When Congress passed the Trade Act of 1974, it stated that one of its objectives was "to assure a swift and certain response to foreign import restrictions, export subsidies, and price discrimination (dumping) and other unfair foreign trade practices." In its efforts to obtain relief from unfair trade practices, Zenith has found little willingness on the part of either the Department of the Treasury or the Department of Justice to provide the "swift and certain" response to unfair or unlawful acts that Congress sought to assure. Instead, Zenith has witnessed what has appeared to be a continuing willingness on the part of both the Treasury and Justice departments to accommodate diplomatic conveniences even when that accommodation has required the avoidance of law enforcement responsibilities. The long history of unfair and/or unlawful trade practices in the U.S. television market and of the failure of the responsible federal law enforcement agencies to take action is one that has involved serious economic injury to the employees and stockholders of many U.S. television companies. It is a record that provides a warning of possible future injury to the employees and stockholders of other U.S. industries, and it is a record that suggests the time has come to reconsider this nation's attitudes toward the ideal of "free trade" in today's world. 'Foreign import restrictions' No nation has benefited more than Japan from the willingness of other nations to relax import restrictions and to permit a free exchange of goods. Japan, however, while exploiting opportunities in the markets of its trading partners, has persisted in pursuing a protectionist policy at home. In 1976, color television sales in Japan exceeded 5 million units; fewer than 500 of these units were imported (see Exhibit I). The exclusion of foreigners from the Japanese color television market has, so far, been close to absolute. The lack of television competition from abroad in Japan does not result from home market prices that are so low as to make importation unattractive. The least expensive 19-inch color television table models available for sale in Japan are priced at about ¥150,000, or, at the current exchange rate, about $700. Similar imported and domestically manufactured sets are selling in the United States for less than $350. The price differences between the Japanese and U.S. markets are even bigger in the case of largescreen console receivers. Prices of these large furniture models in Japan begin at about 390,000, or $1,800. Furniture consoles with comparable features and screen sizes are readily available in the United States for about $750. Spokesmen for the Japanese television industry sometimes explain the absence of import competition in Japan by suggesting that U.S. television manufacturers are uniquely inept in marketing their products abroad. These spokesmen fail to note, however, that even such European television giants as Philips, Telefunken, and Grundig, which actively participate in most of the television markets of the world, have also been unable to find a place in Japan's home market. Matsushita, Hitachi, Sanyo, Sharp, and other Japanese television manufacturers have plants in Taiwan where labor costs are substantially lower than those in Japan's home islands. The output of the Taiwan plants moves in volume to Japan's export markets; but Japan's Ministry of Finance reports that no television receivers have been imported into Japan from Taiwan. Six years ago, the Nixon administration showed great concern over a growing U.S. trade deficit with Japan. In reply, the Japanese launched a major public relations effort, not unlike the one we are seeing today, to communicate their intention to lower trade barriers and increase imports from the United States. As a part of that public relations effort, considerable press attention was given to Motorola's announcement in 1972 that it would market largescreen U.S.-made television receivers in Japan with the assistance of a Sony affiliate, AIWA. Motorola estimated that it could sell 60,000 units annually and obtain about 1% of the Japanese market. The president of AIWA was quoted in the press as stating that the planned $1,245 price for a 25-inch Motorola receiver would compare favorably with the prices of large-screen models then available in the Japanese market. In the spring of 1974, Matsushita acquired Motorola's television assets. The plan to export television receivers made in the United States to Japan died with the acquisition, and it has not since been resurrected. In 1973, with the help of C. Itoh & Co., one of Japan's largest trading companies, Zenith attempted to develop a plan for exporting Zenith color television products to Japan. C. Itoh completed the research necessary to provide Zenith with a complete analysis of the Japanese market. At about that time, Seibu, one of Japan's leading department stores, had 35-134 O-78-3 168 Harvard Business Review September-October 1978 entered into an agreement with Sears, Roebuck & Co., which provided that the Sears catalog would be made available in a number of Seibu stores to permit Japanese buyers to purchase Sears's offerings. C. Itoh's report to Zenith stated that Japanese customers who were interested in buying the color television sets (among them, Japanese-made models) shown in the Sears catalog were advised that they would have to multiply the dollar