by Eugene Volokh, VESOFT
     Published by CATO Institute, POLICY ANLYSIS, #99, Jan 1988.

   Perhaps the most disquieting aspect of the troubles presently faced
by  America's  semiconductor industry is that  high technology was the
very  area  in which the United States  was *supposed* to be superior.
When  the automobile and steel industries  were in deep trouble in the
late  1970s  and  early  1980s,  pundits predicted that  the future of
American  industry lay in "sunrise industries," high-technology fields
where  the cheap labor available to  foreign competitors would be more
than compensated for by our Yankee ingenuity.

   Unfortunately,  it  seems  we Yankees do not  possess a monopoly on
ingenuity,  for  the  Japanese semiconductor industry  has proven very
competitive.  In  one  particular  area -- the  production and sale of
general-purpose  memory chips, so-called  DRAMs (Dynamic Random Access
Memory)  and  EPROMs  (Erasable Programmable Read  Only Memory) -- the
performance  of American companies has  been disastrous. In 1975, U.S.
merchant producers (companies that make chips to sell to others rather
than  just  for  their  own  internal  use) had 100%  of the U.S. DRAM
market.  In 1986, they had 5% of  that market. [1] When all chips sold
by  merchant  producers  are  taken into account,  the U.S. producers'
market share declined from 60% in 1975 to less than 50% in 1985, while
the Japanese share rose from 20% to 40% in the same period. [2]

   Naturally,  such  a  loss  of  industrial  competitiveness  and the
accompanying  losses  in  employment  quickly turned the  issue from a
private  one  to  a  public  one. In 1983,  the Semiconductor Industry
Association  (SIA)  published a report that  accused the Japanese of a
variety  of  unfair  trade practices [3]. In  1986, the U.S. and Japan
signed  the  Semiconductor  Trade Agreement, under  which the Japanese
promised  to  take steps designed to  alleviate the plight of American
chipmakers.  In  February  1987,  the Department  of Defense's Defense
Science Board issued its "Report on Defense Semiconductor Dependency,"
which  asserted  military  reasons  for  protecting  and strengthening
America's  semiconductor  industry;  and,  finally, in  April 1987, in
response  to  Japanese  violations  of  the  1986  Semiconductor Trade
Agreement,  the  U.S.  government imposed trade  sanctions on Japanese
imports;  and, currently, the congressional trade bill would authorize
$500  million  over  the  next  five  years  to  finance  Sematech,  a
government-industry  research consortium to  develop new semiconductor
manufacturing  techniques, a proposal advanced by  the SIA and then by
the Defense Science Board.

   This,   of  course,  is  not  the  first  time  foreign  trade  and
protectionism  have  been  discussed  in  the United  States, and will
certainly  not  be  the  last.  In a democracy,  it is inevitable that
whenever  one segment of society feels  put upon by forces it believes
are outside its control, it will petition the government for help; and
there  might  well  be  some  cases  where  a  hands-off  approach  to
international  trade  is  not  the best solution.  However, before the
United States embarks on a new round of trade protectionism, it should
first investigate where the true interests of the nation as a whole --
not just semiconductor manufacturers -- lie.

                             Us vs. Them

   "We  don't  want  [a  U.S.  - Japanese trade  war] and the Japanese
certainly  don't  want one," said the  late U.S. Secretary of Commerce
Malcolm Baldrige. "Japan sells about $85 billion worth of goods to the
United  States  in  a  year,  while  we sell about  $27 billion to the
Japanese.  Who has the most to lose?" [4] This presented, of course, a
classic  mercantilist  question and Baldrige  clearly implied that the
party  with the most to lose was  Japan -- that the U.S. trade deficit
with  Japan indicated that Japan was somehow getting the better end of
the deal.

   Mercantilism,  however,  is  not a highly  regarded economic theory
these  days,  and  has  not  been  for about 200  years. The classical
mercantilists  measured  a  nation's  wealth by the  amount of gold --
these  days,  it  would  be  by  foreign  reserves --  that the nation
possesses;  when  the  United  States buys $100  million of goods from
Japan,  the U.S. "loses" $100 million and Japan "gains" it -- the U.S.
wealth is decreased and Japan's is increased.

   Classical   economists,  starting  with  Adam  Smith,  successfully
challenged  mercantilist  analysis  by pointing out  a simple fact: an
informed  voluntary trade is, by definition,  to the advantage of both
parties  involved.  This  is  a  cliche,  but  a  cliche is  merely an
often-repeated  truth,  and  this  truth is worth  repeating. The U.S.
doesn't really "lose" $100 million by trading with Japan; it exchanges
$100 million for some amount of goods, an amount that is clearly worth
more  (to the American purchasers) than $100 million. Similarly, Japan
does  not "gain" $100 million from the  trade -- it gains $100 million
minus  the  value  of the goods to itself.  Both parties gain, or else
they would not trade. A cash trade "deficit" usually turns out to be a
wealth  surplus, since the dollars we give  up are more than offset by
the goods we get in return.

   On  the microeconomic level, when  a Japanese chipmaker sells chips
to  an  American  chip  user (typically a  computer manufacturer), the
American  clearly  gains  by  getting a better  deal than he otherwise
could;  cessation  of  international  trade  would certainly  hurt the
American  computer  maker  a  great deal, since it  would drive up its
costs  and thus its product prices,  and drive down profits. One third
of the total production cost of a microcomputer is in the chips [5].

   This is why it is useless to speak of which trading partner has the
most  to gain from trade and which has the most to lose. Japan's gains
and  the  U.S.  gains  are  hard  to  compare, since  they are largely
subjective,  reflecting  the value that each  places on the goods that
were  sold;  suffice  it to say that both  sides gain, and gain rather
handsomely indeed.

   In fact, it appears that in the short term, chip consumers may gain
more  than  chip  producers.  Chip  producers  -- American  as well as
Japanese   --  have  been  having  an  unprofitable  streak  recently,
suffering  hefty losses while their customers  have been raking in the
benefits  in  low  prices.  Although  this  is  unlikely  to  remain a
long-term  trend (economics teaches us  that people rarely sell things
at  a loss for long), these days  our cash trade "deficit" in the chip
trade  might  actually mean a "surplus" in  the total amount of wealth
being  exchanged. This is important because  it is tempting -- and, to
some  parties, profitable -- to label the current trade situation as a
case  of  "Us  vs. Them," with "us" being  the United States (the good
guys)  and  "them"  being Japan (the bad  guys). The trouble with this
idea,  though, is that at least some  of "us" -- the chip consumers --
benefit  as much as "they" do from  low Japanese chip prices. The real
losers  are  American  chipmakers,  who  are  seeing  themselves being
undercut by Japanese competition. Japanese competition is not "bad for
America"; it is bad for some Americans and good for others.

                         "Unfair" Competition

   Naturally,  U.S. chipmakers are not willing to simply complain that
the  Japanese outcompete them. The American public has little patience
for  companies that are failing just because  they cannot do as good a
job as the next guy. In fact, the Semiconductor Industry Association's
1983  report concentrated on several  specific allegations of "unfair"

   *  Dumping. The Japanese are said to sell their chips at below cost
     to  the  U.S.,  thus forcing American  chip manufacturers to take
     similar losses just to say even.

   * Government Targeting. The Japanese have the benefit of government
     subsidies  (from the infamous Ministry of International Trade and
     Industry,  or MITI) which American  chipmakers do not receive, so
     the game is not being played on a "level playing field."

   *  Import Restraints. While the  Japanese merrily export chips (and
     other  things) to the open U.S. market, they stubbornly refuse to
     let American exporters return the favor.

   The  great thing about being in favor of fairness is that it is, by
definition, so hard to oppose. When a presidential candidate campaigns
on a platform of fair trade, how could anybody disagree with him? What
would be the alternative, "unfair trade"?

   Still,  before launching a crusade for fair international trade, we
must ask ourselves a few key questions:

   * Are the trade policies in question really unfair?

