Is Japan really ready for free trade?

The U.S. trade deficit with Japan has increased steadily over the past four years, reaching $79.9 billion in 2012, an increase of $13.4 billion (20.2 percent) over the 2011 bilateral deficit of $66.5 billion. Two of the most important causes of persistent U.S.-Japan trade deficits are currency manipulation and Japan’s vast and impenetrable network of non-tariff trade barriers. Last month, the United States and Japan agreed on language that could allow Japan to join negotiations to enter the Trans-Pacific Partnership (TPP), a proposed free trade agreement with 10 other Asia-Pacific countries (a new round of negotiations on the TPP began in Singapore last week ). Unless Japan is willing to end its currency manipulation and informal trade barriers once and for all, it should not even be allowed to participate in the TPP negotiations.

The effect of trade flows on U.S. jobs is relatively straightforward: exports support U.S. jobs but the larger volume of imports displaces even more jobs. Trade deficits such as the one we have with Japan have cost the United States millions of jobs, most of them high-paying jobs in manufacturing. Signing trade deals is an ineffective way to create jobs, in large part because they usually result in higher trade deficits. Further, trade deals have traditionally not included effective means to deal with one of the biggest causes of our trade deficits: currency manipulation by our trading partners, which acts as an artificial subsidy to other countries’ exports, and a tax on U.S. exports. Japan has a history of currency manipulation, and recently-elected Prime Minister Shinzo Abe campaigned on his intention to stimulate the Japanese economy, in part by weakening the yen. Financial markets have responded to Mr. Abe’s wishes, and the yen has declined 18.8% since October, falling to 96 yen per dollar on March 12, 2013.1

Motor vehicles and parts alone were responsible for 64.0% of the bilateral trade deficit in 2012, reflecting persistently high trade barriers in Japan’s auto market. Evidence of these barriers is that U.S. auto imports exceeded exports by more than 28 to 1, as shown on the dashed line in this chart:

U.S. exports of autos and parts fell from a mere $2.7 billion in 2000 to an even lower $1.7 billion in 2012, a reflection of the near-complete closure of Japan’s motor vehicle and parts markets to foreign competition. Historically, U.S. trade deficits in this industry have been responsible for 60% of more of the U.S. trade deficit with Japan in ten of the past twelve years. In most market segments, Japanese auto and parts companies seem essentially unwilling to purchase from U.S. suppliers, at any price.

One of the most remarkable facts about Japan’s auto and parts market is that Japan maintains zero tariffs on autos. However, Japan does maintain a discriminatory system of taxes that makes it more expensive to purchase imported autos. In addition, Japan maintains costly and burdensome vehicle certification procedures. It also has a complex and changing set of safety, noise and pollution standards that make it extremely costly for foreign automakers to develop and market vehicles for the Japanese market.

The Japanese government has repeatedly promised to tear down these barriers in sector specific negotiations dating back to the 1980s. These include the Market-Oriented Sector-Selective talks in 1986, the Structural Impediment Initiative Agreement of 1990, and the 1995 U.S.-Japan Auto Agreement. Despite all of these initiatives, the Japanese auto market remains essentially closed to U.S. vehicles and parts.

Overall, Japan remains one of the most closed markets to U.S. exports despite more than twenty years of trade negotiations and market opening initiatives designed to end Japan’s unfair trade practices. Informal business practices, as typified by the interlocking relationships between banks and corporations in the Japanese Keiretsu system, serve as an impenetrable barrier to foreign imports in many markets, no matter how competitive foreign goods or suppliers may be. Highly imbalanced trade is the natural result of this system.

Given the extensive history of failed trade negotiations, and Japan’s history of currency manipulation and beggar-thy-neighbor policies, there is no justification for inviting Japan to join the Trans-Pacific Partnership negotiations. Given that the invitation has already been issued, the U.S. must ensure that currency manipulation is prohibited in the core text of the TPP agreement. Currency manipulation should be defined as government purchases of foreign assets (either directly or indirectly, through intermediaries) that suppress or depress that country’s currency, and result in substantial, sustained global trade surpluses. The agreement should include a snap-back provision that suspends all benefits of membership in the TPP to currency manipulators until intervention is terminated and trade balance is restored. The U.S. needs to end currency manipulation now, and any new FTA should include strong language that prohibits currency manipulation by member countries.


1. It is important to note that official holding of foreign exchange reserves by the Bank of Japan declined by about 2.5% ($31 billion) in 2012. However, additional research is required on the role played by other government investment funds in foreign exchange markets (e.g. pension funds and other forms of sovereign wealth).