japanese market to more American products. Moreover, say many Reagan officials, it is necessary to take controversial protectionist action now, risking a trade war, to avoid sweeping protectionist legislation from Congress.

Clearly shooti ng across Japan's bow makes some sense if it shocks Tokyo into reducing restrictions on U.S. imports. But e erience teaches that such shots often go astray. Sharp all-out trade wars. And even if the strategy has initial success, Congress may simply smell b lood and push even harder for further protectionist legislation but limited sanctions to make the o '3: er side "see reason" in the past have led at times to I In this "microchip war the economic case is very clear. It makes bad economics and it victimize s Americans and other customers of the Japanese microchips. The original microchip agreement was no more than a cartel arrangement between the U.S. and Japan to keep up prices and to divide up the world market. American retaliation last week thus was no mo r e than a sanction to enforce the cartel Befitting a Third World Country. Opening up the Japanese market to U.S. goods, on the other hand, would benefit America and Japan. To 0, moreover, at last must recognize that the post-war era is over and that Japan m ust begin ehaving as the advanced industrial country that it is. The wa that Japan protects its domestic market and finds ways to keep out foreign goods befits a dird World country, not wealthy, high-tech Japan. The Reagan Administration is thus correct t o seek some means to force Japan to accept the responsibilities of maturity.

But the Administration is probably wrong when it commits the U.S. to defensive action on such a uestionable issue as enforcing a cartel. The microchip agreement was a mistake he A dministration should negotiate with Japan an end to the agreement and to the punitive U.S. tariffs. In exchange, gven the action already taken by Washington, the U.S. should seek reductions of real Japanese barriers to such U.S. products as telecommunicat ions equipment, beef and citrus products, services, and construction.

Above all, U.S. negotiators should tread warily A trade war is a mutual assured destruction approach to international economcs All sides lose. Conversely, free trade benefits all parties involved The Administration must not risk losing the benefits of free trade, espeaally over the computer chip issue THE COMPUTER CHIP AGREEMENT In 1986 a number of U.S. semiconductor roducers complained that their Japanese counterparts were "dumping" cer t ain types o P semiconductor memory chips in the Japanese firms were selling below their costs of pro cf uction. It also was alle ed that Japan American market and in third markets. By dumpin the U.S. firms meant that the so restricts its domestic market t o U.S. semiconductors, that U.S. firms cou d obtain only a 10 percent share of that market f To head off potential action August signed a semiconductor principal concessions by Tokyo these practices, Tokyo last document contained two 1) Agreed to monitor e x ports of their firms and to ensure that these firms were not selling semiconductors either in the U.S. or in third countries for less than the costs of production. The production cost was to be determined by the U.S. government U.S. market share increase s ignificantly over the 10 percent level. If necessary, the 2) Promised to promote the sales of U.S. memory chips in Japan and to ensure that the 1. For a good overview of this trade dispute, see Michael Becker, "Semiconductor Protectionism: Goodbye Mr. Chi ps,"

Citizens for a Sound Economy Issue Alert No. 9, August 27,1986 2Japanese overnment would force its companies to curtail production, to create a shortage to be fille d by U.S. products The result of this, in effect, was an international cartel for semi conductor chips? In a cartel the major suppliers of an item attempt to divide the market and regulate supply and price to keep rices above the level which supply and demand would dictate. It is anathema to tK e principles of free trade. The Organization o f Petroleum Exporting Countries is an example of such a cartel When the parties to a cartel are private businessfs, the attempt usually fails, since other suppliers can enter the market and undercut prices. But when governments create and enforce a cartel, the power of each overnment can be used agsunst firms seeking to avoid government determines the price and the Japanese government is expected to enforce the price floor against its own producers, to allow Amencan firms to sell their products for equally high prices. The wctims of this cartel, as of other cartels, are the consumers who end up paying higher prices.

THE CAUSE OF THE CURRENT DISPUTE the agreement. In such cases, carte I? s can survive. In the case of semiconductors, the U.S are true.

