Why Japan Can Still Say No

Walking out of an Italian restaurant in Tokyo one evening, a fortysomething Japanese manager confided to a couple of American friends that he soon would be asking his boss for a leave of absence, after working on U.S.-Japan issues for several years. "I really like American people," said the intensely emotional dinner partner. "But I just can't stand the American government anymore."

Japan's elites always have talked tough. They have been saying "no" to the U.S. for years, making grudging compromises only at the last minute. But there's a new tone these days, as Japan recoils at the incessant rat-a-tat assault of trade demands from the Clinton Administration. "We won't be subject anymore to unilateral threats" is an increasingly common line.

The reason for the worrying escalation in Japan's defiance of U.S. trade demands is this: Despite the appearance of crisis in Japan's politics, a new power equation is emerging in U.S.-Japan relations. For the first time, America is encountering a Japan that considers itself every bit an equal and, in many ways, is.

Leaders of the world's top industrial nations will get a taste of this when they descend on Tokyo on July 7 for their annual summit. Many will arrive with demands that Japan open its markets to more imports and shift its savings-driven economy to one that consumes more. They may assume that an economically weakened and politically confused Japan will acquiesce. But Japan is much stronger than they recognize. Because it is driven by big business and bureaucrats--with politicians wielding far less power than in the West--Japan is in a position to resist the pressure, and it will. Says one frustrated U.S. official involved in talks aimed at opening Japan's construction market by June 30: "I didn't budge them, not even an inch."

So, too, are the Japanese increasingly candid in rejecting appeals to abandon uniquely Japanese systems and values and head down the path toward a more Western economic and political system. The hoopla surrounding the recent royal wedding demonstrates that ancient institutions live on. Japanese still refer to their bureaucracy as okami, or "honorable ones above." And the national anthem, once in disrepute because of its imperial hue, is heard more and more often.

The Japanese may eat at McDonald's and shop at Toys 'R' Us, but on a deeper level they seem to be embracing the message of an early-1990s best-seller, The Japan That Can Say 'No,' by politician Shintaro Ishihara and Sony Corp. Chairman Akio Morita. "We Japanese feel like we've been pretty successful," says Kazuo Nukazawa, a managing director of the vaunted Keidanren, the leading federation of business leaders. "Why should we change? Others who are doing worse should change, not us."

The emergence of this more assertive Japan is likely to confound experts who have wanted to believe that any "change" in Japan will result in a Westernized society which poses a dramatically reduced competitive challenge. These analysts argue that the current maneuvering in Nagata-cho, Tokyo's political district, will prove to be a revolution that shatters big business' grip on politics.

Others argue that Japanese women, unhappy with workaholic husbands, will be the wedge that forces fundamental change in favor of consumers, thereby benefiting foreign makers of goods. Another view is that there may be a labor shortage that cripples Japan's economy. Perhaps the most enduring hope is that younger generations of more "internationalized" Japanese may refuse to work hard enough to sustain the economic machine that their parents have built.

In reality, however, none of these pressures is as overwhelming as some believe. Yes, they will force Japan's system to adapt, as it has adapted so ably in the past. But this change will occur gradually and within the confines of Japan's own culture and economic system. Even young people who have lived abroad are not about to destroy the heart of a system that has produced such wealth. "The 20- and 30-year-olds are working harder than my generation did," says Mitsuharu Ishii, a director at Sumitomo Corp. "My engineer son was born and raised in the States and speaks better English than Japanese, but when he comes home at night he usually calls his boss to make sure everything is O.K."

Similarly, there are some ominous economic signs. Banks are creaking under perhaps $500 billion in bad loans. Corporate profits have tanked, and the stronger yen won't help them recover. Employees are worrying about their job

security. The electronics industry trails other countries in such key areas as software and telecommunications. American companies have been able to grab back market share in the U.S. auto market. In short, Japan is no longer the invincible world-beater of earlier Western nightmares.

But Japan does retain many strengths that have been overlooked as the excesses of its late-1980s "bubble economy" get purged. These strengths include the continued viability of its keiretsu, or corporate groupings. Even though some Japanese companies have started pursuing such Western-style goals as fatter profits and closer attention to shareholders, they're preserving crucial links to other members of their keiretsu. Other strengths include high savings, a highly skilled work force, and an awesome buildup of economic prowess in booming East Asia. Japan hasn't faded away.

In fact, Japan's modest pace of economic growth could soon accelerate. Inflation and unemployment basically don't exist. Many companies are cash-rich and are sitting on cutting-edge plants and technology. Their cost of capital still is competitive with the rest of the world's. The rising yen hurts, but as senior American executives doing business in Japan note, the end result will be more efficient Japanese competitors. "Tougher conditions for them will only make things tougher for me," says James C. Morgan, chief executive of Applied Materials Inc., the leading U.S. supplier of semiconductor-production equipment.

