March 27, 2008
HP-892

Under Secretary McCormick Remarks to the Japan Society

New York − I'd like to thank the Japan Society for inviting me to speak here today. The Japan Society recently celebrated its 100th anniversary, and over the past century the Society's efforts have contributed greatly to making the U.S.-Japan relationship one of the strongest – and most important – bilateral relationships we have.

As this group knows well, the U.S.-Japan alliance is the bedrock of economic stability and prosperity in Asia. The economic success of the Asia Pacific region owes much to the open trading regime promoted by the United States and Japan. There is no doubt that this relationship has had its moments of tension over the past 60 years, but through the strength of our mutual interests and our shared values, it has grown, flourished and matured.

While this economic relationship is exceptionally strong and successful, it also is clear that it has not achieved its full potential in many ways. Given the size of our two economies, for example, we have failed to achieve the full benefits of economic integration through bilateral trade and investment. Likewise, despite our many mutual interests around the world, we have not fully leveraged the strength of our alliance to confront common challenges and opportunities on crucial issues such as global trade, energy and the environment, or investment liberalization.

With this context, my argument today is a simple one: in this time of dramatic global economic change – a period marked by factors including the rapid growth of emerging economies, the rise of protectionism, and global financial market turmoil and uncertainty – U.S.-Japan cooperation on the international stage is more important than ever. Japan and the United States must work together on a focused agenda for addressing these common challenges and opportunities. Today, I'd like to suggest some critical components of the common U.S.-Japan agenda.

To get a sense of how much the challenges confronting Japan and the United States have changed – one needs only to go back a single generation. In the early 1980s, the U.S. and Japanese economies overwhelmingly dominated the Asia-Pacific region, accounting for 84% of the area's GDP. Economic issues were synonymous with trade issues – steel, autos, and semiconductors dominated U.S.-Japan economic discussion. The Asian tigers – Korea, Taiwan, Hong Kong, and Singapore – were growing rapidly but still relatively small. China was just beginning its turn towards a market economy.

Today, the emerging markets of Asia – China in particular – are far larger in the region and the world. The U.S. and Japan share of Asia-Pacific GDP has fallen to 75 percent. We should be absolutely clear: the rapid growth of Asian economies is a validation of the open global economic system that the United States and Japan fostered. Their growth has enhanced our prosperity. But it has also altered the world that we operate in and the many challenges that we face.

The US-Japan economic relationship has also changed over this period. A quarter-century ago, Japan was America's top economic challenger and the face of the globalization threat for U.S. workers. Ironically, just as American fear of the Japanese challenge became most intense, the bursting of an equity and property market bubble launched Japan into a period of sluggish growth, financial crisis, and deflation. The Japanese now refer to this as the "lost decade." U.S. worry about Japanese economic weakness and its effect on the global economy after the Asian financial crisis displaced worry about Japan's strength. And lectures about macroeconomic policy supplemented U.S. demands for market opening.

This Administration has recognized Japan as an indispensible ally in Asia and introduced a quiet, less strident and more respectful dialogue across all dimensions of the relationship. We understood that solving financial sector problems and deflation were key to restoring the vibrancy of Japan's economy. And, restoring a vibrant economy was essential if Japan was to play a confident, leading role on the world stage.

Economic and financial sector reforms have restored health to Japan's banking sector and Japan is now in its longest postwar economic recovery. But deflation remains surprisingly stubborn and domestic demand – particularly consumer spending – has been weak. Despite years of structural reform, Japan still relies heavily on foreign demand and lacks the domestic vibrancy to stimulate growth. For these reasons, Japan should continue with comprehensive reforms to spur competition and raise Japan's long-term growth. There are some encouraging signs, including the government's financial sector reform plans and its recent creation of a blue-ribbon panel to consider how the Japanese economy should evolve over the next quarter century. But it is fair to say - as many of my friends in Japan would acknowledge – that beyond discussion, more action must be taken faster.

Our joint focus on the bilateral relationship has sometimes come at the expense of our two countries presenting a common and forceful front on issues of international significance. Yet, in many areas of international policy, a strong US-Japan partnership is critical and necessary for success. There are several particularly important and timely areas for cooperation.

Maintaining open trade and investment is perhaps the most important common global challenge we face. Although trade liberalization and increasing openness to capital flows and investment have been fundamental to our two countries' growth and prosperity, they are now under increasing challenge. The Doha Round of trade negotiations presents a significant opportunity to create new trade in agriculture, industrial goods, and services. It is important that Japan play a leading role, along with the United States, in bringing Doha to a successful conclusion. In addition, Japanese leadership is critical to achieving ambitious trade liberalization in the Asia-Pacific region through a Free Trade Area of the Asia-Pacific.

Openness to investment is as important as openness to trade. The United States has benefited greatly from the free flow of capital. Cumulative foreign direct investment in the United States now exceeds 28 percent of GDP. International investment in the United States fuels U.S. economic prosperity by creating well-paid jobs, importing new technology, and providing healthy competition that fosters innovation, productivity gains, lower prices, and greater variety for consumers. Over 10 million Americans – 9.2 percent of the U.S. private sector – are employed, directly or indirectly, by the U.S. operations of foreign-owned firms.