In response to these violations of the August cartel agreement, the Reagan Administration has slapped a 100 percent tariff on $300 million worth of Japanese consumer im orts such as televisions, computers, air conditioners, and electrical equipment. &I is decision to retaliate rested on two foundations 1) Japan had failed to enforce a formal trade agreement. If no action were taken, it was felt, Tokyo would conclude that such agreements meant nothing. Thus whether or not the agreement was wise, a violation has occurred and a firm response seemed necessary 2) U.S. policy makers am frustrated at the exceeding1 slow progress of Japans trade feet, delaying access to its markets for as long as possible. Man American olicy makers agreement to send Tokyo a signal t hat America is serious about more open markets and wll take strong measures in response to Japanese recalcitrance. Failure to do this, reason Administration officials, would offer red meat to those in Congress who wish to enact sweeping protectionist meas u res liberalization. The government of Japan, say almost all o i! servers, has been dragging its thus believe that the U.S. must take the opportunity of a clear Y apanese vi0 Y ation of an 2. See Tokyo Concerned About Setting a Trade Precedent, Financial T i mes August 8,1986, p. 4, for an overview of the problems involved with the agreement 3. There is no indication that private Japanese semiconductor producers are receiving any subsidy from the Japanese government 4. Andrew Pollack, Cuts by Japan Now Spur F e ars of Chip Shortage, The New York Times, April 7,1987, p. D1 3Advocates of retaliation oint out that past Japanese government actions intended to liberalize trade have often B one little to open markets. U.S. firms often find that as one Ead negotiated a c cess to the Japanese market F or U.S. tobacco products, it had to seek specific trade barrier is removed, another is encountered. Example: in 1985 the Japanese government supposedly privatized its tobacco monopoly and opened its market to American tobacco products. But the Japanese tax and tariff structure effectively raised the removal of yet another barrier which limited U.S. sales rice of imported tobacco products by over 40 ercent. Thus after the U.S. government The microchip apeement embodies a tactic for dealing with this trade roblem. By demanding a specific share of the Ja anese semiconductor market, the U.i. government were necessary to bring about the agreed result ECONOMIC PROBLEMS WITH THE SEMICONDUCTOR CASE established an easily measured stan C P ard and left it to the Japanese to take whatever steps Given a seemin8 open and shut case, the Reagan Administration's actions against Japan in the corn uter chip case are intended to demonstrate U.S. determination to open Japanese markets pa is then aim s at heading off heavily protectionist measures by Congress.

The problem is that dumping is an ambipous economic concept, involving the business practice of selling below the cost of production, often as an attempt to secure a greater market share. Yet sel ling below cost, or charging different prices in different markets, can be a le 'timate business practice. Man U.S. businesses charge different prices in different another region, to retam market share. Most woul be shocked to be accused of dumping Plungi n g Chips. Companies also sell products below the cost of production to liquidate large surpluses, especially if the market price of the product is dropping and supply is increasing. This seems to be in part the case with Japanese microchips. During the las t few years, chip prices have plunged as supplies have increased and production methods have become more efficient. In certain lmes of chips, U.S. producers have not been able d parts o fl the U.S using profits from s J es in one re 'on temporarily to offs e t losses in the Ja anese, while competitive, have found surprising that Japanese producers try to dump their older P ines of chips, such as 64K and 256K RAM defensive action to deal with a fallin market--the chips likely would not sell at all i P the true production cost were charged. b urther, the Japanese face stiff competition from to ta yc e away Japanese market shares semiconductor memory chip market. But the alleged dangers P rom predatory pricing have private companies could lead to a permanent mono poly. If the Qr .S. does not see a chips at a low price.

Even if the chips are selling below the costs of production, it may have been a Ja anese low- riced Korean semiconductors. Japanese price increases could thus allow the Koreans Predatory Pricing. The charge has been leveled, of course, that the Japanese companies actually are engaged in predatory pricing practices, in an attem t to monopolize the properly been called into question b the Reagan Administration and U.S. courts regarding U.S. business ra c tices ample: In the 1986 case of Matsushita Electric Industrial Co. Ltd. vs. gnith Radio Corp which concerned the television set industry the U.S. Supreme Court effectively rejected the possibility that redatory pricing by 4problem with below-cost pricing when private U.S. companies engage in the practice, it is difficult to see why there are such objections when the practice is undertaken by Japanese firms.

The dum ing accusation seems especial1 weak when it entails markets in third countries I F such cou ntries as Taiwan and A ong Kong are open equally to semiconductor trade from the U.S. and Japan, then there are two economic situations possible, neither of which warrant action against Japan. First if Japanese and U.S. firms are equally efficient then pr ice cuts by the Japanese could be met by price cuts from the Americans. On the other hand, if American businesses are uncompetitive in third markets, it is hardly the role of the U.S. government to protect them.

U.S. Consumer Gains. Dumpin in a third marke t, moreover, usually benefits the count receivin the cheaply pnce d products that use the dumped components. Taiwan Hong Xd on& an other countnes receiving low-priced Ja anese computer chips can cut more e ectively wth Japanese finished products. Converse l y, when Japanese firms began tJ their production costs. When these are exported to the .S the American consumer ains-and so also do many U.S. exporters. For example, the IBM "PC a product that E as accounted for billions of dollars in sales for the Americ a n computer giant, contains 60 percent foreign arts, including imported computer chips. If these foreign parts were not available, the P e would have been more costly to produce, reducing IBM sales and exports. Less e ensive chips have cut production costs for IBM, allowing the company to compete to raise the prices of their semiconductors in the U.S as a result of the agreement between the two governments, American computer systems firms and software producers encountered rising production costs.

