When I arrived in Washington in the fall of 1981 to serve as counselor to President Ronald Reagan's commerce secretary, the United States was more afraid of Japan than it had been since Pearl Harbor. The Japanese auto industry was preparing to have Detroit for lunch. Imports of gas-sipping Hondas and Toyotas were forcing America's Big Three automakers to close plants and lay off hundreds of thousands of workers. The American semiconductor industry, pioneered by Silicon Valley start-ups, was on the ropes: Japanese producers, supported by their government, took over half the market for the newest generation of computer chips. And all this was happening amid a crippling U.S. recession.
Japan's economic miracle was no accident: It came out of a careful program of subsidized investment in "strategic industries" -- steel, machinery, electronics, chemicals, autos, shipbuilding, and aircraft. Japanese leaders focused on exports to drive their economy, suppressing domestic consumption with taxes and limited consumer credit, while encouraging high savings and investment rates. They established world-class factories and emphasized Japanese-developed technology, while requiring foreign companies to hand over their own as a condition of market access. They prevented industrywide labor unions and kept the yen undervalued against the dollar, while protecting domestic industries with tariffs and trade barriers.
If this sounds familiar, it should. Japan's economic miracle became the template that other Asian tigers would follow in the decades to come: South Korea, Malaysia, Singapore, Taiwan, Thailand, and now, the biggest of them all, China. Which is why it's important to know the truth about how the United States, today facing a new Asian economic challenge, dealt with the last one -- not the myths we've told ourselves for the past 20 years about how our free market tactics defeated our Japanese rival.
For all its laissez-faire rhetoric, the Reagan administration fought fire with fire, responding to Japan's market-distorting industrial and trade policies with a firm hand. It quickly concluded a "voluntary export restraint" agreement under which Tokyo, threatened with protectionist congressional legislation, limited its auto exports to 1.68 million per year. In effect, this forced Japanese automakers to build transplant factories in the United States, somewhat stanching the loss of U.S.-based auto-production and manufacturing jobs. Washington also rescued the failing Harley-Davidson company by raising tariffs temporarily on certain high-end motorcycle imports and was even more aggressive in its support of the domestic semiconductor industry, initiating anti-dumping procedures and getting Tokyo to guarantee U.S. manufacturers 20 percent of the Japanese market.
Most important was the 1985 Plaza Accord under which Washington convinced Tokyo to revalue the yen to reduce the large U.S. trade deficit. Over the next few years, the yen rose against the dollar, and the tide of U.S. imports from Japan receded. The trade deficit fell from $55 billion in 1986 to $43 billion in 1991. Harley-Davidson and Silicon Valley came rushing back, and Detroit's automakers gained a new, if temporary, lease on life.
Somehow these successes from America's last great trade war have been forgotten -- blotted out by patriotic sloganeering ("American industry pulled up its socks to meet the Japanese challenge") and economic shibboleths ("Trade is always and everywhere a win-win proposition"). But wishful thinking won't help with China -- much less at such a volatile time in the global economy.
Like 1980s Japan, China today is pursuing an export-led growth strategy, suppressing domestic consumption, pushing savings, and guiding investment into strategic industries. It has a multitude of trade barriers, weak labor unions, and an undervalued currency. The U.S. trade deficit with China is now about $250 billion -- four times that with Japan. Despite its early welcome to foreign investors, Beijing is focused intensely on developing its own technology. More importantly, U.S. high-tech industries -- solar energy, computer chips, and fiber optics -- are increasingly being offshored to China. And Chinese commitments to strongly protect intellectual property are often honored more in their breach than in their execution. As one Chinese friend explained to me last year, "Now we have all the foreign dogs in the kennel, and we're going to beat the stuffing out of them."
But Washington has become so convinced it beat Japan with free market policies that it is not responding to Beijing at all as it did to Tokyo. Barack Obama's administration has filed only one WTO complaint since taking office and has steadfastly refused to label Beijing a currency manipulator -- though it clearly is. Washington has not even dared to think about voluntary export restraints and has had little success persuading Beijing to revalue the yuan. That's no surprise: The Chinese are convinced that the Plaza Accord led to Japan's collapse and have vowed to avoid the same mistake. As one high official of the People's Bank of China told me, "We're not going to be crazy like the Japanese."
The United States also has less leverage with China today than it did with Japan then. Washington needs China to deal with transnational threats like Iran, North Korea, and global warming, not to mention financing the mounting U.S. government debt. So Obama has been less able and less willing to act -- except, that is, when he is making inexplicable concessions. During his trip to China last November, for example, Obama pledged that the United States would assist Beijing in developing its own commercial jet, though aerospace technology is one of the few U.S. strategic industries that still exports to China.
But even smarter tactics might not be enough to regain lost ground. For though Reagan's aggressive policies were enough to stop the bleeding, they weren't enough to make the U.S. economy genuinely competitive again. Most U.S. producers never recovered what they lost in the 1980s. In fact, the question of just who beat whom in the last great trade war has no easy answer. Consider this: Japanese GDP growth from 1990 to 2000 -- Japan's so-called lost decade -- was just 0.2 percent less than America's when you account for increases in the U.S. population. And Japan comes out ahead on a per capita basis. Even with the battering it took, Japan's productivity growth outpaced that of U.S. workers in the 1990s.
As for that $55 billion trade deficit with Japan that so concerned Reagan in 1986? By 2006, it was $90 billion. Overall, the United States today is running a global trade deficit of roughly $600 billion.
The numbers aren't lying: It's time to realize that the United States never really beat Japan -- and it's unlikely to win against China without a new strategy. Chanting tired ideological mantras didn't save us in the 1980s. And it won't save us now.