   *  Do these trade policies contribute substantially to the American
     producers' woes?

   * Even if these trade policies are unfair, could we not profit from

   *  If we find that we do  want to do something about Japanese trade
     policies (whether or not they are fair), will our planned actions
     actually bring about the desired results?

   The answers to these questions are by no means obvious.


   The   dumping   issue   has   surfaced  with  a  vengeance  in  the
U.S.-Japanese  "voluntary"  Semiconductor  Trade  Agreement  of August
1986.  Prior  to  the  agreement,  U.S.  authorities had  declared the
Japanese  guilty  of  selling  chips *below cost*,  with the intent of
driving  American  competitors  out  of the market  and then recouping
their  losses  using  their "unfairly won"  market share. In response,
Japan  agreed  to  a  "worldwide  minimum  price  for  Japanese  chips
determined by the U.S. government" [6]. Note the adjective "worldwide"
--  Japanese exports to other countries,  such as Europe, South Korea,
etc.  would be controlled by this  agreement just as surely as exports
to the U.S.

   Now,  let  us  defer  for  a moment the  allegation that dumping is
"unfair" -- we will get to it shortly. Is Japan's sale of chips *below
cost*  to  American firms actually harmful  to American interests? The
mercantilist  would,  of  course, say yes.  Mercantilists consider any
successful  competition  by  a foreign producer to  be harmful. If the
foreign producer happens to be unrestrained by considerations of cost,
that  just makes it all the more  likely that the producer can compete

   The  trouble  with the mercantilist view  is that it considers only
the  interests  of  the  American  chip  producer.  The  American chip
consumer,  on the other hand, is more  than glad to buy chips for less
than  they cost to make. Just as any low-priced competition is bad for
the producer (whether it is "fair" or "unfair"), so it is good for the
consumer.  An American computer manufacturer  does not really care how
much  it costs the Japanese to produce a silicon wafer; he has his own
competitors to worry about, and he will profit from any price decrease
in his product's components, whatever its origin.

   Looking at things from a macroeconomic point of view, the situation
looks  even  better. Suppose that the  Japanese are selling the United
States  $100  million  of  chips that cost them  $125 million to make.
Presumably,  to the American chip consumers,  the chips are worth $150
million  (or some amount greater than $100 million, or else they would
not  be buying them). In terms of net change in wealth -- factoring in
both  cash  and product value -- Americans  gained $50 million and the
Japanese actually *lost* $25 million. Both American gains and Japanese
losses  are greater than what they would  be if no dumping took place.
Admittedly,  this is a crude model,  but seemingly the only reasonable
one -- how can the Japanese (or anyone, for that matter) at all profit
from selling a product below cost?

   But,  the  anti-dumping  argument goes, the  consumer benefits from
foreign  dumping  are  only  short-term,  to be  followed by long-term
disadvantages   caused   by  dumping's  destruction  of  the  domestic
competition.  Dumping, it is said, is actually "predatory pricing," in
which  dumpers  sell  products  at artificially low  prices, drive the
competition out of business, and then take advantage of their monopoly
position   to  recoup  their  losses  by  charging  exorbitant  rates.
Certainly,  if this were true, we  might well be justified in forgoing
the  short-term advantages of dumping in  order to avoid the long-term
harm from the imminent monopoly.

   But  this  just  is  not  true. Predatory pricing  is a theoretical
bugaboo  with  no  real  possibility  of  practical  manifestation. It
requires  more  than  just  an  establishment of a  monopoly (which is
itself  a hard proposition, considering the losses a firm has to incur
to  get it) -- it requires retention of the monopoly even after prices
are raised.

   Once   the   Japanese   manufacturers,   at  great  cost  to  their
pocketbooks,  destroy  the  American  chipmakers  and  start  charging
monopolistic  prices,  what  is to prevent  a would-be competitor from
undercutting  them?  Certainly there are entry  costs, but they may be
more  easily  borne by the would-be  competitor than the dumping costs
incurred  by the would-be monopolist. Furthermore, there are plenty of
"captive  producers"  in  the  domestic  market who  produce chips but
simply  do not choose to sell them  to others [7]; if someone tries to
charge monopoly prices, the captive producers can easily jump into the
fray  with little start-up costs (Western Electric, for example, tried
to  use  its  "captive"  chipmaking ability to  sell to the commercial
market in 1983 -- an arguably bad time to do this [8].)

   But,  finally,  let  us even assume that  not a single chipmaker or
would-be  chipmaker remains on American shores.  It is a capital error
to  assume  that the Japanese are somehow  a the monolith Japan, Inc.,
able  to  monopolize  anything in every way.  Even the Defense Science
Board   report,  while  maintaining  that  Japanese  chipmakers  often
cooperate  in R&D, acknowledges that  "In the application of resulting
technology  to  products  [chips],  the  [Japanese]  companies compete
fiercely"  [9]. To really profit  from predatory pricing, the fiercely
competing  Japanese companies would have to  organize a cartel to keep
prices   artificially  high.  But  the  only  people  guilty  of  even
contemplating any sort of semiconductor industry cartel these days are
the American chipmakers and the American government.

   If  the Japanese are not dumping  for predatory pricing's sake, why
are  they  dumping  at all? There must be  some reason for anything as
silly as selling something below cost.

   There  is  indeed  a  reason,  and it is hardly  as sinister as the
protectionists  would  have  us  believe.  According to  one observer,
"Japanese   companies   were   accused   of  selling  below  what  the
anti-dumping  laws  call  'fair  market  value,'"  which  is  based on
"average  rather than marginal costs" [10].  Say that company A spends
$100  million to build a plant and another $100 million on R&D for the
basic  chip  design.  It  then produces 50 million  chips a year, each
costing  $1 to make (raw materials, labor,  etc.). What is the cost to
be used for fair market value calculations? If the initial investments
are   depreciated   over   5   years,   it   would  cost  $90  million
((100+100)/5+50) per year to produce 50 million chips, an average cost
of $1.80 each.

   Unfortunately,  though  company A may  have definitively calculated
the "fair market value" of a chip at $1.80, it may have a hard time of
getting  the  market  to agree. Prices are,  of course, determined not
just  by  the  supply  curve  but  also  by  the demand  curve; if the
customers  are  not willing to pay more  than $1.25 for each chip, the
company  will be hard put to make them pay more (unless, of course, it
can get the government to enforce a Semiconductor Trade Agreement).

   What is more, there is nothing unfair or unreasonable about selling
each  chip  for  $1.25. The firm still makes  a profit of $.25 on each
chip  sold,  because it only costs me $1  to produce that chip. It may
take more time to recoup the original investment this way, but as long
as  the  price  is  higher  than  the  *marginal cost*, it  is a sound
business  decision to keep selling. (Prices below *average cost* might
call  into question the soundness of the original decision to get into
the  business  in  the first place, but it  is too late to do anything
about that once the fixed costs have already been paid.)

   Other  perfectly good reasons can be  supplied for selling chips at
below  what  one  might think to be  the "cost." Boom-bust conditions,
endemic  in  the  industry drive prices down  below average cost [11];
chip  obsolescence,  which  happens  every  few years,  does the same.
Another reason for below-cost sales is to liquidate large surpluses --
products  that are already on the shelf and that must be gotten rid of
at any price, even below marginal cost [12].

   The  bottom line is that "dumping" is  just a pejorative name for a
variety  of perfectly sound, fair business practices that are actually
beneficial to American consumers.

                   Japanese Governmental Subsidies

   A  more  serious fairness issue that has  been raised by critics is
that   the  Japanese  chip  producers  supposedly  enjoy  governmental
subsidies that U.S. chipmakers do not have. Therefore, U.S. chipmakers
cannot  possibly  compete  without  matching  subsidies of  their own,
whether  they  be  direct  payments  or some sort  of artificial price

   One would not want to argue that the Japanese subsidies were a good
thing.  In fact, one of the troubles  with subsidies is that they tend
to  reproduce at an amazing rate,  with each nation creating subsidies
to  offset  other  nations'  subsidies  and  each  industry  demanding
subsidies  of  its  own  whenever  it  is seen that  the government is
willing to subsidize some other industry.

