Today's date:
Summer 1995

Trade War: Battle of Fools in a Borderless Economy

Kenichi Ohmae, formerly director of McKinsey & Co.'s Tokyo office, is Japan's leading management consultant. A recent candidate for the governor of Tokyo, Ohmae is the author of The End of the Nation State (Free Press, 1995), from which the second edition of this article is excerpted.

TOKYO - The trade negotiators have lost their cool. Japan has finally said "no" to the United States, prompting in turn the heaviest trade sanctions in American history.

If creating jobs in North America is the important issue, the politicians should just say so, because then there really would be no conflict with Japan. It is, after all, the Japanese auto plants located in North America and their affiliated auto components companies which have collectively created more jobs over the past decade than A indigenous American manufacturers put together. American politicians should be thanking the Japanese automakers, rather than slapping their face with sanctions.

I could understand a demand that Japan buy more American airplanes or agricultural products to correct the trade imbalance, but not auto components. Of Japan's $15 billion worth of auto component exports to the US, the Big Three American auto manufacturers buy a third, or $5 billion. If US Trade Representative Mickey Kantor wanted to reduce the trade deficit with Japan in a big way overnight, he could far more easily have told the Big Three to stop their use of Japanese auto parts.

If the overall imbalance is created by the purchases of the American automobile industry, why should Kantor demand that Japan buy more American auto components? Less clear is confining the sanction to Japanese luxury cars.

The US has a huge imbalance with the Middle East due to oil. Wouldn't it be strange to ask the Arab countries to buy American petrochemical products to equalize trade? In fact, the US sells weapons to them to balance that account.

No matter how much politicians want to play it as a showdown, consumers will probably pay little attention to it

A because they have not felt much impact from sanctions in the past. When Toshiba's laptop computers became a target of sanctions, some American companies bought the sanctioned models and sold them under their American brand name. Eventually Toshiba transferred laptop production to the US. TO date, Toshiba has kept its top market share in the US laptop computer market.

This time around, if the too percent surcharge on the likes of imported Lexus and Infiniti cars were to be charged, who would benefit? Not consumers and not the Big Three, but the Germans with their BMWs and Mercedes.

If sanctions do go into effect, over time Toyota, Honda and Nissan will all shift their production model mix in North America to minimize the effect. For example, they could quickly convert the Lexus or Legend into a complete knock-down produced in North America, while bringing back to Japan the production of some lower-priced Corollas and Civics. So long as there are customers who want the product, and dealers who want to sell the product, the location of production is of secondary importance.

As a global business consultant for two decades, I have not come across any sanctions that have resulted in really knocking a product out of a market. If nothing else works, then Japan always has the option of buying American companies by taking advantage of the currency exchange rate which heavily favors the yen over the dollar. If a Lee Iaccoca can buy Chrysler, so can a half-dozen automobile companies in Japan.

Japan and America ought to be celebrating their trading relationship. No two countries in the world are more interdependent. Statistics on bilateral trade compiled by the bureaucrats only make things look unbalanced because they don't account for the new shape of the world economy. US companies, for example, manufacture products in Canada, Mexico and Asia to sell to Japan. And they produce in Japan to sell to the Japanese. Sometimes they even send back home what they produce in Japan. Yet this shows up in trade statistics as an import from Japan, not an inter-company transfer.

The problem of bean-counters who have lost touch with the world economy is compounded in this instance by the fact that top trade officials in both Japan and the US are politically ambitious laymen. One is a lawyer whose mission is to represent the interests of his client (President Clinton, in this case), regardless of the issue. The other is a politician whose interest is to become the prime minister of Japan, sooner rather than later, with the backing of idiosyncratic bureaucrats and narrow-minded industries.

So let's not get carried away with the thrilling battle of the Goliaths. It is actually a battle of uninformed fools more akin to mud wrestling than serious people want to admit.

Let's not get the Europeans and others pulled down into the muddy contest in the W70 ring. This battle is not worth fighting. A battle better engaged is getting consumers and honest businessmen in both Japan and America to cast off statistical misapprehensions that blur our real common interests and only provide fodder for the politically ambitious.

In a borderless economy, any statistical regime that takes the nation state as its primary unit of analysis is-and must be-badly out of date. For well over a decade now, I have been arguing just this point in the context of the perennial squabbles between Japan and the United States on questions of trade and trade balances. On both sides, however, most officials and even most commentators remain perversely afflicted with trade blindness -an inability to see, let alone understand, in the broad daylight of media attention, the core facts about crossborder economic activity.

Position papers and headlines notwithstanding, the trade problem between Japan and the US is neither the American trade deficit nor the Japanese surplus. The reason is quite simple: The flows of activity measured by official trade statistics represent a tiny and steadily diminishing share of the economic linkages between the two countries. These data, remember, do not count the revenues from services, licenses, or intellectual property, or from goods manufactured by US firms in third countries but sold in Japan, or from goods both manufactured and sold in Japan by US firms. All they count is that relatively small universe of things physically produced in the US, crated, loaded onto ships or planes, passed through customs, and then uncrated and sold in Japan.

