In 1995, the United States trade deficit with Japan was $59.3 billion; this represents a decrease of $6.4 billion or 20 percent from that in 1994. U.S. merchandise exports to Japan were $64.3 billion, $10.8 billion or 20.2 percent more than in 1994. Japan was the United States' second largest export market in 1995. U.S. imports from Japan totaled $123.6 billion in 1995, a 3.7 percent increase over those in 1994.

The value of new U.S. foreign direct investment (FDI) into Japan totaled $37 billion in 1994, up 19 percent over 1993. U.S. direct investment in Japan is concentrated largely in manufacturing, wholesale and finance.

OVERVIEW

The Framework

When President Clinton took office in 1993, he pledged to take a new results-oriented approach to dealing with trade with Japan. Whereas previous Administrations had reached bilateral and multilateral agreements with Japan, long term access to Japan's market for foreign goods and services has remained elusive. While Japan has reduced its formal tariff rates on imports to very low levels, invisible, non-tariff barriers -- such as non-transparency, discriminatory standards, and exclusionary business practices -- maintain a business environment protective of domestic companies and restrictive of the free flow of competitive foreign goods into the Japanese domestic market.

Determined to crack the unique structural obstacles to market access in Japan, President Clinton and then- Prime Minister Miyazawa signed in July 1993 the U.S.-Japan Framework for a New Economic Partnership (Framework), a new vehicle for addressing the myriad of barriers that foreign companies encounter when doing business in Japan. Under the Framework, the Administration has sought agreements with distinctly defined commitments from Japan that can be measured using quantitative and qualitative objective criteria.

This approach, which assesses the implementation and success of agreements through "tangible progress," has been successful in creating more avenues for entry into Japan's market. Under the Framework, Japan has committed to address major barriers in five sectoral and structural "baskets":

• Government Procurement: Japan committed to establishing and implementing measures to significantly expand Japanese Government procurement of competitive foreign goods and services. Agreements were reached in the telecommunications and medical technology sectors in 1994. The medical technology agreement is yeilding results in demonstrably increased sales of U.S. medical technology exports.
• Japanese Regulatory Reform and Competitiveness: To reduce the overwhelming regulations that both burden foreign and domestic firms and minimize competitiveness, Japan pledged to reform its regulatory regime and make it more compatible to foreign goods and services. Such reform measures are included in the financial services and insurance agreements, which were negotiated

under this basket. Additionally, the Deregulation and Competition Policy Working Group is addressing a number of key structural issues within the context of this basket, including: deregulation, administrative reform, competition policy, and distribution.

• Other Major Sectors: In 1995, the United States and Japan completed negotiations in the automotive sector -- the key sector under this basket -- and reached an agreement which is beginning to substantially open Japan's market to foreign autos and auto parts.
• Economic Harmonization: To correct the outstanding macroeconomoic imbalances in Japan's marketplace, especially Japan's low receptivity to foreign direct investment, negotiations under this basket concentrating on investment and long-term buyer-supplier relationships resulted in the conclusion of a bilateral investment agreement in 1995. In addition, two intellectual property agreements were reached in 1994 under this basket.
• Implementation of Existing Arrangements and Measures: Under this basket, all existing bilateral agreements are being monitored -- or have been renegotiated, as in the case of flat glass -- to ensure full implementation and market access for U.S. companies. This basket is an essential part of monitoring the numerous existing arrangements, negotiated by previous Administrations, and achieving the tangible results that this Administration seeks.

In addition to these sectoral and structural initiatives, under the Framework Japan also committed to make the necessary adjustments to the fundamental economic asymmetries that have afflicted Japan's international economic relations. In particular, Japan agreed to work toward reducing its current account surplus as a percentage of its GDP. While in 1992 Japan's current account surplus was 3.2 percent of GDP, in 1995 it had dropped noticeably to 2.5 percent despite minimal economic growth in Japan over the past three years. Additionally, in 1995, U.S. exports to Japan reached an historic high of $64 billion, nearly 20 percent greater than in 1994 and 34 percent more than in 1992. More specifically, in those sectors covered by recent trade agreements with Japan, exports have grown by more than 80 percent since President Clinton took office, and 2.5 times as fast as other U.S. exports to Japan.