   However, the questions we must ask are:

   (1) What exactly has the scope of Japanese subsidies been?

   (2) Are Japanese governmental subsidies really bad for America?

   In  the recent debate over protectionism and industrial policy, the
name  of  Japan's Ministry of International  Trade and Industry (MITI)
has  acquired  an  almost  mythical  status.  Both  industrial  policy
advocates  and  protectionists have sought to  explain much of Japan's
economic  success as a result of  MITI's intervention -- the former to
justify  a  comparable  American  industrial policy and  the latter to
justify American retaliation in the name of "fairness."

   The facts, however, do not justify this point of view. According to
David  Henderson,  former senior staff  economist with the president's
Council  of  Economic  Advisers,  "The  idea that  central planning is
responsible   for  Japan's  success  is  a  myth.  MITI  has  made  no
contribution to many of Japan's biggest industrial successes." [13]

   In  fact, in the late 1970s,  only 28% of Japanese R&D expenditures
(including  defense)  was paid for by  the Japanese government; at the
same time, 48% of U.S. R&D was government-funded. [14] In the computer
industry,  Japan  spent  $127 million in the  1976-82 period while the
U.S.  spent  $279  million  in  the shorter 1978-82  period. The Japan
Development  Bank's  low-interest  loans  to the  electronic machinery
industry  in 1982 were equivalent to less than 0.5% of the total plant
investment   by   the   industry.   [15]  The  Semiconductor  Industry
Association's  report indicates that in 1978  (the last year for which
it  provides  figures),  MITI's semiconductor  industry subsidies were
$45.7  million -- but equipping a  single production facility can cost
up to $75 million. [16]

   Note  that  the Defense Science Board's  report recommends that the
Department  of Defense (DOD) spend $400  million per year to stimulate
the  U.S.  semiconductor industry. [17] According  to one study, "When
American  negotiators complain of the Japanese joint research ventures
in electronics, the Japanese quickly point to the Defense Department's
VHSIC   (Very   High  Speed  Integrated  Circuit)  program.  Even  the
production  equipment developed for this program will not be permitted
to  be  sold  abroad. . . . We claim  that the purpose of such defense
programs  is not commercial development.  Whatever their purposes, our
trade  partners  retort,  these  policies  have  commercial commercial
consequences  and must be considered  when negotiating." [18] The very
existence  of  the  vast U.S. defense  establishment (much bigger than
Japan's)  guarantees  that  much  high-technology  research  would  be
subsidized  by  the  DOD.  Our  slate  is hardly clean  in the area of
government  subsidies, especially when one  considers how small MITI's
and the Japan Development Bank's aid to Japan's semiconductor industry
has really been.

   In fact, whatever subsidies the Japanese government has provided in
the  past  have had hardly the effect  that the protectionists and the
subsidy  enthusiasts  claim.  It  is  certainly  not  clear  that  the
subsidies  actually  helped  Japan's  economy;  in fact,  the evidence
points to the contrary.

   If  the  Japanese government chooses to  give, say, $100 million to
the  Japanese  semiconductor  industry,  there  is  no doubt  that the
industry  will  be helped. By using that  $100 million to pay for what
would  otherwise  be $300 million of  semiconductors, the industry can
now  profitably  sell  them for, say, $250  million (while at the same
time,  even  equally  productive  American  competitors would  have to
charge $350 million to make the same profit).

   We may concede that American chipmakers will not like this state of
affairs  (just  as  they would not like it  if the Japanese managed to
sell chips for $250 million without any government help). However, the
buyers  naturally have an entirely different opinion. The $100 million
Japanese  government subsidy actually goes  directly into the American
chip  buyers'  pocket! Without the subsidy,  the American buyers would
have  had to pay $350 million. With the subsidy, they only have to pay
$250  million.  The  Japanese  manufacturers  still make  the same $50
million  profit,  with  the Japanese taxpayer footing  the bill -- and
there  are  more American companies buying  computer chips than making

   On a macroeconomic level, the picture with subsidies is the same as
with  dumping.  Americans  acquired  $350  million of  wealth for $250
million  cash; the Japanese acquired $250 million cash but had to give
up  goods that cost them $300 million  to produce. It appears that the
U.S.  is  the real beneficiary here, not  Japan; in fact, if these are
the  real terms of our trade,  then the answer to Secretary Baldrige's
question  --  "who do you think has the  most to lose from a cutoff of
trade?" -- is emphatically the U.S.

   Government  subsidies are not a good  idea, either for the Japanese
or  the  Americans. Though they do  indeed help those being subsidized
(which  includes both Japanese producers  and American consumers) they
are  economically  foolish  for  the  subsidizing  government  and are
cruelly unfair to those trying to compete on their own.

   However, in our quest for "fairness" we should neither overestimate
the  level of Japan's subsidies (which is relatively small) nor ignore
the  money  that  the  U.S.  government  is pouring  into the American
semiconductor  industry  through lucrative defense  contracts (many of
which  cannot even be bid on  by foreigners). Neither should we ignore
practical   political  considerations.  What  subsidies  the  Japanese
government  does  provide  are  --  like all  subsidies -- politically
entrenched  and  thus  very difficult to remove.  Imagine for a moment
that  a  foreign  competitor  demanded  that the  U.S. government stop
subsidizing  its farmers. The U.S. government, American consumers, and
foreign competitors would all benefit from abolition of subsidies, but
the  chances of this are slim. In fact, if we impose our own subsidies
to "counteract" Japanese subsidies, we will surely have as hard a time
removing them as we would convincing the Japanese to remove theirs.

                      Japanese Import Restraints

   One  other  thing  that the Japanese have  been accused of doing is
shutting  their markets to American exporters.  To the extent that the
Japanese do this -- and they do -- their protectionism is every bit as
counterproductive  as  that  which is now being  proposed for the U.S.
However, the key questions are, first, whether there really are import
restraints  in  the  semiconductor industry, and,  second, how large a
role they play in the troubles of U.S. chipmakers.

   The  Semiconductor  Industry  Association's  1983  report discusses
alleged  Japanese  import  restraints  as well  as Japanese government
subsidies. One of its recommendations, in fact, is that

   the  U.S.  government  should insist that  U.S. semiconductor firms
   receive commercial opportunities in Japan that are fully equivalent
   to  those enjoyed by Japanese firms. .  . . U.S. firms must receive
   real,  not  "cosmetic"  market  access, reflected  in significantly
   greater  participation by U.S. firms  in the Japanese market. *This
   will   require   an   affirmative   action  program*  to  normalize
   competition  in  Japan.  The  Japanese government  should establish
   programs to see that this result is achieved. (emphasis added) [19]

However,  while  the report produces  evidence that U.S. semiconductor
firms do not have a large market share in Japan, it offers no evidence
that  this  is caused by Japanese  government restrictions on imports.
Consider the report's limp analysis:

   This low share [12% of the market], coupled with Japan's history of
   import  restrictions,  suggests  that barriers to  sales of foreign
   semiconductors remain. [20]

Neither the SIA report nor any subsequent publications have documented
substantive  import barriers, i.e. real, government-enforced barriers,
rather than individual preferences (however irrational) on the part of
Japanese  consumers. Furthermore, the measures  proposed by the report
are  futile  almost to the point  of being dangerous. The "affirmative
action  program"  recommended by the report --  and then echoed in the
1986  Semiconductor Trade Agreement, which "called for . . . U.S. chip
makers  to  get  more  than  their  current 10% share  in the Japanese
market"  [21] -- is not something that is easily forced on a sovereign
ally. How exactly do we force Japanese chip purchasers -- not "Japan,"
but  private citizens, free to buy what they please -- to buy American
chips  simply in order to boost American companies' market share? This
"affirmative  action"  is  one of the  most irrational economic policy
proposals  imaginable. It requires  massive government interference in
corporate purchasing decisions and guarantees sales to firms that have
been unable to earn them; all in all, a very poor incentive system.

