The U.S.-Japan economic relationship remains key under Trump

As Donald Trump prepares to assume office as the forty-fifth president of the United States on January 20, 2017, he will inherit an economic relationship between the U.S. and Japan that is as strong and intertwined as it has ever been. The two countries are not only important trading and investment partners, but the two governments also share the same goals for global development and for a rules-based trading system, and recognize the need for more vigorous policymaking to combat the threat of secular stagnation in the G7. Indeed, largely as a result of these shared interests, the two governments were able to conclude what amounted to a U.S.-Japan free trade agreement as part of the negotiations for the Trans-Pacific Partnership (TPP), overcoming disputes over sensitive issues like market access for agriculture and automobiles. Notwithstanding TPP’s fading chances of coming into force—the president-elect has said he will withdraw from the pact upon taking office—the ability of Washington and Tokyo to forge an agreement illustrates the extent to which they have put the days of “Japan bashing” and “Japan passing” behind them.

The challenge for the new administration is to preserve and deepen this partnership. On the one hand, the president-elect regularly singled out Japan along with China for criticism on the campaign trail, branding it a currency manipulator and accusing it of taking advantage of U.S. security guarantees to outcompete U.S. producers. On the other hand, since his victory, Trump has criticized China’s trade practices but appears willing to build a personal relationship with Japanese Prime Minister Shinzo Abe, who was the first foreign leader to meet with the president-elect after his victory and could be one of the first leaders to meet with him after his inauguration. Members of the president-elect’s transition team, meanwhile, have reportedly suggested to Japanese officials that they should not take everything Candidate Trump said as indicative of what President Trump will do. The designation of Wilbur Ross — who has served as chairman of the Japan Society of New York and in 2014 was awarded the Order of the Rising Sun, Second Class — as commerce secretary is another indication that the incoming administration may be more keen to preserve an economic partnership with Japan than the president-elect’s campaign rhetoric suggested.

It is too early to predict what the new administration will do once it takes office, since in many respects that will depend on those named to cabinet and sub-cabinet posts —and the influence those officials have on policy decisions. However, as the transition process unfolds, the Trump administration may present the Abe administration with opportunities for closer engagement with the U.S. but also perhaps difficult choices that could have significant effects on the U.S.-Japan relationship.

Trade

The biggest near-term question in the U.S.-Japan economic relationship is what happens in the event that Trump follows through on his promise to pull the U.S. out of TPP. There is no formal obstacle to prevent the president-elect from doing so “on day one,” as he has promised, although Japan and other TPP countries—as well as the many Republican and a smaller number of Democratic TPP supporters in the U.S. Congress—may still be trying to convince the president-elect to change his mind regarding the agreement.

But failing that, both Washington and Tokyo will have to decide whether they can salvage anything from TPP’s demise. Senator Orrin Hatch (R-UT), chairman of the Senate Finance Committee that has jurisdiction over trade policy, has suggested that the U.S. and Japan could carve a bilateral free trade agreement (FTA) out of their TPP negotiations, which could satisfy Trump’s desire to focus on bilateral FTAs while also offering a boost for both economies.

However, the transition team itself has not responded to Hatch’s proposal and the Japanese government has reacted coolly. Deputy Chief Cabinet Secretary Koichi Hagiuda, for example, said on November 23 that Japan would “probably not find it easy” to enter FTA talks with the U.S. It is not altogether surprising that the Abe administration continues to prefer TPP to any alternative, since it believes in TPP both as a vehicle for deepening U.S. engagement in Asia and for promoting structural reform domestically. Given the intricate supply chains of Japanese manufacturers, which extend throughout Asia’s emerging markets, and the existing openness of American markets, an agreement that includes those countries will likely be more economically appealing than a bilateral FTA with the U.S.

But as Japan considers whether to intensify its commitment to regional agreements that exclude the U.S.—whether a modified TPP that can come into force without the U.S. or the Regional Comprehensive Economic Partnership (RCEP) being negotiated by the ten countries of the Association of Southeast Asian Nations (ASEAN), Japan, China, South Korea, India, Australia, and New Zealand—Tokyo will have to consider how the U.S. would react to Japan’s participation in a regional trade bloc that excluded the U.S., especially if it joined RCEP, in which China would be the dominant economy.

