Wider implications of a trade row

The trade tensions between the US and Japan were ratcheted up a couple of notches at the weekend by the decision of the US to set in motion trade sanctions designed to open the Japanese market to imports of telecommunications and medical kit. Japan now has 60 days to respond or it will face higher tariffs on selected exports to the US.

The impact on the financial markets was, predictably, to push the yen up a little further against the dollar and Japanese share prices down. Much of the commentary has been in terms of the political implications for the world trading system. This is understandable - most discussion of US-Japan trade tensions focuses on either the market implications or the political ones.

But it is worth casting an eye beyond both of these - to the impact on world trading patterns, in particular the refocusing of Japan's trade away from the US and the more general shift in world trade away from physical transport of goods altogether.

The first point can be quickly made. From a strategic point of view, Japan is unusual in two ways.

She exports a small proportion of her output - around 9 per cent, compared with about 18 per cent for the UK and France and 25 per cent for Germany. And she is unusually dependent on a single market. A third of her exports go to the US.

Britain's largest market, Germany, takes only 14 per cent of our exports while only 13 per cent of Germany's go to her largest market, France.

This is obviously an unsatisfactory situation. In so far as Japan is able to think in a strategic way about trade relations, it would be in her interest to switch exports to other markets. This is precisely what is happening, with exports to the rest of East Asia rising rapidly. In a curious way US trade retaliation against Japan is helping to push the country along the path of diversification of export markets - which she should be doing, anyway.

The second effect is that any restriction of trade in goods - or threat of such restriction - encourages local production. The way Japan's motor and electronics industries have built factories abroad, particularly in Britain and the US, is an obvious manifestation of this trend.

But, while such foreign investment has attracted much attention, the impact on the pattern of international trade has not. How many people know that invisible trade - trade in services, plus transfers, plus income from profits, interest and dividends - was last year 40.5 per cent of total world trade, up from 34.6 per cent in 1984, and is growing at one-and-a-half times the rate of growth for physical trade?

On present trends invisible trade would overtake visible trade around the year 2010. In fact it may well occur earlier, for this growth is taking place despite greater restrictions on trade in services than in goods.

As service trade becomes progressively liberalised, expect its growth to proceed at an even faster pace. And, although this particular dispute may be settled in some way or other before retaliation takes place, each such threat further hastens the build-up of local production and hence the shift from physical trade flows towards the financial flows associated with localised production.

The resistance in Japan to foreign imports is having a less useful impact on its industrial structure. Because the yen is being forced ever higher by the large Japanese current account surplus, inability or unwillingness to import is forcing a more rapid de-industrialisation in Japan than the country would like. Production is being shifted abroad too fast, and manufacturing being pared back too quickly, for the service industries to take up the slack.

That Japan has to de-industrialise is not in dispute. The process is already taking place. From a Japanese perspective the issue is more how to enable the rundown to take place in an orderly manner. Japanese leaders feel they must play for time. The trouble is that so doing risks provoking even quicker deindustrialisation by over-valuation of the yen. Playing for time may give Japan less time.

The things to look for during the next 60 days will not so much be the detail of the discussion between the two countries. Rather it will be the extent to which foreign products are allowed to penetrate the Japanese market at a retail level.

There is a good example of movement at the moment. As we reported yesterday, Japan's unusually hot summeris leading to a surge in beer-drinking. In previous years foreign beers have sold at premium prices, allowing fat profits for domestic brewers.

But the surge in the yen has given a large cost advantage to imports.

Result: a surge in imported (mostly Belgian) beer. This is much more telling of Japanese attitudes than the 'objective criteria' sought by the US trade negotiators.