POLITICAL PROBLEMS WITH THE SEMICONDUCTOR AGREEMENT The political dangers caused by the semiconductor agreement are as serious as the economc. While it is convenient to speak of trade between the U.S. and Japan as though countries or governments traded, this is on l y a metaphor. Individuals and companies in the U.S. purchase goods and services from individuals and companies in Ja an. Free trade semiconductor agreement with Japan requires interference in private trade by both the Japanese and U.S. governments. betwee n countnes means the absence of government restrictions on suc I& transactions. The To increase the U.S. share of the Japanese memory chip market, the Japanese government must somehow compel private Japanese companies to purchase American products, even wh e n these do not suit the price or production needs of these companies. If it is to prevent dumping in either the U.S. or other markets by Japanese compames, the Japanese government must monitor closely exports by its computer firms and enforce strict price controls.

The U.S. thus is demandin that the Japanese exercise the kind of dictatorial control over its private sector that the fJ .S. would not tolerate in its own market. For instance, it is difficult to imagine Americans accepting demands from Con ress that they must cease instead buying less expensive and better quality imported items and uy American products 5 An unintended consequence of the semiconductor agreement could be to strengthen the International Trade and Industry MITI which enforces the c a rtel leaders, including Prime Minister Yasuhiro Nakasone, who are market to more U.S. exports run into resistance from MITI see Japan's economic interests furthered by a closed market As the agent of enforcement, MITI would be strengthened if Ja an renewe d its efforts to enforce a robably unenforceable agreement. A stronger &would be better able to instance, the U government finds itself in the business of determining the ''fair market price" of computer chi s. This is a dangerous interference in the marke t and sets a bad Hong Kong Anger. Further, by attemptin to control the rices at which private further ammunition to those who complain about American efforts to enforce its aws beyond its borders. It is easy to understand the anger in the Republic of China or Hong Kong when the U.S. government tries to increase the cost to them of Japanese computer chips frustrate K ture attempts to open further the Japanese market to U.S. goods and sexvices precedent for those w l! o fear national industrial planning.

Japa nese businesses sell semiconductors in zird countries, t K e U.S. government ives The political roblems for the U.S. from the computer chip cartel are also serious. For B This resentment is manifested in a suit against the U.S. brought by the Europeans un d er the provisions of the General Agreement on Tariffs and Trade (GATT). The Europeans point out that the creation of a government enforced international cartel for chips violates GATT trade laws. The U.S. undermines its own attempts to liberalize internat i onal trade through the new Uruguay Round of GATT negotiations when it violates fundamental principles of the current agreement THE DANGERS OF A TRADE WAR The U.S.Japanese semiconductor dispute reminds Americans again what could result from a trade war. Th e $300 million in punitive tariffs against Japanese goods which increases prices to American consumers and limits supplies, is just the tip of the icebere. If the agreement is actually enforced, American manufacturer's who employ corn uter chips retaliates , say a ainst U.S. agricultural products, American exporters will suffer and there ignite a full trade war that would seriously erode worldwide confidence in the U.S. economy sunil~ to the reaction following the passage in 1929 of the protectionist Smoot-H a wley Tariff in their products will see costs increase and competitiveness decrease. And if P apan will be loud cal B s for even tougher action against Japan. Such "tit-for-tat" actions could Moreover, the claim that tough--albeit protectionist--actions b the White House will head off damaging action b Congress is uestionable. There is t i e strong possibility that if Japan backs down and abi 2 es by the carte 7 agreement, thanks to U.S. protectionism Congress may conclude that protectionism works.

CONCLUSI ON Japanese trade policy is understandable. This is a frustration shared by the rest of the The frustration of the Reagan Administration, the Congress, and American firms over 5. Milton Friedman Outdoing Smoot-Hawley The Wall Street Journal April 20,1987, p. 22 6trading world--developed and undeveloped countries alike. The Reagan Administration has, for once, caught the Japanese in clear violation of an agreement and Washington is takin the opportunity to show that America means business. It is very troubl i n however all others committeed to trade liberalization that i% e whole dispute centers on a cartel--a practice usually denounced by the 6 .S. and This is the wrong battle over the wrong issue attack on Japanese Then, to turn a arriers to A breakdown in t rade relations between Washington and To o would help nobody.

Perhaps Washington even should take the first step. But only if 'r apan--at last4 willing to give free trade the respect it deserves.

Edward L. HudFins, Ph.D Walker Fellow in Economics 7-