SCARY NUMBERS. At the same time as its economy is displaying such resilience, Japan's dependence on the U.S. as a market has been greatly reduced. Japanese exporters are engaged in a massive switch to Asia, both in investment and trade (chart, page 20). This spells less leverage for the U.S. "Japan's options are definitely broadening," observes Kent E. Calder, director of Princeton University's program on U.S.-Japan relations. "Anybody who has recently been to Hong Kong or booming southern China understands what Japanese electronics and auto companies are looking at." This year alone, for example, Japanese steel exports to China should more than triple, to 7 million metric tons.

Japan's Asian neighbors will continue to climb the technology ladder and eventually will take over some Japanese markets, but Japan will stay ahead of the pack in leading-edge manufacturing sectors for years to come. "East Asia will be the only growth center of the world economy, and Japan is situated in Asia," says a senior Finance Ministry official. "We will benefit."

Others cast a more alarming picture. "Japan is taking strategic control of East Asian markets," warns Kenneth S. Courtis, strategist at Deutsche Bank in Japan. What's more, Courtis adds, "everyone in the world needs money, but an increasing amount of that money is in the hands of Japan and Asia." Throughout the region, the U.S. is clearly falling behind, thanks to the blistering pace that the Japanese and other Asians are setting.

U.S. leverage over Japan also has declined because the end of the cold war has reduced Japan's reliance on America for security. Senior Administration officials are correct in asserting that Japan wants U.S. troops to remain in the region as a counterweight to China and to help ensure stability on the Korean peninsula. However, Japan's need for a nuclear umbrella and a rapid response to Soviet troops pouring over the horizon is gone. By failing to account for this new reality, America is "miscalculating" its approach to Japan, according to the Keidanren's Nukazawa. He says: "There's a lessening on the value of the alliance. Japanese people are feeling we can talk back and say what we want to say."

Even though the Japanese are dismayed at their political system, this kind of confidence extends to the largely invisible "old boys" who run Japan's economy. In fact, the ability of Bank of Japan Governor Yasushi Mieno and other top bureaucrats to manage a soft landing for Japan's bubble economy has demonstrated once again for most Japanese the virtues of their special brand of capitalism. In a remarkable rescue of the Tokyo stock market this spring, bureaucrats engineered a so-called price keeping operation, which catapulted the Nikkei index from the brink of catastrophe to a nearly 50% rise. Through administrative guidance and by tweaking regulations, they also steered the country's troubled main banks through the end of a tricky fiscal year, defying warnings of failures.

Unquestionably, Japan faces painful restructurings in its corporate and financial sectors, and job security is less sacrosanct than before. But the safety net provided by Japan's main-bank system, its keiretsu ties, and the supportive bureaucracy cushions many of these blows. In case after case, the sprawling keiretsu have come to the rescue of their members and affiliates. For example, Nissan Motor Co. has undergirded Fuji Heavy Industries, maker of Subaru cars, with management help and schemes for co-production and co-design. Also, Sumitomo group arranged for the merger of its bankrupt real estate affiliate Itoman into another group company, thus saving virtually all Itoman jobs. The list goes on and on.

HALCYON DAYS. When the Japanese compare this performance with Bill Clinton's stumbling start, America's credibility is eroded in their eyes. All this has contributed to the new power equation that is emerging between the U.S. and Japan. "I'm not sure the U.S. has any idea how much our leverage with Japan has diminished," says James C. Abegglen, a veteran consultant based in Tokyo and the author of several books on Japan. "Our line of credit is about to close."

That doesn't presage a rogue Japan, nor does it suggest that its companies will run rampant across the globe. Nor does the new power balance mean that Japan is completely turning its back on the U.S. Tokyo remains painfully aware of its lack of friends and of its need to sow seeds of international goodwill. Even as it seeks greater maneuvering room, it will attempt to maintain relations with America.

But that does not diminish the need for America to seriously rethink its way of dealing with Japan. Traditional trade policy won't work in curbing Japan's $50 billion surpluses with the U.S., particularly since the offshore push of Japan's top companies has turned them into global powerhouses. Retaliation of the sort long threatened has too many boomerang effects. Tariffs, the primary weapon, can be effective only in a handful of cases, and they cannot wipe out the deeper competitive imbalances. In short, Japan has now become too sophisticated and too confident to be shaped by the blunt trade instruments of a bygone era.