   In  fact, there are a lot of good reasons why in a market free from
government  import  restraints  American producers might  fail to make
headway.  First,  even discounting  transportation costs, salesmanship
does not travel well. Obviously, a Japanese salesman will do better at
selling   to   Japanese  just  because  he  knows  the  market  better
(incidentally,   the   years   of   American  trade  superiority  have
undoubtedly  taught  the  Japanese salesman to  know even the American
market better than Americans know the Japanese). Second, many Japanese
companies  consume  more  of  their  own  chips than  do most American
"merchant  suppliers."  [22] Finally, there is,  no doubt, some simple
chauvinism  at work. But considering the recent campaign in the United
States  to "Buy American" -- a campaign supported by state and federal
legislation,  not just private bias -- can we really be outraged? And,
even if we are, what can the Japanese government do about it?

   What  is  more -- and perhaps the  most injurious thing to American
pride  --  there  does not even seem to be  a very good reason for the
Japanese  government to restrict American  DRAM and EPROM imports. The
U.S.  government certainly does not  restrict American chip sales, and
still the Japanese seem to be able to outcompete American firms in the
U.S.  itself.  This  being the case, it  seems pretty obvious why U.S.
chip manufacturers have only a 10% market share in Japan and why it is
quite unlikely that they will ever get anything higher, at least until
they can compete better in their home market. In other words, in those
areas where American chipmakers hurt most -- and where calls for trade
reform  are loudest -- opening up the Japanese market (if it is indeed
closed) will help least.

   To summarize the issue of Japanese import restrictions:

   (1)  where  they  exist,  they  are undoubtedly bad,  and should be
       abolished forthwith;

   (2) they do not seem to exist in the semiconductor industry;

   (3)  even  if they did, they would not  be very relevant as long as
       American chipmakers cannot even compete in their home market.

                 Semiconductors and National Security

   The  preceding discussion has been strictly concerned with economic
issues,  concentrating  on the pocketbooks of  chip consumers and chip
producers  more  than anything else. National  security, however, is a
horse of a different color. Few would argue that for the sake of lower
chip  costs we should endanger  American security. If American defense
*requires*  American-built  chips,  there  is  no doubt  that American
industry should be protected at all costs.

   In  February  1987,  the  DOD's Defense Science  Board released its
ominously  titled  "Report of the Defense  Science Board Task Force on
DEFENSE  SEMICONDUCTOR DEPENDENCY" (emphasis  theirs). Its conclusions
were  "that  a  direct threat to  the technological superiority deemed
essential  to U.S. defense systems exists" and that "U.S. defense will
soon  *depend  on foreign sources*  for state-of-the-art technology in
semiconductors,"  considered  by  the  board  to  be  "an unacceptable
situation" (emphasis in original). [23]

   To  avoid  this  "unacceptable situation," the  Board recommended a
vast  DOD-  and  industry-funded  research  program,  focusing  on the
establishment  of  a Semiconductor  Manufacturing Technology Institute
(costing  the  taxpayers  a  projected  $1 billion over  5 years) plus
various  other  spending  in  universities,  the  DOD,  and  industry,
amounting to an extra $160 to $350 million per year). [24]

   Conspicuous  by its absence from  the report was any recommendation
of  import  restrictions, whether tariffs  or anti-dumping agreements.
Although   governmental   support  of  Japanese  industry,  "allegedly
explicit  and implicit trade barriers," and dumping were all mentioned
as   possible   causes  of  Japanese  leadership,  they  were  largely
discounted.  According  to  the report, "changes  in these policies by
themselves   will   not   solve  the  problems  that  beset  the  U.S.
semiconductor industry". [25]

   The  report's refusal to recommend import restrictions, however, is
the  only  reasonable  thing  about  it.  In  its main  thrust -- that
Japanese  leadership in the DRAM and  ROM sectors of the semiconductor
industry somehow threatens American national security -- the report is
an  utter failure. In fact, none of the 100-odd pages of evidence that
it presents actually support this position.

   The  key  point that the Report seeks to  make is not that the U.S.
defense  industry  uses semiconductors extensively --  in this day and
age  of  high  technology,  that  much  is  beyond  doubt --  but that
*domestic   production  is  somehow  inherently  superior  to  foreign
production  in  meeting  the needs of the  defense industry*. In other
words,  if  we can build our missiles  and fighter planes equally well
with  Japanese chips as with American chips -- a plausible assumption,
since  the  laws  of  physics  and  electronics work  equally well for
Japanese and Americans -- then there is no reason why we should prefer
more  expensive  American  goods  to  cheaper, more  efficient foreign
goods. In fact, the report admits:

   Finding  2.6.   Acquisition  of  specific devices  or materials for
   foreign  sources for defense applications is not a critical problem
   as  long as the U.S. has  the knowledge and resources to substitute
   domestic  sources in a timely fashion  should the supply of foreign
   products  and technology be interrupted. However, this substitution
   is  possible only if it can in fact be accomplished within the time
   available  and  does  not  impoverish  U.S.  capabilities  in other
   important areas. [26]

   Readers  will search in vain for  any evidence that substitution of
domestic  production  for  interrupted  foreign  production  cannot be
reasonably   accomplished;  the  report  certainly  produces  no  such
evidence.  In fact, not only are chips a manufactured good (unlike oil
and  strategic  metals), which can be produced  by anybody who has the
knowledge,  but  there is also plenty  of American industrial capacity
(and  expertise)  that can be easily  converted to producing DRAMs and

   Remember,  the  leadership  that  the  Japanese  have is  mostly in
production of *mass-market general-purpose memory chips*. For economic
purposes,  we may draw distinctions  between the "merchant" production
that  the  Japanese  have  a  lead in and  the "captive" production by
domestic companies such as AT&T and IBM for internal use; however, the
fundamentals of chip production and design are the same in both cases.
In  time of war, AT&T and IBM can certainly be convinced to sell their
chips  to others; it is just that in time of peace, they choose not to
for economic reasons.

   Not  finding  any  direct  evidence  that  interruption  of foreign
supplies  will not be easily remediable when it occurs, the report had
to  grasp for more tenuous  straws such as "technological leadership."
The  issue of leadership centers on the premise that if we "lose" DRAM
and  ROM  manufacturing  to  the Japanese, we will  lose not only that
particular  segment, but also many (if  not all) other portions of the
electronics industry. Figure 1, taken from the Defense Science Board's
Report, makes this point and relates it to national security.

   U.S. military forces depend heavily on technological superiority to

   Electronics is the technology that can be leveraged most highly

   Semiconductors are the key to leadership in electronics

   Competitive  high-volume  production  is  the key  to leadership in

   High-volume production is supported by the commercial market

   Leadership in commercial volume production is being lost

   Semiconductor technology leadership will soon reside abroad

This  argument, like all good fallacious arguments, is 90% correct. It
is true that U.S. military forces depend on technological superiority;
it  is  true  that  competitive  high-volume production is  the key to
leadership  in  merchant  DRAM  and  ROM  production; it  is true that
merchant  DRAM  and  ROM  production  leadership  is  already residing
abroad.  What  are questionable are two  key points: (1) that merchant
DRAM  and  ROM  leadership  is equivalent  to semiconductor technology
leadership, and, (2) that "semiconductors are the key to leadership in

   On  the  surface  this  seems  like a pretty  good record (only two
errors  out of seven assertions and six implications!). Unfortunately,
these  are fatal errors, and betray either a misunderstanding of (or a
desire  to mislead about) the way  computers and the computer industry

   A  computer system consists of two distinct parts: the software, he
programs  that  tell  the  machine  what to do;  and the hardware, the
pieces  of electronics that actually execute the instructions provided
by  the  software.  It  is  easy  to  overemphasize the  importance of
hardware, because it is "real" -- it can be seen, touched, weighed and
measured  -- whereas software is merely a set of electronic encodings,
bits  that  are  turned on or off.  However, software costs have risen
from  20%  of the total cost of a  computer system in the mid-1960s to
80%  of the total system cost by  the mid-1980s. When a cruise missile
looks  down on a piece of terrain and decides whether or not it should
drop  a  bomb on it, only a small fraction  of the work is done by the
hardware  (the cameras, the chips,  the detonation devices, etc.). The
majority  of  the  image  recognition  and  analysis  is  done  by the

   Hardware  itself can be divided into two components: semiconductors
and  everything  else.  This  "everything  else" includes  disks, disk
drives, tape drives, terminals, and printers. While semiconductors can
legitimately  be called the "smarts" of hardware, they are by no means
the only component. A personal computer certainly would not do much if
it were made of semiconductors alone.