Like the United States, Japan has been the beneficiary of inward foreign portfolio investment and the ability of its firms to invest overseas. In contrast, however, foreign direct investment flows into Japan have averaged just 0.1 percent of GDP over the past ten years, and the Ministry of Finance estimates the stock of foreign direct investment at just 3.0 percent of GDP, among the lowest in the OECD. The Fukuda government has ambitiously pledged to double incoming foreign direct investment by 2010. This would spur an increase in productivity and domestic demand growth.

The most immediate challenge to maintaining open investment regimes comes from the rapid growth and increasing importance of state-owned sovereign wealth funds as international investors. Sovereign wealth funds can bring many benefits, by boosting funds available for investment, and by being patient, long run investors. Sovereign wealth funds, as public sector entities, should have both an interest in and a responsibility for financial market stability.

At the same time, rising investment by state-owned wealth funds could provoke a new wave of investment protectionism, which would be very harmful to the global economy. Protectionist sentiment could be partially based on a lack of information and understanding of the objectives of sovereign wealth funds. It could be done in part due to limited transparency and spotty communication on the part of the funds themselves. Better information and understanding on both sides of the investment relationship are needed.

To maintain open investment regimes and ensure that the world continues to benefit from investment by sovereign wealth funds, we have proposed the development of a multilateral framework for best practices. The International Monetary Fund should develop best practices for sovereign wealth funds, building on existing best practices for foreign exchange reserve management. These would provide guidance to new funds on how to structure themselves, reduce any potential systemic risk, and demonstrate they are responsible, constructive market participants.

We have also proposed that the Organization for Economic Co-operation and Development (OECD) identify best practices for countries that receive foreign government-controlled investment. These should have a focus on avoiding protectionism and should be guided by the well-established principles embraced by the OECD and its members for the treatment of foreign investment. Japan has been, and should continue to be, an important ally in the development and adoption of best practices for sovereign wealth funds and for the recipients of sovereign wealth fund investment.

A more obvious cause of protectionist backlash against open trade and globalization is rigid exchange rate policies in surplus countries, particularly China. The U.S. and Japan both recognize the value of maintaining floating exchange rates. We have found common ground with Japan in the G7, which in February 2008 welcomed China's decision to increase the flexibility of its currency, but also encouraged accelerated appreciation of China's effective exchange rate.

RMB exchange rate policy is a multilateral issue, and Japan and others in the G7 have highlighted the importance of RMB appreciation for the global economy. Japanese Finance Minister Nukaga has also called publicly for China to accelerate the appreciation of the RMB. And, Japan has established a ministerial "High Level Economic Dialogue" with China, which covers pressing economic issues, including the protection of intellectual property, food and product safety, and currency flexibility.

Japan's engagement with China on currency is particularly useful. Chinese academics and government officials frequently suggest that China won't move faster on currency because they do not want to repeat Japan's experience with deflation and sluggish growth following the appreciation of the yen in the mid-1980s. For this reason, Japan's willingness to engage in a full and frank discussion has helped encourage China's progress on currency reform. In addition, Japan's full support for vigorous implementation of the IMF's new exchange rate surveillance mechanism would encourage China's progress toward a fully market-determined currency.

An additional prerequisite to achieving sustainable global growth is facing the high costs of energy demand and the associated environmental challenges. Climate change is a global challenge that requires global solutions. Our and Japan's strategies reflect this reality. In this area, we share common commitment and capabilities for developing and promoting cutting edge clean technology. We also share a common commitment to play leading roles in the Major Economies process launched by President Bush in September of last year and in working towards a successful conclusion to the Bali roadmap that was agreed to last December. Japan's leadership in the upcoming G8 will be crucial to pushing this important agenda forward.

In addition, the U.S. and Japan, together with the UK, have agreed on one part of the solution for addressing climate change through the creation of a fund to accelerate deployment of clean technologies in the developing world. Our three countries are working with the World Bank to launch a multibillion-dollar multilateral trust fund, to help fund deployment of clean technology to reduce greenhouse gas emissions in major emerging economies.

The fund would support national policies that use market forces to encourage the adoption of clean technologies, and help finance the cost difference between clean and dirty technologies. President Bush will be seeking authorization for a U.S. contribution of $2 billion over three years to this "Clean Technology Fund". Japan announced its support for the Fund in January. This, too, will be a crucial part of the agenda at the upcoming G8.

Ladies and Gentlemen, as I hope my remarks have made clear, the U.S.-Japan bilateral relationship is robust. It is important. And, it offers enormous unrealized potential. A vibrant, confident Japan on the world stage is critical for addressing global challenges. Given our leading economic positions, the U.S. and Japan share a unique responsibility for maintaining and strengthening the global trade and financial system. Our committed, comprehensive, and energetic cooperation is critical for making this goal a reality.

Thank you for your attention today, and I welcome your questions.