When a US software house sells its leading-edge program in Tokyo, the trade data capture little, if any, of the value added. When a US chip manufacturer sells its products in Osaka, the sales may count toward the 20 percent of the market earmarked for US firms, but -if the chips were, as is likely, actually produced in Malaysia-they will not show up in US export statistics. When a US sportswear company retails in Hokkaido garments sewn in Indonesia or Taiwan, the sales do not matter to those who count bilateral trade flows. When enough Japanese consumers see a US movie to generate, say, $200 million in box office revenues and, perhaps, $40 million in royalties, these figures show up in Japan's current account, but not in its trade statistics. But if the moviemaker "sold" each copy of the film to be shown in Japan for $1 Million, those monies would count as trade revenue.

As everyone should know by now, the official statistics that attract so much political attention are unreliable. I'm being polite: They are an out-and-out falsehood. They are not an accurate reflection of real flows of economic activity. They are not an accurate reflection of anything. Indeed, in the mid-1980s if you included in these official numbers all the sales in Japan of "American" (as consumers perceive them) goods and services, you would find that the Japanese bought- per capita -four times as much "American" stuff as Americans bought "Japanese" stuff. Since then, the ratio has only gotten larger.

Trade, however, is only the most visible of the areas in which official, nation-state-based statistics prove their worthlessness. The list is long and varied. Some countries, for example, classify life insurance as savings; in others, it is an expense. Some treat government-funded pensions as part of individual income; others, as a public liability. Some view mortgage investment income as consumption; others, as a form of savings. Some categorize devices like microwave ovens as white goods; others, as consumer electronics or even furniture. At even the simplest level, therefore, meaningful comparisons are hard to come by. Apples and oranges are not the problem. It's fruit salad.

These differences matter. In the mid-1980 s - in 1986, to take a particular example - the official Japanese domestic savings rate was 16.6 percent; the US rate was 4.3 percent. The result: loud and acrimonious debate between the two countries, with the US calling on Japan to boost domestic consumption and Japan insisting that the US get its own fiscal house in order by reducing wasteful, deficit-financed consumption. These charges and countercharges continue to fly. Neither then nor now, however, do they bear much relation to the underlying facts: The savings rate in both countries is pretty much the same.

Japanese data on savings, like those for most other countries, are based on a System of National Accounts (SNA) advocated by the United Nations. By contrast, the US data are based on National Income and Product Accounts (NIPA), which are administered by the Department of Commerce. Converting from NIPA to SNA would boost the 1986 US savings rate from 4.3 percent to 6.8 percent. This is a substantial jump, to be sure, but still far less than Japan's 16.6 percent. If you also removed the other structural inconsistencies between SNA and NIPA - the differing treatments of government social insurance, for example, which SNA views as personal savings and MIRA as government savings-the 6.8 percent figure would rise further to 10.9 percent. And much of the remaining 5.7 percentage point gap (16.6 percent vs. 10.9 percent) would disappear if you corrected for essentially social differences between the two countries.

In the US, for example, if you buy a house for $200,000 and invest the same amount again in renovation, the government counts the first number as savings and the second as consumption. When you sell the house, of course, you hope to get at least $400,000 for it, which effectively equates overall resale value with savings. In Japan, however, where renovations are usually not appreciated by later buyers and only land is treated as having real value, the equivalent of $200,000 spent on fixing things up truly is consumption.

There are still other adjustments to be made. Americans tend to buy on credit; the Japanese, given low resale values, "save to buy." Adding savings to consumer credit in both countries gives roughly the same number: 29 percent of disposable income. The only difference is the timing of payment. The Japanese buy later, thus showing more money in the bank at present; Americans buy now and pay later, thus borrowing from the future. Moreover, for major purchases like homes, Japanese banks require a much larger down payment than their US counterparts. If, in addition to the other adjustments noted above, Japan's banks were to reduce their requirements to the low end of the US spectrum - say, 10 percent or so of the down payment - virtually all of the statistical "savings gap" between the two countries would disappear. The numbers everyone knows and everyone uses are simply untrue.

So, it is not culture that produces the huge statistical differences between the Americans and the Japanese. It is the differences in their systems- taxation, say, or banking on the statistical treatment of things like pensions-that collectively make the two peoples behave very differently. Certainly, the Japanese are not by nature more hardworking or more inclined to save than the Americans. The crucial point, of course, is that if these systems were changed, both would behave pretty much the same.

The evidence, then, is as exhaustive as it is uncomfortable: In a borderless economy, the nation-focused maps we typically use to make sense of economic activity are woefully misleading. We must, managers and policymakers alike, face up at last to the awkward and uncomfortable truth: The old cartography no longer works. It has become no more than an illusion.

©Kenichi Ohmae

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