Finally,  semiconductors  themselves fall into  two categories: memory
chips  and logic chips. Memory chips, such  as the DRAMs and ROMs, are
the  subject of today's protectionism debates. They allow the computer
to  store and access data. Of all  the functions of the computer, they
implement  two: "remember a piece of  information" and "recall a piece
of  information." Logic chips implement all the other functions of the
computer.  The Motorola 68000, the 8080, 6502, Z80, etc. (just to name
a few of the more widely known ones) are all logic chips and can truly
be  considered the smarts of the computer, or at least of the hardware

   The  key  factor  in  logic chips is not  cost but design; both the
speed  of  operation  and the ease of  programming of the computer are
largely  determined  by  the quality of the  logic chip design. To its
credit,  the Defense Science Bord's report  admits that the U.S. still
has  a  lead  in "design-intensive custom  logic and microprocessors,"
[27]  though it claims that the U.S. lead is being reduced by Japanese
advances.  No evidence for this decline is presented beyond Table 1 of
the  report,  which  merely  states  that the U.S. has  a lead that is
perceived to be declining. [28] Furthermore, the major recommendations
of  the  report emphasize subsidies of  memory chip manufacturing, not
logic chip design.

   There  is  no  doubt that all of  the above-mentioned components --
software, non-semiconductor hardware, logic chips, and memory chips --
are  necessary  for  any computer system; no  computer system will run
without  all  four  ingredients.  However,  the  "leadership" argument
states  that  memory  chips  are  not just necessary  but are vital to
continuing superiority in all (or most) of the other fields.

   This  is  simply  wrong. The place of  memory chips in the computer
industry is well defined -- they store and retrieve data. The Japanese
may make them cheaper; the trend in today's technology is to make them
more  compact; with luck, they can  even be made faster (a substantial
consideration  for today's computers). They will not, however, be made
smarter;  it  takes  logic  chip  advances  and,  especially, software
advances,  to  add  new  smarts to computer  systems. When the Defense
Science  Board's report says that  "electronics is the technology that
can  be  leveraged most highly," [29]  the technological advances that
provide the leverage will come mostly from logic chips and software.

   Memory  chip  production  has  become a manufacturing  issue, not a
design issue. As pointed out by one observer, "A company's competitive
position  in  the production of memory  chips depends primarily on its
manufacturing  capabilities, whereas its competitive position in logic
chips depends more on its design and engineering skills." [30] Perhaps
in  automobile  and  steel  production -- mature  industries where the
basic  design  has  been  long settled --  manufacturing capability is
indeed the key to leadership; in the computer industry, however, it is
design  advances, in fields such  as artificial intelligence, software
engineering  (to  maximize  software quality  and minimize maintenance
costs), and execution speed (partially a memory speed issue but mostly
a logic chip and especially software issue) that are important.

   What  we have here is a crude sort of "Not Invented Here" syndrome,
an  attitude  that "we can only make a  good computer if we make every
single  one of its components." The Defense Science Board's chapter on
"Effects  on Downstream Industries"  (where "downstream industries are
those   which   use  thr  products  of  the  semiconductor  industry,"
presumably  including computer makers and defense contractors) puts it

   A  strong  domestic  semiconductor industry is  a prerequisite to a
   strong position in these downstream industries since the ability to
   perform  competitive services and sell competitive products depends
   upon access to the most advanced semiconductor devices. [31]

As  any good entrepreneur will tell you,  any company that tries to do
everything  itself will lose to one that buys its expertise from those
most  competent to provide it. IBM bought the operating system for its
wildly  successful IBM PC from Microsoft, Inc.; Apple bought the logic
chips   for   its   MacIntosh   from   Motorola.   Neither  sacrificed
"technological leadership"; in fact, they enhanced their leadership by
focusing on those areas that they are best at. Economists know this as
Ricardo's  "comparative advantage"; businessmen know  it as just plain
good business.

   Other  findings  of  the report are as  suspect as the "interrupted
foreign  supply"  issue and the "technology  leadership" issue. A very
interesting one is Finding 2.7:

   Even  more  critical is the possible  movement of electronic device
   and system capabilities to overseas locations from which the Soviet
   Union  can  readily  access the technology. In  that case, the U.S.
   could  lose the considerable margin of  advantage it holds over the
   U.S.S.R.  in this critical area of  technology -- and upon which it
   relies to offset quantitative military disadvantages. [32]

In  other words, it is not enough that the U.S. produce all of its own
semiconductors -- Japan must not be allowed to produce any. Production
and  design  capabilities  do not "move"; they  replicate. Even if the
United  States regains a competitive  advantage over Japan, Japan will
still  have  their own, constantly  improving, semiconductor industry,
every bit as accessible (or inaccessible) to the Soviet Union as it is
now.  The  only  possible solution to the concern  of Finding 2.7 is a
preemptive  strike  against  all foreign  producers of semiconductors.
Only  by  making sure that *nobody* except  the United States can make
semiconductors   can   we   prevent  the  Soviets  from  stealing  the

   Where  the  findings  of  the report vary  from the implausible and
unproven  (that  interruption  of foreign  semiconductor supplies will
damage the U.S. in case of war or mobilization) to the implausible and
vague  (that  some  sort  of "leadership" is being  lost in the entire
computer industry because of uncompetitiveness in memory chips) to the
irremediable  and  downright  silly (that any  foreign production is a
risk  to  the  U.S. because the Soviets  might steal it), the report's
recommendations are almost innocuous:

   (1)  "Support  the  establishment of  a Semiconductor Manufacturing
       Technology  Institute  which  would  develop,  demonstrate, and
       advance the technology base." [33] Projected cost: $250 million
       from  industry, plus $200 million per year over five years from
       the  DOD. "The principal and most crucial recommendation of the
       Task  Force is that an Institute be established by a consortium
       of  U.S.  firms ... to jointly  advance the state-of-the-art in
       generic  semiconductor  *manufacturing* (emphasis  in original)
       technology.  An appropriate objective  would be the development
       of  the  manufacturing  technology  needed  for the  64 megabit
       DRAM." [34]

    2.  "Establish  at  Eight  Universities Centers  of Excellence for
       Semiconductor  Science  and Engineering"  [35]. Projected cost:
       $50 million per year from the DOD.

    3.   "Increase  DOD  spending  for  research  and  development  in
       semiconductor    materials,    devices,    and    manufacturing
       infrastructure."  [36] Projected cost: $60 million in the first
       year, rising to $250 million in the fourth and final year (paid
       by the DOD).

    4.   "Provide  a  source  of  discretionary  funds  to  the  DOD's
       semiconductor   suppliers  to  underpin  a  healthy  industrial
       research  and  development  program." [37]  Projected cost: $50
       million per year (paid by the DOD).

    5. "Establish under the DOD a Government/Industry/University forum
       for  semiconductors..." [38]. Projected cost: $200 thousand per
       year (paid by the DOD).

   After   all   the   problems   elucidated   by   the   report,  the
recommendations  seem  almost  a  relief: only $2  billion of taxpayer
money  over  5  years  -- small change to the  DOD, smaller yet to the
federal government.