Meanwhile, thanks to their supply chains, Japanese companies could also be exposed to other dimensions of the new administration’s trade policy. For example, thanks to the North American Free Trade Agreement (NAFTA) and Japan’s own economic partnership agreement (EPA) with Mexico, Japanese producers—especially automakers—have moved facilities to Mexico as a platform for exporting to the U.S. and overcome the diversionary effects of NAFTA on Japanese competitiveness. Japanese producers could therefore be vulnerable were the Trump administration to act on the president-elect’s hostility to NAFTA. According to a transition memo, the new administration will not necessarily withdraw from the agreement, though it may be prepared to threaten withdrawal to convince Canada and Mexico to accept amendments to the agreement. Given the extent to which China is integrated in Japanese supply chains, Japanese producers would also be vulnerable if the new administration imposed punitive tariffs on Chinese imports to punish China for currency manipulation and other practices like export subsidies and technology theft and intellectual property piracy that critics argue have given Chinese producers an edge over American competitors.

The reality is that Japan and Japanese companies have benefited greatly from the global trading system, and could suffer if the Trump administration significantly changes the conditions for access to the U.S. market. Moreover, broader U.S.-Japan ties could suffer from the advance of regional trade agreements that exclude the U.S.

Investment

That said, as Japanese manufacturers have shifted facilities abroad, the U.S. has been a major recipient of Japanese foreign direct investment (FDI). Since 2014, Japan’s FDI stock in the U.S. has been second only to the United Kingdom, and leading Japanese firms have continued to make high-profile investments throughout the U.S., with a particularly strong commitment to investment in the U.S. south but also in western states and the “Rust Belt” states in the Midwest, including Indiana, home of Vice President-elect Michael Pence, who as governor touted Japanese investment in his state.

Japanese automakers in particular have made significant investments throughout the U.S. and, according to the Japan Automobile Manufacturers Association (JAMA), 75% of Japanese automobiles sold in the U.S. are now manufactured in North America. A study by Rutgers economist Thomas Prusa, commissioned by JAMA, notes that Japanese automakers directly employ 88,000 Americans and another 375,000 through their dealer networks. When suppliers and “spin-off” jobs are included, Prusa estimates that Japanese automakers support more than 1.5 million workers, an increase of 17% since 2011.

Trump’s December 6 meeting with Masayoshi Son, founder and CEO of Japanese telecommunications company SoftBank, may provide some evidence on how the new administration will view Japanese FDI. Trump’s enthusiastic response to Son’s announcement that the $100 billion SoftBank Vision Fund — which he recently established with Saudi Arabia — will invest as much as $50 billion in the U.S. and create as many as 50,000 jobs suggests that the new administration will continue to welcome Japanese investment in the U.S. The fund may have been prepared to make investments in the U.S. anyway (as portfolio investments, not FDI), and the market reaction to the meeting—both SoftBank-controlled Sprint and rival telecom T-Mobile, which Sprint tried to purchase but was blocked on antitrust grounds, rallied—suggests that investors saw the meeting largely as an attempt to win the president-elect’s support for the blocked merger. But Son’s motivations matter less than Trump’s reaction, which suggests that despite his campaign rhetoric about Japan’s trading practices he views Japanese investment in the U.S. favorably. Ross’s appointment as commerce secretary may also be an encouraging sign of how the new administration will view Japanese investment, since Ross’s portfolio will include the SelectUSA program to attract FDI. While neither country has floated a bilateral investment treaty (BIT)—which the investment chapters of TPP would have effectively provided—a U.S.-Japan BIT may be a worthwhile first step to strengthen the economic relationship post-TPP.