1995 in Review

After nearly two years of negotiations, the United States concluded an accord with Japan in June 1995 to provide greater access to Japan's market for foreign autos and autos parts. This agreement includes broad deregulatory measures that will eliminate unnecessary and burdensome regulations placed on foreign auto parts, and contains detailed provisions for measuring anticipated sales increases of American autos and auto parts in Japan.

In January 1995, the United States also reached a market opening agreement with Japan on flat glass. Implementation of the provisions of this agreement has begun to break up the oligopolistic market share held by the major Japanese glass producers, thereby enabling American glass manufacturers to gain a solid, long- term market presence in Japan.

The United States and Japan signed a financial services agreement on February 13, 1995,allowing foreign investment advisory companies (IACs) to compete in Japan, for the first time, for the management of public pension assets and for larger shares of corporate pension assets. Japan also liberalized its corporate securities market and cross-border financial transactions. The U.S. and Japan assessed implementation of the agreement in a review meeting on February 6, 1996, and both sides agreed that the implementation was progressing smoothly.

In July 1995, the U.S. and Japan signed an agreement on inward direct investment and buyer-supplier relations. It promotes increased foreign business presence in Japan and encourages stronger links between Japanese buyers and foreign suppliers. It also details policies and measures the Government of Japan instituted during the course of the negotiations, as well as further actions Japan is taking to promote foreign direct investment.

In September 1995, USTR identified Japanese market practices in both the wood and wood products sector, and the paper and paper products sector under Super 301 as practices which could warrant future action under Section 301 of U.S. trade law. Market access barriers in these two sectors continue to restrain competitive U.S. manufacturers and protect the Japanese industry from international competitive forces.

In addition, serious problems have arisen in the interpretation and implementation of the U.S.-Japan insurance agreement. Japan's failure to meaningfully deregulate its primary life and non-life insurance sectors before allowing Japan's insurance providers to expand entry into the "third sector" is inconsistent with the terms of the bilateral insurance agreement.

In 1995, USTR also initiated a section 301 investigation into Japan's consumer color photographic film and paper sectors in response to allegations that Japanese Government policies have encouraged the creation and toleration of an anticompetitive market structure that restricts the sale of U.S. photographic film and paper in Japan. This case is a fundamental example of the difficulties that many U.S. companies face in trying to compete in Japan against established exclusionary relationships between manufacturers, distributors and retailers.

IMPORT POLICIES

Tariffs

In the Uruguay Round, Japan agreed to "zero for zero" tariffs on pharmaceuticals, paper, beer, whisky and brandy, agricultural equipment, medical equipment, construction equipment, furniture, steel and toys. Japan also adopted the Chemical Harmonization Initiative. Japan cut tariffs on copper and on aluminum, with the top rate reduced from 12.8 percent to 7.5 percent. Most of Japan's remaining high tariffs affect agricultural and food products -- including white distilled spirits, corn grits, wood and wood products, and leather and leather products.

General Food Products

In the Uruguay Round, Japan agreed to bind tariffs on all agricultural products and to reduce the bound rate by an average of 36 percent during the six-year period 1995-2000, with a minimum 15 percent reduction on each tariff line. Japan also agreed to gradually reduce tariffs on imports of beef, pork, fresh oranges, cheese, confectionery products, and vegetable oils. Imports of many intermediate and consumer-oriented food products are still accorded relatively high tariff protection.

Japan agreed to convert all import bans and quotas (with a delayed conversion for rice) to tariffs, which would be reduced gradually during the period 1995-2000. Strict import quotas for wheat, barley, starches, peanuts, dairy products and pulses were replaced by tariff rate quotas. However, Japan retains state trading authority and price stabilization schemes.

The U.S. is closely monitoring Japan's implementation of the Uruguay Round measures for agriculture, including safeguard measures for beef and pork, and is continuing bilateral efforts to counter any technical or food safety-related measures that threaten to impede imports.