   Ignore  for a moment that the ostensible reason for this funding --
the  bugaboo  of  "dependency  on  foreign supplies" --  appears to be
fictional.  It is admitted that one of the reasons that Japan is doing
better   than  the  U.S.  in  memory  chip  manufacture  is  more  R&D
expenditure  (according  to  the  Report,  13%  of profits  vs. 10% of
profits  in 1970-1985 [39]). So, the report suggests, pump in some R&D
money.  Even  if  the  subsidy is not vital  for national security, it
might  help  a  slumping  industry, and besides,  it won't really hurt

   But $2 billion invested in such research is $2 billion not invested
in  something  else  --  perhaps  something  more  profitable  for the
investors and for the nation. As one analysis states the problem, "The
government  directly  funds some 775  research laboratories across the
country, employing some 80,000 people (about one-sixth of the nation's
scientists  and  engineers)  and gobbling up about  half of the annual
$123  billion that goes to pure and applied research nationwide. . . .
But  the  work  they  do  . . . does  almost nothing for the country's
broader  economic  competitiveness.   Since the 1950s,  only 5% of the
government's   28,000  patented  inventions  have  been  licensed  for
commercial use." [40]

   There  are  several  good  reasons  for  this  condition.  For one,
government-funded bodies, lacking a profit incentive, are plagued with
vast economic inefficiencies (witness the Pentagon's penchant for $600
toilet  seats) and thus provide far less bang for the investment buck.
The  government, by monopolizing half the national research budget and
one-sixth  of  the  nation's  scientists, is consigning  both of these
valuable  resources  to a much less  economically productive life than
they would otherwise lead.

   Second,   the  investment  decisions  themselves,  being  made  for
fundamentally noneconomic reasons, often ignore economic realities and
subsidize the impractical or unprofitable. The Defense Science Board's
report  says  that "The principal  policy difference [between Japanese
and  American subsidies] is . . .  that Japan has elected to focus its
subsidies  on emerging, leading edge  industries, whereas the U.S. has
to a considerable degree elected to subsidize sunset industries." [41]
This  praise  of  MITI's  business  acumen is  largely unwarranted. As
Katsuro Sakoh writes, "it seems clear that most of the funds disbursed
by   [Japanese]   policy-implementation   financing  institutions  are
allocated  by  political  or  social  considerations, rather  than for
consciously  planned targeting of  specific manufacturing industries."
[42]  In  Japan,  agriculture,  coal  mining,  and  shipbuilding  have
received  vast  government  aid; automobiles  and consumer electronics
have gotten virtually none. Agriculture is now a massive budget drain,
domestic  coal production has decreased from 54 million metric tons in
1962  to 19 million metric tons in 1978, and shipbuilding is operating
at  35%  of  capacity;  automobiles  and consumer  electronics are, of
course,  Japan's  great  success  stories.  [43]  Even  in  Japan, the
government-invested   dollar  (which  goes  where  privately  invested
dollars fear to tread) provides an inadequate rate of return.

   Finally, note that nobody is better than the government at throwing
good  money  after bad. What will happen  when the $2 billion runs out
five  years from now? Will American semiconductor companies be willing
to  dig  into  their  own  pockets to continue this  high level of R&D
investment?  Or  will  they  run to the DOD  asking for another two or
three billion dollars?

   All  in all, it seems that the  $2 billion that the DOD proposes to
invest  would be much better kept in the hands of the private sectors,
which  is  known for making generally  sounder economic decisions than
the  government. By taking this $2 billion out of the private sector's
hands,  the DOD may actually hurt American technological leadership by
depriving  other  industries  of funds that  would have otherwise been
invested  in them. Five years from  now, those industries will in turn
be  hurting,  and  the  Defense  Science Board  will perhaps recommend
governmental subsidies for them too because for some mysterious reason
these industries were not sufficiently funded in the past.

   Americans  can  sleep  secure  tonight,  knowing  that  our alleged
"dependency"  on Japanese semiconductors is  unlikely to lose us World
War  III. Semiconductor manufacturers, however, cannot sleep securely,
because they are in a bad spot profit-wise. Their predicament is quite
likely  caused  by  the  low  levels  of  R&D expenditure  by American
industry,  and  should  perhaps  be  remedied by higher  levels of R&D
expenditure *by American industry*. Why the DOD should get involved in
this is not clear; what is clear is that DOD involvement will not help
the American economy as a whole.

                   The Economic Costs of Protection

   An  important question alluded to in the discussion above was this:
even  if  we  decide  that  something  ought to be  done about various
Japanese  trade  practices  (fair or unfair),  what alternatives do we
have?  Can  we make sure that our actions  do not cause more harm than

   One  of  the points that the above  arguments tried to establish is
that  dumping  and Japanese government  subsidies actually have highly
desirable  effects  for American chip consumers  and -- perhaps -- for
America  as  a  whole.  On the other hand, there  is no doubt that the
effects  on  American producers are quite damaging,  and can lead to a
variety  of costs. One could readily  claim that, although cheap chips
are  good  for the U.S., their advantages  are more than offset by the
dislocation  and  suffering  caused  by declines  in native chipmaking
industry.  Certainly  protection  of  American workers  should also be
given some weight.

   Alas,  protecting  the  American  worker is easier  said than done.
According  to  a  report  on  trade  protection  in the  United States
published  by  the  Institute  for International  Economics (IIE), the
costs   of   saving  American  jobs  by  protectionism  are  literally
staggering.  Some  640,000  jobs  were  preserved in  the U.S. textile
industry  by protectionist action in the  years 1957-86 [44]. Each job
saved  was  estimated  to  cost  the  U.S. consumer  from *$22,000* to
*$42,000*  [45].  The recent spate of  protection of the auto industry
has saved an estimated 55,000 jobs between 1981 and 1985, at a cost of
*$105,000*  per  job  [46]; in carbon  steel production, protectionism
saved  about 7,000 to 9,000 jobs  between 1969 and 1986, of *$240,000*
to  *$750,000*  per  job saved [47]. In fact,  the lowest cost per job
saved  among  the  31  cases  studied by the IIE  was in the fisheries
industry, where 27,000 jobs were saved at a cost of $21,000 in each.

   These  numbers may at first seem so  high as to be implausible, but
upon reflection they are actually quite logical. Restrictions on cheap
imports  coupled with the removal of competitive pressures on domestic
producers  will  certainly  raise prices dramatically.  In fact, price
increases  are  exactly  what any producer wants,  even if he pretends
that  he  just  wants  to  save worker's jobs. The  only thing that is
surprising  is just how much of a price increase is seen for so little
job savings.

   Self-defeating side effects are also not uncommon. According to the
IIE study:

   An  important  factor  in the difficulties  of the textile industry
   during the 1950s was the protection benefiting United States cotton
   growers.  This  permitted  foreign cotton  textile manufacturers to
   obtain  their  raw material at much  lower prices than their United
   States competitors. [48]

   Is it so unlikely that, if American computer-makers are not allowed
to  buy  cheap  foreign  chips,  they will soon  be seeking protection
because foreign computer-makers can successfully undercut them?

         The 1986 U.S.-Japanese Semiconductor Trade Agreement

   The 1986 Semiconductor Trade Agreement between Japan and the United
States  was  actually  implemented  with price increases  very much in
mind.  A  worldwide minimum price for  Japanese chips was established,
allegedly  to counteract Japanese "dumping"  effects. According to the
*Wall  Street  Journal*, "Assigned prices  for 256-kilobit D-rams, for
example,  ranged from about $3 to $7.50, compared with a $2.25 average
price  before  the agreement." [49]. 256-kilobit  EPROMs that sold for
$2.53  in  Japan  cost  $3.95  in  the U.S. Before  the agreement took
effect,  it  was  estimated  that it would  cost American consumers an
estimated $568 million a year. [50]

   By  early  1987,  it  was  fairly clear that  the Japanese were not
meeting the terms of the agreement. The agreement called for

   (1)  The Japanese government to prevent Japanese firms from selling
       chips  either to U.S. companies or to anybody else (besides the
       Japanese themselves) at less than "fair market value"; and,

   (2) The Japanese government to promote U.S. chip sales to Japan and
       ensure  that U.S. firms' share of the market rose significantly
       above  the 10% level; if  needed, the Japanese government would
       force Japanese companies to curtail their own production.