Growth and exchange rates

Trump’s victory may boost Abe and Abenomics by giving the prime minister an ally in his attempt to boost global growth. During his presidency of the G7 in early 2016, Abe tried to forge a global consensus in favor of a multi-stage growth strategy of monetary easing, fiscal stimulus, and structural reform; in other words, “global Abenomics.” Although he won the support of Canada and Italy for an approach that included fiscal stimulus, his initiative foundered because of gridlock in the U.S.—the Obama administration could offer little more than rhetorical support—and opposition from Germany, France, and the UK. Trump’s victory and unified Republican control mean that the U.S. could embrace tax cuts, deregulation and possibly infrastructure spending despite the party’s concern over America’s large and growing debt, although without monetary easing since the Federal Reserve could increase the pace of interest rate hikes to avert overheating if fiscal stimulus is implemented.

The prospect that the Trump administration will introduce fiscal stimulus while the Fed raises rates has solved what has been the most significant source of tension between Washington and Tokyo in 2016: the yen’s appreciation against the dollar and other currencies. Japanese officials repeatedly threatened to intervene in foreign exchange markets while the yen strengthened from nearly ¥125 to $1 in June 2015 to just over ¥100 to $1 on the eve of the U.S. election, prompting multiple warnings from Treasury Secretary Jacob Lew and other U.S. officials about the risks of intervention. When news of Trump’s upset victory emerged on the afternoon of November 9 in Japan, it seemed as if Japan might finally intervene to weaken its currency for the first time since 2011; as the Nikkei 225 index plummeted and the yen rallied, officials from the finance ministry, Bank of Japan (BOJ), and Financial Services Agency (FSA) convened an emergency meeting to discuss how to cope with market turmoil, but no such intervention took place.

A month later, it appears as if Trump has inadvertently solved the yen’s difficulties. The Nikkei immediately recovered and is now the highest it has been since January 2016, and the yen has lost nearly 9% against the U.S. dollar, providing a boost to exporters who had seen their profits fall as the yen rose. The weaker yen, largely a by-product of market expectations of fiscal stimulus and rising interest rates under the Trump administration that have led the dollar to strengthen against both developed and emerging market currencies, removes a potential irritant from the U.S.-Japan economic relationship as the U.S. transitions to a new administration (though an overly strong dollar could in time become an irritant of its own).

At the very least, the yen’s reversal may come at a fortuitous moment for the Abe administration, which is ramping up pressure on employers—especially major exporters in the manufacturing sector—to raise wages in 2017 wage negotiations that will begin in January, essential if incomes and consumption are to rise. Leading employers have been skeptical about raising wages due to the impact of the stronger yen and global uncertainty on their profits, but if the weaker yen and the “Trump rally” improve the growth outlook it could also improve the outlook for wage increases.

If the yen remains weaker, it would enable Japanese policymakers to avoid having to consider intervention and other policies to depreciate the yen that would bring Tokyo into direct conflict with the Trump administration. Whereas Trump has promised to brand China a currency manipulator in the Treasury Department’s next report on the exchange rate practices of major trading partners, Japan has not been the subject of a specific threat. The most recent report, issued in October 2016, included Japan along with China, South Korea, Taiwan, Germany, and Switzerland on a monitoring list of countries that meet two of three criteria: a significant bilateral trade surplus, a material current account surplus, and one-sided foreign exchange intervention. Countries judged to have all three would be referred for “enhanced analysis” that could also result in bilateral engagement to rectify the issue. Japan may escape scrutiny, particularly if the new administration makes security cooperation with Japan a priority. However, if the two countries were to embark on bilateral FTA negotiations, the Trump administration could insist on currency manipulation provisions, which could add to Japan’s reluctance to pursue a bilateral FTA.

Conclusion

Although the failure of TPP will be a missed opportunity for deeper integration between the U.S. and Japanese economies, the two countries will remain important economic partners under the new administration. Trade and investment flows will undoubtedly remain robust, providing a foundation for an enduring partnership to shape Asia and the global economy. But much will depend on the Trump administration’s willingness to work with Japan and other major partners to devise rules and institutions that ensure the survival of an open trading system that creates prosperity for all.