Leather and Leather Footwear

In March 1991, Japan liberalized treatment of footwear imports, setting a footwear quota of 2.4 million pairs per year. In JFY 1993, the quota was set at 6.955 million pairs and raised to 8.34 million pairs in JFY 1994. The JFY 1995 quota was just over 10 million pairs. MITI will not confirm that it will continue to expand the quota in the future, but U.S. industry expects continued quota increases of about 20 percent per year. The U.S. Government and U.S. leather and leather footwear industries have been pushing for elimination or further liberalization of the quotas.

In the Uruguay Round, Japan undertook to reduce over an eight-year period tariffs: on under-quota leather footwear (from 27 percent to 21.6 percent); on the tariff category that includes crust leather (from 20 percent to 13 percent); and on other leather categories (from 20 percent to 16 percent). Footwear imported above tariff rate quota levels faces a tariff of 52.3 percent or 4,675 yen, whichever is higher. By 2002, this will drop to 30 percent or 4,300 yen, whichever is higher. In principle, the over-quota tariff rate was reduced 50 percent from the 1994 rate, but the operative tariff is the yen minimum alternative rate. This was reduced by 10 percent over the eight-year period.

The quota has resulted in high quality and high fashion manufacturers in France and Italy taking a large percentage of Japan's leather shoe import market. The American share of the leather shoe market has fallen. Leather shoe manufacturing continues to slowly decline in Japan, while imports of leather uppers grew by 31 percent to 14 million pairs in 1994. Finally, it should be noted that 50 million pairs of non-leather, athletic shoes were imported into Japan in 1994. Most of these were American-branded products manufactured in Asia.

Wood Products

Japan is the United States' largest export market for wood products. U.S. exports to Japan totaled $3.25 billion in 1995, up 4.3 percent from 1994. Raw logs and chips accounted for 68 percent of the trade flow.

The 1990 U.S.-Japan Wood Products Agreement addresses: tariff reduction, tariff reclassification, consistency of Japanese subsidies with international agreements, improvements in product standards and Japanese certification procedures, and liberalization of building codes/standards -- particularly for regulations that are not performance-based. Japan has implemented most of the agreement's specific obligations, but a range of barriers still impede import access and wider use of wood products in the market. Therefore, the agreement has not fully realized its broad objectives of increasing Japanese imports of value- added products and of the use of wood.

Wood tariffs are being reduced under Japan's Uruguay Round commitments, but continue to pose a significant access barrier. The U.S. Government continues to seek further reductions.

Subsidies to the Japanese forest product industries warrant continued scrutiny to ensure that U.S. access gains are not diminished unfairly. Progress has been made toward the adoption of performance-based codes and standards in Japan, but more steps are needed to allow greater use of wood building materials and construction systems.

Japan's restrictions on market access for wood products were identified in 1994 and again in 1995 as a practice that may warrant future identification as a priority foreign country practice under Super 301. There have been several rounds of discussions with the Japanese Government, at both policy and technical levels, to monitor implementation of the 1990 measures and to identify areas for improvement. Some progress toward resolution of standards-based barriers was made in the February 1996 talks. The United States continues to make elimination of market access barriers and increased importation of value-added wood products in Japan a priority.

An imported housing initiative announced by Japanese Prime Minister Hashimoto in February 1996, if fully implemented, will create new and expanded opportunities in Japan for U.S. building materials. The initiative includes promotion of wooden materials and North American construction methods, including expanded construction of wooden three-story apartment buildings, a renewed effort to move toward performance-based standards, and recognition of U.S. grademarks.

Fresh Agricultural Products

Japan continues to restrict, for phytosanitary reasons, the entry of numerous U.S. fresh fruits, vegetables and other horticultural products. Some products like tomatoes, potatoes, and plums are banned outright due to Japanese concerns about entry of pests or plant diseases. In other cases, such as apples, cherries, and nectarines, phytosanitary protocols may include only specific limited product varieties, while excluding other almost identical varieties. This has occurred despite presentation of evidence that treatments that are effective against pests attacking one variety can easily be extended to new varieties. Under the current system, new varieties must undergo costly and time-consuming additional scientific research and testing to be allowed entry under a phytosanitary protocol.

