4End of September.

- 28.5

-78.3

10 - 24.4

89.1

53.1

10 61.9

-7.0

- 14.4

10 -6.3

68.7

95.6

117.5

1 Jan-June, S.A.A.R.

Jan-June, year-over-year. Estimated 1994 figure.

Savings as percent of personal disposable income.

Public and private domestic fixed capital formation and inventory investment/nominal GNP.

7Jan-August average, N.S.A.

Jan-September cumulative, N.S.A.

Jan-August cumulative, S.A.

10 Jan-August cumulative, N.S.A.

1. General Policy Framework

In 1993, the Japanese economy, the world's second largest at more than $4 trillion, posted its lowest calendar year GDP growth since 1974, negative 0.2 percent for the year. Output declined slightly in 1994, the first time since the early 1970s. Japan is now recovering from the second longest economic slowdown in Japan's postwar history. Prior to the slowdown that began in 1991 and lasted through 1993, Japan had never experienced two consecutive years of less than 3 percent real growth. The surge in asset prices and high rates of capital investment and hiring in the late 1980's gave way, by 1991, to sharply slower growth, corporate restructuring, and balance sheet adjustment by businesses and consumers. Very low levels of utilization for existing capacity suggest that business investment will be a lagging factor in the current recovery.

Japan's 1993 external accounts posted record global trade and current account surpluses of $141 billion (BOP basis) and $131 billion, respectively. Sluggish domestic demand slowed growth in import volume, while exports, especially to other Asian markets, continued to grow steadily. Yen appreciation helped swell dollar-denominated surpluses in the short run through the so-called "J-curve effect." Over the longer run, yen appreciation since 1990, plus eventual recovery in domestic demand, is widely expected to contribute some downward adjustment in Japan's external imbalance.

In recent years, the Japanese government has used public spending to counter the overall negative contribution of private demand to domestic demand growth. Four fiscal stimulus packages between August 1992 and February 1994 injected a substantial amount of public works spending into the economy, some of which is still being disbursed in 1994.

In 1994 the Diet passed tax reform legislation that will extend FY 1994 income tax cuts totalling yen 5.5 trillion ($55 billion) through FY 1995. A "permanent" por

tion of the income tax cut (yen 3.5 trillion/$35 billion) will continue thereafter. The remaining "temporary" portion (yen 2 trillion/$20 billion) of the tax cut is currently scheduled to be dropped after 1996, but may be dropped at the end of 1995. To offset the tax cut, beginning in April 1997, the consumption tax (a value-added tax) is to be raised from the current rate of three percent to five percent. In addition, the government announced a new public works investment program totaling yen 630 trillion ($6.3 trillion) that will run from FY 1995 through FY 2004.

In order to ease credit conditions, the Bank of Japan lowered the Official Discount Rate (ODR) seven times between mid-1991 and September 1993, from 6.0 percent/ year to 1.75 percent, a record low. Nominal interest rates set new record lows during 1994; yet demand for funds, particularly for investment purposes, remained relatively weak, as shown by year-on-year declines in bank lending from mid-1994. The Bank of Japan continues to focus on the ODR as its primary policy adjustment tool, and, through its daily operations, on provision of funds in the money market for "fine tuning."

2. Exchange Rate Policy

The yen has appreciated against the dollar over the past year, moving above the 100/1 dollar level for the first time in the summer of 1994. On paper, Japan ended most foreign exchange controls in 1980. In practice, numerous controls remain on foreign exchange-related transactions and impede the provision of financial services by competitive foreign firms.

3. Structural Policies

The Japanese economy remains in transition. Structural change has been a market-driven response to domestic economic conditions and the changing global competitive environment. In the past decade, efforts at economic deregulation also contributed to change.

The Japanese government, which formerly directed considerable public and private resources to priority areas, has been gradually moving away from such industrial policy measures, partly in response to criticism of export-oriented policies. The government still has a direct role in promoting and organizing cooperation among Japanese high technology firms, using off-budget resources and small amounts of appropriated funds to contribute to investment projects and government-private sec

tor efforts.

From 1989 to 1992, United States-Japan structural economic issues were handled under the Structural Impediments Initiative (SII). SII targeted structural problems in both countries that impeded reduction of foreign payments imbalances. Under SII Japan agreed to liberalize elements of its distribution system, liberalize its foreign direct investment regime, improve disclosure rules governing transactions among related companies (in order to help make business practices more transparent), and strengthen anti-monopoly enforcement. Moreover, under SII, the U.S. and Japan conducted two joint price surveys to demonstrate that Japan's structural impediments contribute to unusually high price differentials between Japan and other overseas markets. The issues taken up in SII talks are now addressed as appropriate under U.S.-Japan Framework discussions.