What then must be done? The influential school of Japan-watchers called revisionists, whom BUSINESS WEEK first identified in 1989, were successful in changing the world's perception of Japan. Such experts as Chalmers A. Johnson, Clyde V. Prestowitz, Karel Van Wolferen, and others argued that Japan operates according to different rules and that change in Japan is not tantamount to Westernization. That analysis clearly has impressed the Clinton Administration. But the revisionists have never agreed on the best way to respond to the Japan that they portrayed.

What's needed now is another conceptual leap--call it Revisionism II--toward tackling the West's competitive imbalances with Japan. A broader strategy is needed in Washington, one that will recognize exports as the engine of growth and that will give U.S. companies better footing in Japan. That means not only lower trade barriers but also stronger and better coordinated export-promotion programs, new incentives for investment in Japan, and continued reform of antitrust laws at home. This more systematic array of policy instruments should extend the battle from the negotiating table to the competitive trenches, where it is most needed.

RIGHT DIRECTION. There are some hopeful signs. Although the Administration's demands for numerical targets for measuring market-cracking progess is currently winning the most attention, the Clinton Administration is not putting all its eggs in that basket. "They're proceeding along the line they committed to in the campaign," says George M.C. Fisher, CEO at Motorola Inc. and chairman of the nonpartisan Council on Competitiveness.

Fisher notes the Administration's moves to bolster funding of the National Science Foundation, to reorient government laboratory work toward more commercial applications, and to improve education and training. President Clinton has also sent important signals to Detroit's Big Three auto makers, sitting with them to discuss ways of building the "clean car" of the future.

That kind of government-business cooperation would have been unthinkable in the Reagan or Bush eras. "This Administration hasn't dropped the ball," says Motorola's Fisher. "It's working in the right direction."

But there's an enormous distance to go. Clinton has inherited a "patchwork quilt of policies" toward Japan, says Mark Foster, a former Tokyo-based negotiator for the U.S. who now helps foreign companies enter Japan. The U.S. government needs to move more aggressively, he says, to encourage collaborative efforts among U.S. companies attempting to compete with Japanese rivals. And in addition to fixing Uncle Sam's export-promotion machine, the U.S. should ease cold war controls on high-tech products. Too much of Washington's bureaucracy is aimed at preventing U.S. exports, not encouraging them.

In some respects, the needed strategy toward Japan hinges on a new psychology and a new set of attitudes. The Americans, for example, have allowed adversarial relations between labor and business and between government and business to diminish their competitiveness against Japan. Chalmers Johnson, known as the godfather of revisionist thinkers, argues that what is necessary is "changing the American environment" to cope better with a Japan that is "stonewalling" on the trade front.

NOT INTERESTED? One important lesson is that government alone doesn't have all the solutions. As Motorola and other successful foreign companies in Japan have shown, teaming up with Washington to play hardball against Japan can pay--but only when all the other ingredients are in place. Witness the Motorola/Washington victory in 1989 for entry into Japan's pocket-phone market. Fisher maintains that his company's unremitting devotion to quality, productivity, and cost-cutting was key. "We couldn't have gained access without competitive products," he says.

But in too many other cases, American trade negotiators have claimed victory, only to find that companies aren't truly interested or able to compete. In the early 1980s, Washington made baseball bats into a huge issue. But once Japan relented and allowed imports, U.S. companies barely responded. And despite the years Washington has spent battering on Japan's construction market, a surprising number of U.S. construction companies have not set up offices in Japan or established credentials to make bids. Coordination between private sector and public sector has been spotty at best.

NEW JOBS. Ultimately, the U.S. must come to grips with the economic dynamism of Asia and how it works to Japan's advantage. Competing with Japan means more than just doing battle in the U.S. and Japan. The U.S. also must tap much more aggressively into the wealth that Asia is generating. A handful of American companies, such as Intel, Hewlett-Packard, and Motorola, are doing so, but that isn't nearly enough. Rather than concentrating energy en tariffs, quotas, and import targets for Japan, Americans need new policies to encourage investment and trade with East Asia.

That means overcoming the notion that to invest offshore will necessarily mean losing U.S. jobs. Establishing a deeper U.S. presence in Asia should be perceived as locking into the biggest source of economic growth, guaranteeing a much brighter future for Americans back home. Indeed, many U.S. companies that invest overseas find that the increased profits create high-quality jobs at home.

The risk is that the Clintonites will stumble through the same cycle--making threats and then backing down--that have failed for many years. Japan's surpluses have totaled $445 billion with the U.S. over the past 10 years. Now, with the surplus headed still higher, it is time to reengineer the U.S. competitive model.

Making that argument does not mean taking sides with Foreign Ministry bureaucrats, who argue that the "fault" for competitive imbalances lies with North America. Rather, it's a pragmatic recognition of what works and what doesn't work with a Japan that is increasingly tempted--and able--to say "no."

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