In  April 1987, with neither goal being met, the United States slapped
a  100%  punitive tariff on $300  million of Japanese consumer imports
(such as televisions, computers, and power tools). [51]

   Now, it is never a good thing when trade agreements -- or any other
kind  of international agreement -- are  violated, even when they were
bad agreements to start with. Unfortunately, reality makes fools of us
all,  and  this  agreement was made seemingly  in ignorance of certain
economic  and political realities. As  *Fortune* magazine put it, "the
agreement  has  produced  every  perverse  effect a  free-trader could
imagine." [52]

   Like  any  trade  restriction,  the  semiconductor  accord  begat a
flourishing  "gray market." "Chip brokers" smuggled chips out of Japan
to  other  Asian  countries,  plugged  then into  dummy circuit boards
(chips  wired  into circuit boards are  not covered by the agreement),
and  sold them to U.S. companies at 20% to 40% below the prices set by
the  agreement.  "Suitcase brigades" would fly  with suitcases full of
chips  to  the  U.S.,  Hong  Kong, South Korea,  Taiwan, or Singapore,
relying on the easy portability of the chips (tens of thousands, worth
hundreds  of  thousands  of  dollars,  could  fit into a  bag) and lax
customs  checking (customs agents being  loath to check every business
traveler's  suitcase).  "'We are not  doing it deliberately', contends
Tomihiro  Matsumura,  a  senior  vice  president of NEC  who heads the
corporation's semiconductor group. It happens anyway, he says, because
assigned  prices in the U.S. 'go against the fundamental principles of
business.'  'No  matter  what you do,' he  explains, 'what is cheap is
going to flow to where it is expensive.'" [53]

   The  gray  market,  which  would have arisen  anyway because of the
American shortage of cheap chips, was exacerbated by the corresponding
Japanese  glut.  As U.S. demand for  the now-overpriced Japanese chips
fell  drastically,  the  Japanese  began  to  face a  vast oversupply.
"'Prices  just cratered', says Wilfred  Corrigan, the president of LSI
Logic  Corp.,  a Milpitas, California concern  that makes chips in the
U.S.  and  Japan. 'They had to do  something with all those chips they
could not sell over here.'" [54]

   Needless  to say, with the glut  caused by the first goal (stopping
"dumping"),  the  second  goal  (increasing  American market  share in
Japan)  became  virtually impossible to meet.  If Americans had a hard
time  competing with preaccord prices in Japan, they would have a much
harder  time competing with the lower  postaccord prices. On the other
hand,  Japan's  legitimate  export  business  was further  hurt by the
extended waiting period that MITI imposed for export licenses in order
to stop the gray marketeers.

   Squeezed  by  these  restrictions,  Japanese companies  pushed even
harder  in  markets  not covered by agreements,  and also moved to buy
American   companies.   This   did   not   sit   well   with  American
protectionists, either; for instance, Fujitsu's planned acquisition of
Fairchild  Semiconductor Corp. was vetoed by the Reagan Administration
in  March  of  1987  for fear of "giving  away precious technology" to
foreigners. [55]

   In light of all this, it is not surprising that the Japanese -- who
only  reluctantly accepted the agreement in  the first place -- should
be  equally reluctant to fully  enforce it. Naturally, while Americans
see  the  Japanese  as the trade villains,  the Japanese do not agree.
Japan  is  beginning  to  have unemployment woes of  its own with some
experts predicting 6% unemployment rates in a country used to rates of
less  than 3% [56]. Now their export industries -- financed to a large
extent  by high Japanese saving  rates, representing the sacrifices of
the Japanese consumer -- are, in Japanese minds, being made to pay for
their own efficiency.

   The  complaints that the United States makes about Japan can easily
be  reversed in the minds of the  Japanese. The Americans say that the
Japanese  spend "too little" and save "too much" -- but some of former
Prime Minister Nakasone's Japanese critics argue that it is rather the
Americans  who  save  too  little  and spend too  much. [57] Americans
complain about Japanese willingness to take short-term losses in order
to  obtain higher market share (which  is exactly what the allegations
of  "dumping"  mean),  but  Japanese  can easily put  the blame on the
American  companies  so obsessed with the  bottom-line that they avoid
necessary short-term sacrifices.

   Perhaps  the  worst  aspect  of  the  1986  agreement  is  that  it
essentially  requires the Japanese  government to exercise dictatorial
powers  over  its  own  citizens,  a people as  enamored of liberty as
Americans are. As one observer has explained the demands placed on the
Japanese government by the agreement,

   To  increase the U.S. share of the Japanese memory chip market, the
   Japanese must somehow compel private Japanese companies to purchase
   American  products. . . . If it is to prevent dumping in either the
   U.S.   or   other  markets  by  Japanese  companies,  the  Japanese
   government  must closely monitor exports  by its computer firms and
   enforce strict price controls. [58]

   Note  that if the agreement called  merely for elimination of overt
import  tariffs,  the  Japanese  government could do  that by a simple
unilateral  action;  if the agreement attempted  to prevent dumping to
the   United  States  alone,  the  American  government  could  simply
intervene  at the border. Instead, the agreement calls for far broader
restrictions,  which require the Japanese  government to take steps to
coerce  Japanese  companies to do what  the Americans want. Recall the
vast  opposition that America's own  "affirmative action" policies and
price controls have met with; imagine what the Japanese must feel when
a  *foreign  government*  tries to require  such intrusive controls of
citizens' daily business lives.

   The  U.S.  government  essentially  strong-armed the  Japanese into
setting  up  a  cartel,  a  cartel  which was against  the interest of
American  consumers,  which  was  not  practically enforceable  by the
Japanese  government,  and  which,  curiously enough,  would have been
criminal  under U.S. antitrust law if two American producers had tried
it.  it is a well-known economic  fact that people always break cartel
agreements  (witness  OPEC) because cheating is  so tempting, being to
the  benefit of both the cheating producer and the consumer. It should
hardly  be  surprising,  then,  that such a  misguided trade agreement
would  inevitably  fail;  the  laws of economics  and politics are not
easily  overturned  with  a  stroke  of  a pen. Rather  than using the
agreement's failure as an excuse to exacerbate trade tensions, perhaps
we  should  instead learn from it  the mischief that protectionism can


   Several conclusions may be drawn from the evidence assessed here:

   (1) Japanese "dumping" -- a reasonable and proper business practice
       labelled "unfair" by rather specious reasoning -- is actually a
       boon  to American consumers of  chips. American chip consumers,
       like  all consumers, love cheap products and use them to become
       more  competitive themselves. American chip producers object to
       "dumping"  for  an  obvious  reason: nobody  likes competition,
       especially efficient competition.

   (2)  Japanese  government  subsidies, while hardly  something to be
       approved   of,  have  in  effect  been  subsidies  to  American
       consumers  just  as  much  as to  Japanese producers. Subsidies
       always  distort  the  international  trade  picture,  but these
       subsidies  have not been remarkably  large (nor is the American
       slate  clean here, considering the volume of U.S. high-tech R&D
       subsidized by the Defense Department).

   (3)  Import restrictions against the American chips in question are
       largely mythical, hypothesized solely on America's low share of
       the  Japanese market (a rather arrogant argument, implying that
       the  Japanese can outcompete Americans only if they have import
       restrictions  working  in their favor).  Import restrictions in
       other areas are present and should be removed; however, this is
       only  likely to help those American industries that have proven
       able to compete well at home.

   (4)  Japanese  superiority  in  DRAM  and  EPROM  production hardly
       threatens U.S. national security, either directly (by threat of
       cut-off  of  strategically vital supplies)  or indirectly (as a
       loss  of  some  sort of "industrial  leadership"). In fact, the
       best  way to preserve American leadership in high technology as
       a  whole is to ensure maximum supplies of the best and cheapest
       goods available, regardless of where they come from.