Japan's economy remains heavily regulated, which reinforces business practices that restrict competition and keep prices high. Price controls remain on certain agricultural products. Bureaucratic obstacles to new firms' entry into businesses such as trucking, retail sales and telecommunications slow structural adjustment. The Government of Japan has made deregulation a key theme, issuing its "Policy for Promoting Deregulation" on June 28, 1994. In this connection, the Prime Minister's Office is leading a government-wide effort to draft a five-year deregulation action plan that is expected to set the policy tone and scope of deregulation in Japan until 2000. Implementation of the action plan will begin April 1, 1995.

In 1993, the Clinton Administration announced the U.S.-Japan Framework for a New Economic Partnership. A goal of the Framework is to make our economic ties with Japan more balanced and mutually beneficial, as well as to promote global growth, open markets, and a vital world trading system. The Framework addresses the wide range of U.S.-Japan economic and trade issues through negotiations on macroeconomic, structural and sectoral matters. The structural and sectoral issues are divided into five "baskets" for discussion: government procurement, regulatory reform and competitiveness, economic harmonization, implementation of existing agreements and other major sectors (including autos and auto parts).

Structural negotiations are ongoing under Framework areas such as deregulation and competition policy, foreign direct investment, buyer-supplier relationships, and access to technology. In the deregulation and competition policy discussions, the U.S. has provided detailed suggestions, on areas ranging from telecommunications

to retail policy, for reforms to be included in Japan's five-year deregulation plan. The goal of the Framework's foreign direct investment and buyer-supplier talks is to increase the market presence in Japan of U.S. and other foreign firms by encouraging a more open and flexible investment regime. The United States has made many specific recommendations to the Japanese government.

4. Debt Management Policies

Japan is the world's largest net creditor. It is an active participant together with the United States in international discussions of the developing country indebtedness issue in a variety of fora.

5. Significant Barriers to U.S. Exports

The Japanese government has removed many formal barriers to imports of goods and services. Import licenses, still technically required for all goods, are granted on a pro forma basis, with limited exceptions (fish, leather goods and some agricultural products). Japan's average industrial tariff rate (about two percent) is one of the lowest in the world, and Japan has agreed to further tariff reductions in the Uruguay Round. The Uruguay Round Agreement will reduce but not eliminate trade barriers in agriculture, manufactured goods, and services.

Traditional trade policy measures, however, are not the greatest obstacles to penetrating Japanese markets. Instead of tariffs and official discrimination against imports, U.S. exporters must deal with numerous factors that raise costs and inhibit access in areas ranging from glass to auto parts. These obstacles include archaic and multi-tiered distribution systems, "keiretsu" (networks between manufacturers and distributors linked by long-time business relationships and often by cross-holding of shares) relationships, excessive government regulation and the use of administrative guidance, public procurement practices, and the high cost of land (which inhibits new market entrants).

In October 1994, the United States and Japan signed important market-opening agreements under the Framework; agreements were signed in insurance and gov ernment procurement of medical technology and telecommunications goods_and services (including procurement by Japan's massive phone company, Nippon Telegraph and Telephone (NTT)). In December 1994, the United States and Japan finalized an agreement to open Japan's flat glass sector to foreign suppliers. In addition, U.S. and Japanese negotiators reached agreements in 1994 in a number of other areas, including opening Japan's huge public works construction sector to foreign firms; improving access to Japan's cellular telephone market; eliminating barriers to imports of apples; and streamlining and improving intellectual property procedures.

In the last few years, Japan also agreed to relax rules on value-added telecommunications services, to strengthen copyright protection for U.S. music recordings, and to resolve a dispute involving amorphous metals, for which market entry has been facilitated. The United States continues to closely monitor U.S.-Japan agreements including those in the areas of commercial satellites, government procurement of supercomputers, semiconductors, construction, wood products, paper, medical products and pharmaceuticals, and computer procurement. In 1994, the United States announced that impediments to U.S. market access for paper and wood products in Japan may warrant future identification of these sectors for action under the "Super 301" Executive Order. In 1994, the United States also initiated a Section 301 investigation of regulatory barriers in Japan's market for replacement (after market) auto parts. Framework negotiations on autos and auto parts continue.