television prices shown in the catalog by 600 to establish the yen price. A conversion rate of about 300 to the dollar was then being used for other catalog items. At a 300-to-the-dollar rate, Japanese buyers would have been able to buy Japanese-made television sets through the Sears catalog at prices 30% or more below the prices at which similar products were available for sale in Japan. At the ¥600 conversion rate, the difficulty was eliminated. The Seibu store subsequently announced that it was not ready to accept any orders for Sears color television receivers. Zenith subsequently concluded the time was not yet right for an effort to sell Zenith products in Japan. There are import restrictions in Japan's automobile market also. In 1976, over 2 million automobiles were sold in Japan's domestic market; approximately 40,000 were imported. No British, German, French, Italian, or U.S. automobile manufacturer has been able to penetrate the nontariff barriers that protect Japan's automakers from meaningful foreign competition. In order also to protect its very inefficient farmers, Japan has established quotas to limit the importation of food, such as fruit and beef. In the absence of such quotas, Japan's fruit and beef producers would be economically destroyed by imports. About one in every six persons in Japan's work force is employed in agriculture, and farmers constitute a critical source of support for Japan's ruling Liberal Democratic party. In addition, Japan's political leadership is seriously concerned with any course of action that might cause Japan to rely so completely on imported food as to be vulnerable to possible future supply interruptions. Economic justification? An arguable humanitarian, political, and nationalinterest case could be made to explain Japan's policy of protecting its farmers. In the case of automobiles and television receivers no similar explanations are available. The exclusion of foreign competition from the Japanese television market, however, has provided Japanese television producers with profits substantial enough in their protected home market to permit them to sell their products abroad at prices so low that they displace and/or destroy local competitors. The low prices at which Japanese television receivers are sold in the United States are not a result of superior efficiency on the part of Japanese television manufacturers. There is certainly no evidence of that superior efficiency in the prices at which Japanese television receivers are sold in Japan's home market. In addition, there is no major television plant in Japan that U.S. manufacturing and engineering executives have not visited on many occasions. Had the Japanese developed some extraordinary new manufacturing process, Americans would have learned of it as a result of their visits; or they would have suspected it because those visits were no longer welcomed. Neither has happened. Many U.S. observers have visited the extremely automated and very efficient manufacturing facilities of which the Japanese are justly proud. These plants are not, however, typical of all Japanese manufacturing facilities. About 70% of all Japanese production workers are employed in companies with under 300 employees. Only about 40% of U.S. production workers are employed in companies of a comparable size. The small Japanese companies do not approach the level of capital investment per employee or the level of output per man-hour that is achieved in the larger U.S. or Japanese plants. The U.S. Bureau of Labor Statistics reports that in 1975, the latest year for which data are available, the output per man-hour in Japanese manufacturing was about 64.9% of the output per man-hour in the United States. Expressed differently, the average American worker produced 50% more per manhour than his Japanese counterpart. Exhibit II shows the Japanese output per man-hour from 1960 through 1975 as a percentage of the U.S. output. In recent years, many Americans have been led to believe that the explanation for this country's trade problems with Japan was to be found in an American labor force unable to match the productivity of a Japanese work force that was thought to be more efficient and more industrious. There is simply no evidence to support that belief. Although Japanese television manufacturing is probably more efficient than Japanese manufacturing as a whole, the explanation for the success of Japanese television receivers in the United States is not to be found in superior labor productivity. The explanation lies in advantages Japanese manufacturers have obtained from tax rebates and from their continued ability to violate U.S. antidumping, customs fraud, and antitrust laws. 