   (5)  Even if we wanted to  protect our market against the Japanese,
       it  would  cost  us truly vast  amounts of money. Historically,
       trade  restraints  in  various  industries  have  cost  tens of
       thousands  of dollars per job saved; these costs, incidentally,
       may  be a measure of just how much *benefit* American consumers
       derive from the absence of these restraints.

   (6)  It  is  hardly  a  surprise  that  the  Japanese  violated the
       Semiconductor   Trade   Agreement.   Part   of   the  agreement
       established  a  goal  -- increased American  market presence --
       that  was  made  virtually  impossible to achieve  by the other
       part,  which  drove  down  Japanese domestic  chip prices. Both
       aspects (anti-"dumping" and increased American market presence)
       called  for  the  Japanese  government  to  impose  controls on
       private  Japanese  citizens  that few  Americans would tolerate
       from their own government.

   (7)  Finally,  before  we  panic  about our  "loss of technological
       leadership," we must not automatically assume that what is good
       for  the  chipmakers is good for  the U.S. By modern standards,
       DRAMs  and EPROMs are remarkably low-tech; in fact, it is their
       consumers  -- who would be most hurt by increased protectionism
       -- that are on the true forefront of technological development.

   As  usual,  good solutions are hard to  come by. In the years after
World  War II, when all our  would-be competitors were lying in ruins,
the  United States enjoyed an unprecedented period of superiority in a
vast  number  of  industries.  Much  as  we would like  to retain this
superiority,   it  is  easier  said  than  done.  Protecting  American
industries  hurts  America  as  well  as  foreign  competitors; better
solutions  need to be found. Perhaps  they lie in lower interest rates
or  higher savings rates; perhaps we  have something to learn from the
Japanese  *zaibatsu*s  which (in a manner  quite offensive to American
antitrust  laws)  unite  many diverse companies  in diverse industries
into a stronger, more competitive whole.

   What  seems  clear  is that a new  round of protectionism and trade
warfare will help no one, neither our competitors nor ourselves.


   Eugene  Volokh  is  Vice  President of Research  and Development of
VESOFT,  Inc.,  a  software  firm specializing  in the Hewlett-Packard
large business mini-computer market.


[1]  Office of the Under Secretary of Defense for Acquisition, "Report
    of  the Defense Science Board  Task Force on Defense Semiconductor
    Dependency,"   (U.S.  Department  of  Defense,  Washington,  D.C.,
    February 1987), p. 5.

[2] Ibid.

[3]  Semiconductor  Industry  Association,  *The Effect  of Government
    Targeting  on  World Semiconductor Competition:  A Case History of
    Japanese   Industrial   Strategy  and  Its  Costs  for  Americans*
    (Cupertino, Calif.: Semiconductor Industry Association, 1983).

[4]  "U.S.  Sanctions Saved Computer  Chip Firms," *Washington Times*,
    April 28, 1987.

[5]  Malcolm  Gladwell, "The Big Blue  Computer Firm Overlooked in the
    Trade War," *Insight*, April 27, 1987, p. 42.

[6]  Michael Becker, *Semiconductor Protectionism: Goodbye Mr. Chips*,
    Citizens for a Sound Economy Issue Allert no. 9 (Washington, D.C.,
    August 27, 1986), pp. 3-4.

[7]  Malcolm  Gladwell, "The Big Blue  Computer Firm Overlooked in the
    Trade War," *Insight*, April 27, 1987, p. 42.

[8] *Business Week*, May 23, 1986, p. 90.

[9] "Report of the Defense Science Board", p. 6.

[10] Becker, p. 8.

[11]  For  the  boom,  see "Raking in the  Chips," *Time*, October 22,
     1984,  p.  74.  For  the  bust,  see  "Slump  Still  Plagues U.S.
     Semiconductor Market," *Electronics Week*, May 20, 1985, p. 18.

[12]  Edward L. Hudgins, "*U.S.-Japan Trade War: The Opening Battle*",
     The  Heritage Foundation Backgrounder  no. 577 (Washington, D.C.,
     April 24, 1987), p. 4.

[13]  David  R.  Henderson,  "The Myth of  MITI," *Fortune*, August 8,
     1983, pp. 113-116.

[14]  Katsuro Sakoh, "Japanese Economic  Success: Industrial Policy or
     Free  Market?", *Cato Journal* 4, no.  2 (Fall 1984): p. 523. See
     also  Scott Palmer, "*Panic in  Silicon Valley: The Semiconductor
     Industry's  Cry for Help*," Cato Institute Policy Analysis no. 31
     (Washington, D.C., December 21, 1983), p. 17.

[15] Sakoh, p. 535.

[16] Semiconductor Industry Association report; Palmer, p. 7.

[17] "Report of the Defense Science Board," pp. 11-13.

[18] John Zysman and Stephen Cohen, "Double or Nothing: Open Trade and
     Competitive  Industry," *Foreign Affairs*  (Summer 1983, Vol. 61,
     no. 5), p. 1131.

[19]  Semiconductor  Industry  Association, *The  Effect of Government
     Targeting*, p. 6.

[20] Ibid., p. 71.

[21]  John Burgess, "Japan Cuts Semiconductor Production," *Washington
     Post*, March 24, 1987, p. D1.

[22]  Bro  Uttal,  "How Chipmakers Can  Survive," *Fortune*, April 13,
     1987, pp. 89-92.

[23] "Report of the Defense Science Board," p. 2.

[24] Ibid., pp. 11-12.

[25] Ibid., p. 6.

[26] Ibid., p. 3.

[27] Ibid., p. 8.

[28] Ibid.

[29] Ibid., p. 26.

[30] Becker, p. 2.

[31] "Report of the Defense Science Board," p. 10.

[32] Ibid., p. 3.

[33] Ibid., p. 11.

[34] Ibid., p. 84.

[35] Ibid., p. 12.

[36] Ibid.

[37] Ibid.

[38] Ibid., p. 13.

[39] Ibid., p. 6.

[40]  Malcolm  Gladwell,  "A  National  Interest  in  Global Markets,"
     *Insight*, June 29, 1987, pp. 13-14.

[41] "Report of the Defense Science Board," p. 80.

[42] Sakoh, p. 526.

[43] Ibid., pp. 533-535.

[44] Gary Clyde Hufbauer, Diane T. Berliner, and Kimberly Ann Elliott,
     *Trade   Protection  in  the  United  States:  31  Case  Studies*
     (Washington,  D.C.: Institute for International Economics, 1986),
     p. 16.

[45] Ibid., p. 14.

[46] Ibid., p. 258.

[47] Ibid., pp. 3-4, 15.

[48] Ibid., p. 118.

[49]  Brenton  R. Schlender and  Stephen Kreider Yoder, "Semiconductor
     Accord  with  Japan  fails to Aid U.S.  Firms As Intended," *Wall
     Street Journal*, February 12, 1987, pp. 1, 10.

[50] Becker, p. 1.

[51]  Mark Potts and Caroline E. Mayer, "Some PCs Expected to Disapper
     Here," *Washington Post*, April 19, 1987, pp. D1, D10.

[52]  Bro  Uttal,  "How Chipmakers Can  Survive," *Fortune*, April 13,
     1987, pp. 89-92.

[53]  Brenton  R. Schlender and  Stephen Kreider Yoder, "Semiconductor
     Accord  with  Japan  fails to Aid U.S.  Firms As Intended," *Wall
     Street Journal*, February 12, 1987, pp. 1, 10.

[54] Ibid.

[55]  Steve  Prokesch,  "Stopping  the High-Tech  Giveaway," *New York
     Times*, March 22, 1987, Section 3, p. 1.

[56]  "Now  Japan Faces Unemployment,"  *Financial Times*, January 15,

[57] "'The Real Cause' of the U.S. Trade Deficit," *Tokyo Nihon Keizai
     Shimbun*, January 17, 1987.

[58] Hudgins, p. 5.

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