The governments of the United States and Japan announced on January 10, 1995, a comprehensive financial services agreement under the U.S.-Japan Framework Agreement that will further open Japan's financial markets to foreign competition. The agreement will ensure that U.S. financial institutions have the opportunity to compete more effectively in the Japanese financial market. Inter alia, the agreement opens the $1 trillion Japanese pension market to effective participation by foreign fund managers. The agreement also creates greater opportunities for foreign financial firms to participate in the $500 billion Japanese corporate securities market by permitting greater scope for the introduction of new financial instruments. Finally, the agreement will promote further integration of Japan's capital market with the global capital markets, and will create significant opportunities for competitive financial institutions to help Japanese invest abroad and Japanese firms to offer securities in offshore markets.

The ability of foreign architectural and construction firms to access Japan's public works market continues to be closely scrutinized by the U.S. government. For many years, Japan has engaged in exclusionary practices which have prevented foreign

firms from competing successfully on contracts for major Japanese construction projects. To remedy this situation, the U.S. government negotiated the 1988 Major Projects Arrangements (revised in 1991) which gave foreign firms improved access to thirty-four major construction projects with the understanding that experience gained on these would assist foreign firms in winning contracts on other construction projects. Despite these agreements, U.S. architectural, engineering, and construction firms continued to face difficulties in doing business in Japan. As a result, Japan was designated under Title VII of the 1988 Omnibus Trade and Competitiveness Act for discriminatory procurement practices. Following months of intensive negotiations with the United States, in January 1994 Japan adopted a new Action Plan to overhaul its current public works procurement system. The Action Plan replaces the designated bidding system (under which only specified companies could offer bids) with an open and competitive system, allows foreign firms' international experiences to be considered when determining a firm's qualifications, and applies to all procurement above a certain threshold, not just the thirty-four major projects. A formal review of the implementation of this Action Plan will occur during the spring of 1995.

In addition to progress in the public works area, Framework agreements in October 1994 improved access for foreign firms to government procurement of medical technology and telecommunications goods and services. The United States continues to monitor Japanese government procurement practices to assure that U.S. firms are given an opportunity to compete fairly and openly.

Legal services remain on the U.S.Japan trade agenda. Despite partial liberalization in 1987 which allowed U.S. law firms to open offices in Japan, the Government of Japan continues to maintain severe restrictions on the way in which foreign firms can provide legal services. For example, foreign firms are prohibited from employing or entering into partnership with Japanese attorneys, and lawyers who are not qualified Japanese lawyers may not advise clients on points of Japanese law.

In December 1993, U.S. negotiators included legal services in the U.S. package submitted to the GATT. This decision effectively froze the current practice regarding legal services performed by foreign lawyers in GATT signatory countries which had agreed to include legal services in the final agreement.

Although the Japanese government has simplified, harmonized and, in some cases, eliminated restrictive product standards to follow international practices in a number of areas, many problems remain. The 1985-1987 Market-Oriented Sector Selective (MOSS) Talks resolved many standards problems and set in motion a continuing dialogue through MOSS follow-up meetings of experts.

In general, advances in technology make some current Japanese standards outdated and restrictive. In addition, Japanese industry supports unique safety standards that limit competition. Lastly, bureaucratic inertia inhibits further standards simplification. Standards problems continue to hamper market access in Japan.

Japan's Office of the Trade Ombudsman (OTO) traditionally only responded when an aggrieved party, such as a foreign company or domestic importer, complained about Japanese standards, certifications, and testing procedures. Since 1993, the OTO has brought its own cases to the attention of the Japanese government bureaucracy. Although the U.S. government had hoped the new process would lead to greater pressure on the bureaucrats to change, thus far, the OTO has accomplished very little. Of the twenty-one requests brought before the OTO in 1993, regulations in only seven areas were revised satisfactorily (only two of which involved issues raised by the United States). The OTO seems to have made the most progress in technical areas where the complainant made a good case and where Japanese government bureaucratic resistance to changes was light. The OTO process has not been useful in pursuing policy issues or politicized market access problems, e.g. removal of the tariff on feedgrains. In February 1994, the OTO was upgraded when it was moved to the Office of the Prime Minister, but it was still not granted any enforcement authority. While Government of Japan effort to strengthen the OTO may have boosted the office's profile, it is unlikely to significantly improve the OTO's effectiveness.

