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Tuesday, February 28, 2012

U.S.-Japan Economic Relations: Significance, Prospects, and Policy Options

William H. Cooper
Specialist in International Trade and Finance

Japan and the United States are the two largest economic powers. Together they account for over 30% of world domestic product, for a significant portion of international trade in goods and services, and for a major portion of international investment. This economic clout makes the United States and Japan potentially powerful actors in the world economy. Economic conditions in the United States and Japan have a significant impact on the rest of the world. Furthermore, the U.S.-Japan bilateral economic relationship can influence economic conditions in other countries.

The U.S.-Japan economic relationship is very strong and mutually advantageous. The two economies are highly integrated via trade in goods and services—they are large markets for each other’s exports and important sources of imports. More importantly, Japan and the United States are closely connected via capital flows. Japan is a major foreign source of financing of the U.S. national debt and will likely remain so for the foreseeable future, as the mounting U.S. debt needs to be financed and the stock of U.S. domestic savings remains insufficient to meet the demand. Japan is also a significant source of foreign private portfolio and direct investment in the United States, and the United States is the origin of much of the foreign investment in Japan.

The relative significance of Japan and the United States as each other’s economic partner has diminished with the rise of China as an economic power. For example, China has overtaken Japan and is the largest source of foreign financing of the U.S. national debt. In addition, U.S. economic ties with Canada, Mexico, and China have deepened, further eroding the direct relevance of Japan. Nevertheless, analyses of trade and other economic data suggest that the bilateral relationship remains important, and policy leaders of both countries face the challenge of how to manage it.

During the last decade policy leaders seem to have made a deliberate effort to drastically reduce the friction that prevailed in the economic relationship. On the one hand, this calmer environment has stabilized the bilateral relationship and permitted the two countries to focus their attention on other issues of mutual interest, such as national security. On the other hand, as some have argued, the friendlier environment masks serious problems that require more attention, such as continuing Japanese failure to resolve long-standing market access barriers to U.S. exports. Failure to resolve any of these outstanding issues could cause heightened friction between the two countries.

More generally, other issues regarding U.S.-Japan economic relations may emerge on the agenda of the 112th Congress. U.S. and Japanese leaders have several options on how to manage their relationship, including stronger reliance on the World Trade Organization; special bilateral negotiating frameworks and agreements; or a free trade agreement. On November 11, 2011, Prime Minister Noda announced at a press conference that he decided, after many consultations with potentially affected parties, that “[Japan would] enter into consultations toward participating in the TPP negotiations with the countries concerned on the occasion of the [November 12-13, 2011] APEC Economic Leaders meeting in Honolulu, Hawaii....” Japan’s participation in the TPP will likely be the focal point of U.S.-Japan economic discussion for the foreseeable future.

Date of Report: February 14, 2012
Number of Pages: 22
Order Number: RL32649
Price: $29.95

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