'Export subsidies' On April 3, 1970, Zenith petitioned the U.S. Treasury Department asking it to impose countervailing duties on Japanese television imports. Attached to the Zenith petition was a copy of a U.S. State Department memorandum describing the nearly dozen programs through which the government of Japan assisted television exporters with export trade bills, export insurance, plant and equipment needed to produce for export, and expenses incurred in developing overseas markets. The Japanese government even provided special tax treatment for costs incurred in entertaining foreign buyers. The Zenith petition also addressed the issue of the remission of Japan's commodity tax. Japan assesses a commodity tax equal to 15% to 20% of the factory level value of all television receivers produced for sale in the domestic market, but remits the tax when the products are exported. The Zenith petition contended that under the terms of U.S. law, the remission of the commodity tax amounted to a "bounty or grant" to exporters and that thus they should be subject to a countervailing duty. On January 7, 1976, after a delay of almost six years, the Treasury Department issued a "final negative determination" denying the Zenith petition. The delay made it impossible for Zenith to pursue, within a reasonable period of time, its contentions with respect to bounties and grants other than the remission of the Japanese commodity tax. Early in 1976, Zenith filed suit in the U.S. Customs Court asking that the Treasury be required to impose countervailing duties to offset benefits that accrued from commodity tax remissions. The case raised a legal issue involving the authority of the secretary of the Treasury, the resolution of which would have very substantial international economic consequences. The General Agreement on Tariffs and Trade (GATT), which both the United States and Japan signed in 1947, permits signatory nations to rebate so-called "indirect" taxes when a product is exported. "Direct" taxes may not be rebated. Value added, commodity, excise, and sales taxes levied on the 170 Harvard Business Review September-October 1978 Exhibit III Direct and indirect taxes of the Zenith Radio Corporation for 1976 Taxes per Zenith color receiver $28.50 27.30 $55.80 Estimated taxes on goods purchased from domestic suppliers Source: Zenith Radio Corporation financial statements, 1976 basis of the selling price of the goods themselves are considered to be indirect. Social Security, property, and corporate income taxes levied on wages, property values, or profits are considered to be direct. The Treasury Department maintained that imposing countervailing duties to offset what it found to be "nonexcessive" rebates of indirect taxes would have involved a serious violation of the GATT and would have disrupted world trade. Zenith asserted that the United States had acceded to the GATT only "to the fullest extent not inconsistent with existing legislation" and that existent U.S. law and Supreme Court interpretations of that law require that even rebates of indirect taxes be countervailed. In April 1977, Zenith's position was unanimously upheld by a three-judge panel in the U.S. Customs Court. The Customs Court decision was subsequently reversed by a 3-to-2 margin in the Court of Customs and Patent Appeals. In June 1978, the U.S. Supreme Court resolved the legal issue when it ruled unanimously that the secretary of the Treasury's interpretation of the countervailing duty statute had been reasonable and thus should not be reversed by the courts. Economic justification? While the legal issue has been resolved by the Supreme Court, the economic issue involving remissions of indirect but not direct taxes in foreign trade is likely to continue. When the GATT was adopted in 1947, economists were persuaded that indirect taxes were always and completely shifted forward into the final price of a product and that direct taxes were always and completely shifted backward to become a cost of production. Thus it was concluded that rebating indirect taxes would not provide competitive price advantages but that rebating direct taxes would. The United States obtains virtually all of its national revenues from direct taxes. Japan, as well as most European countries, obtains very substantial portions of its national revenues from indirect taxes. I can illustrate the disadvantage that the GATT tax conventions place on American manufacturers with a simplified example: Assume that products produced in both Country A and Country B are priced at $100, inclusive of all taxes, when sold in the home market. Assume further that Country A assesses only indirect taxes, Country B assesses only direct taxes, and the total of all taxes assessed in each country is equal to 10% of the value of the products sold in those countries. Finally, assume that freight and tariff costs between the two countries are insignificant. If a producer in Country A exports to Country B, $10 of indirect taxes would be remitted on the exported product. Thus, when competing in Country B, the producer from Country A would be able to price his product at $90 against locally produced products that are priced at $100 and are carrying the full burden of Country B's taxes. When a producer in Country B exports to Country A, he would already have paid $10 of direct taxes in his own country, which would not be remitted. When his goods enter Country A, they would be assessed the indirect tax that applies to all products sold there. The products of Country B would thus be priced at $110 or more in Country A where the domestic product is priced at $100. In either case, the producers from Country A have the advantage. Zenith can demonstrate that each of its color television receivers goes to market carrying approximately $85 of federal, state, and local taxes (see Exhibit III). About $28 is accounted for by income, payroll, and property taxes paid by Zenith itself. Another $27 is accounted for by income and payroll taxes paid by Zenith's employees and stockholders on salaries, wages, and dividends that are earned through Zenith's