Foreign investment into Japan in most sectors is now subject to only ex post notification to the Ministry of Finance (MOF), thanks to MOF commitments made under SII. Previously, all foreign investors were required to notify the MOF of their intent to invest 30 days before any investment occurred. Japan still requires prior approval in certain sectors: air and maritime transport, space development, atomic energy, oil and gas production and distribution, agriculture, fisheries, forestry, leather and leather products manufacturing, and tobacco manufacturing.

Foreign investment in the banking and securities industries is subject to a reciprocity requirement. Japan gives foreign investors national treatment after entry, with the Organization for Economic Cooperation and Development (OECD) notified

of limited exceptions. The Japanese government does not employ local equity_requirements, export performance requirements or local content requirements. The Japanese government has not forced foreign individuals or companies to divest themselves of investments. Japanese law allows foreign landholding, and foreign investors may repatriate capital and profits readily.

At the same time, inward foreign direct investment in Japan is much lower than that in its major G-7 trading partners. There are a number of factors underlying the low level of inward investment, including the legacy of many years of active Japanese government discouragement of foreign investment. A major problem today, however, is the high cost of doing business in Japan, particularly for new market entrants, that makes the rate of return on investments far lower than other alternatives. In addition, foreign acquisition of existing Japanese companies is difficult, due in part to crossholding of shares among allied companies, leading to the limited availability of publicly traded common stock. This practice complicates efforts of foreign firms to acquire existing distribution/service networks through mergers and acquisitions. The Japanese government has taken some initial steps to provide incentives to foreign investors. This issue is under discussion in Foreign Direct Investment sub-basket of the Framework.

6. Export Subsidies Policies

Japan is a signatory to the OECD Export Credit Arrangement, including the agreement on the use of tied-aid credit. The Japanese government subsidizes exports as permitted by the Arrangement, which allows softer terms for export financing to developing nations. Of the $11.5 billion of official development assistance that Japan disbursed in 1993, slightly less than half of the bilateral assistance portion (excluding Central Europe assistance) was in the form of concessional loans. In this area, Japan has virtually eliminated its tied-aid credits and now extends over 95 percent of its new loan aid under untied terms. But U.S. exporters continue to face difficulties in competing due to the use of (1) Less Developed Country (LDC) untied aid, where bidding is only open to Japanese and LDC firms, and (2) tied or partially tied feasibility studies (provided by grant aid) for untied (loan aid) projects which result in project specifications more suited to Japanese than U.S. bidders. These programs are the subject of continued discussions within the OECD. Japan exempts exports from the three percent VAT-like consumption tax initiated in April 1989. This provision does not appear to have any significant impact on a manufacturer's decision to sell domestically or export.

7. Protection of U.S. Intellectual Property Rights

Japan is a party to the Berne, Paris and Universal Copyright conventions and the Patent Cooperation Treaty. Japan's Intellectual Property Rights (IPR) regime affords national treatment to U.S. entities. The United States and Japan agree that uniform IPR standards and better enforcement are needed. To that end, U.S., Japanese, and European negotiators are engaged in trilateral patent harmonization talks. Discussions, including the protection of semiconductor mask works, are also taking place in the World Intellectual Property Organization and the GATT. Many Japanese firms use the patent filing system as a tool of corporate strategy, filing many applications to cover slight variations in technology. Public access to applications and compulsory licensing provisions for dependent patents facilitate this practice. The rights of U.S. filers in Japan are often circumscribed by prior filings of applications for similar inventions or processes. The need to respond individually to multiple oppositions slows the process and makes it more costly. Japanese patent examiners and courts interpret patent applications narrowly and adjudicate cases slowly. Japanese patent law lacks a doctrine of equivalence and civil procedure lacks a discovery procedure to seek evidence of infringement.

Average patent pendency in Japan is one of the longest among developed countries, averaging over five years from application to grant. The long pendency period, coupled with a practice of opening all applications to public inspection 18 months after filing, exposes patent applications to lengthy public scrutiny without effective legal protection. Bilateral talks on Japan's slow patent processing led to a reduction in the average patent examination portion of the pendency period, from about 37 months to 30 months. Efforts to reduce this period continue.

A United States-Japan IPR agreement, signed in August 1994 under the Framework, will provide some relief to problems posed by the lengthy pendency period and the practice of multiple opposition filing. The Japan Patent Office will introduce legislation to revise the current system by April 1, 1995. The agreement is to be fully operational by January 1, 1996. The revised system will allow opposition filings only after a patent is granted. Multiple opposition filings will be consolidated and addressed in a single proceeding, minimizing time and costs. There will also be a re