television sales. The final $30 is an estimate of the taxes that are passed on to Zenith by domestic suppliers and that must be recovered by Zenith in the prices of its television receivers. A Japanese exporter avoids virtually all of the tax burdens carried by products produced in the United States. The exporter also benefits from rebates of indirect taxes from his government. He thus obtains substantial price advantages that are attributable to inequitable tax treatment and not to competitive superiority. The problem of tax in equity is not limited to the television market. It is present in the steel, automobile, and other industries subject to import competition. The United States spends about 6% of its gross national product for defense. Defense expenditures in European countries amount to less than 3% of gross national product, and defense expenditures in Japan amount to less than 1% of gross national product. As a result, American industry carries a very heavy tax burden in absolute terms relative to its overseas competitors. It is improbable that American industry will be able indefinitely to bear these higher tax burdens, accept disadvantageous tax treatment in international trade, and compete successfully at home and abroad. A resolution of the tax issue, however, will now have to come from Congress or from international trade negotiations rather than from Ameri can courts. 'Price discrimination (dumping)" On March 4, 1971, the U.S. Tariff Commission (later the International Trade Commission) found that the U.S. television industry "is being injured by reason of the importation of television receivers from Japan, which are being sold at less than fair value." The phrase "importation... at less than fair value" means dumping, or the sale of Japanese television receivers in the United States at prices lower than those at which they are sold in Japan. Both U.S. law and the General Agreement on Tariffs and Trade prohibit dumping and provide for the assessment of dumping penalties if it is discovered. Following the Tariff Commission finding, the U.S. Treasury Department became responsible for assessing dumping penalties. The Treasury required that the importers of Japanese television receivers, other than Sony, post a 9% bond to cover dumping duties that might ultimately be assessed, but it took little action to assess the required dumping penalties. Sony was exempted from the bonding because it was found not to have been involved in the dumping. Between the 1971 dumping finding and early 1977, the U.S. Customs Service, which reports to the Treasury, sought to establish the difference between the value of imported Japanese receivers and the 3. "U.S. Probes TV Import Kickbacks," Chicago Sun-Times, July 7, 1977. 4. "Scandals-Kickbacks in Living Color," Time, June 13, 1977. value of comparable receivers sold in Japan. Customs believed that the value of receivers imported into the United States had been accurately stated on importation documents, and it concentrated its efforts on determining, through information supplied by Japanese manufacturers, the value of comparable receivers sold in Japan. However, in early 1977, when an importer volunteered to pay extra duties on Japanese sets that he had imported earlier, the validity of the pricing data on importation documents became subject to serious doubt. In an internal Customs Service memorandum, the acting assistant commissioner of Customs wrote that a Japanese manufacturer had been "presenting Customs an invoice showing one price while the actual or true price was in fact lower." A review by U.S. Customs investigators of the Zenith antitrust case public records disclosed other cases of double pricing. The memorandum to the commissioner of Customs stated that the Office of Investigations "undertook a massive inquiry of large importers of televisions, including large mass retailers as well as subsidiaries of Japanese television producers. The investigation revealed rebate schemes as well as other practices directed to the masking of potential antidumping duties." The U.S. Customs investigations uncovered schemes in which importers had been billed at what is known as a "check" price, which was also used on customs documents. Of course, the secret rebates were not reported to Customs, thus reducing the risk of incurring future dumping penalties. The Chicago Sun-Times reported that the secret payments involved deposits in Swiss bank accounts and in yen accounts in Japan and that, in some instances, satchels of cash had allegedly been brought into the United States. In June 1977, Time reported that officials of the U.S. Embassy in Tokyo were convinced a major scandal was about to break. Nine months later, in March 1978, the Customs Service turned over to the Criminal Division of the Department of Justice the evidence it had accumulated to support possible prosecutions under U.S. customs fraud statutes. After uncovering the rebate schemes, the Customs Service investigated the accuracy of foreign market value data submitted by the Japanese manufacturers. In a meeting with attorneys representing television importers, Customs reported on the results of those investigations. It found that "a significant number of the foreign market value submissions appeared questionable on their face when compared to cost of production submissions." When Customs formally requested access to Japanese cost of pro |