For some products, Japan requires production site inspection by Japanese Government inspectors, even if the Agriculture Ministry cannot provide enough inspectors to do the job expeditiously. In annual bilateral discussions and under the auspices of Government of Japan deregulation initiatives, the United States has requested that Japan allow U.G. Government personnel to do some of the work under Japanese Government supervision. Shortages of inspectors and overly restrictive procedures in certain cases are serious restraints to increased trade.

Japan's often excessive fumigation requirements are also a concern. Japanese plant quarantine regulations require fumigation of imported fresh fruits and vegetables if, upon inspection, a shipment is found to be infested with live insects, regardless of whether or not such insects (such as scales and aphids) are already present in Japan. This has proved particularly detrimental to imports of more delicate fresh produce such as lettuce, strawberries, and avocados.

The U.S. Government continues to give high priority to removing unwarranted restrictions to imports of U.S. fresh produce in Japan, with particular emphasis on improving access for items such as tomatoes, potatoes, peppers, additional apple varieties, eggplant, and fresh plums.

Feedgrains

Japanese potato starch production is protected by tariff-rate quotas (with high over-quota tariffs for starch), limitations on imports of corn for use in the starch industry, and a blending requirement for imported starch and domestic potato starch. These protective measures make starch and its secondary products, such as organic acids, inordinately expensive for industries which use them as inputs, and make these industries less competitive. The Uruguay Round established an import quota for corn to be used to produce starch for "new uses;" a part of this corn is exempt from the blending requirement. About 90 percent of the "new uses" import quota was used in JFY 1995. The portion of the "new uses" quota that was allocated to the production of biodegradable plastics was not used.

Corn imported for livestock feed use is subjected to an elaborate control system to ensure that it does not enter the starch production stream. Import control measures make feed more expensive than necessary for livestock producers, and make it difficult for Japanese animal growers to compete with imported meat. In recent years, Japan has taken several steps that have liberalized the feed control system somewhat. In 1995, Japan established a tariff quota system for whole shelled corn for feed, and proposed a new system for whole grain barley imports for feed. About 30,000 MT of whole shelled corn was imported under the new tariff- rate-quota (TRQ) in JFY 1995. Japanese farmers have been less than enthusiastic about using the new corn TRQ because of the lack of transparency in pricing and payment terms, requirements for submission of detailed documentation, and costly grain inspections.

Fish Products

Japan maintains seven global and two bilateral import quotas on fish products. U.S. fishery exports to Japan subject to import quotas include: pollock surimi, pollock roe, herring, cod, mackerel, whiting, squid, and several other fish products. These quota-controlled imports into Japan accounted for more than $600 million in sales in 1995, approximately one-fourth of total fishery exports to Japan. In the past several years, there has been a downward trend in sales of these import quota-controlled items, largely a result of which reflects the economic recession in Japan and stagnant markets and prices.

In the Uruguay Round, Japan agreed to cut tariffs by about one-third on a number of fishery items, but avoided commitments to modify or eliminate import quotas. (Because the Uruguay Round agricultural negotiations did not require commitments on fish, Japan has no obligation to convert non-tariff measures to tariff-rate quotas.) While Japan has taken steps to improve its administration of the import quotas, especially the application procedures, the lack of transparency still causes concerns for U.S. exporters. At the January, 1996 session of the annual fishery trade consultations, the United States and Japan agreed to continue formal discussions to identify solutions to these import quota issues, and to exchange papers on these issues.

Distilled Spirits

In 1987, a GATT panel found that Japan's excise tax system unfairly discriminates against imported distilled spirits in favor of the domestic distilled spirit shochu. Afterward, Japan reduced the extent of discrimination, but Japan still maintained taxes on shochu far below those on imported whisky, brandy and white spirits. Imported distilled spirits are significantly disadvantaged on the retail level. Industry comments and market surveys demonstrate that the excise tax discrimination is the number one remaining market access barrier for U.S. exports to Japan of Bourbon, Tennessee whiskey, rum, gin, vodka and other brown and white spirits. Japan is the second-largest market for U.S. distilled spirits exports. Elimination of the discrimination is particularly important in view of Japan's agreement to eliminate tariffs on brown spirits, and the high growth potential of this market.

Meetings between foreign industry representatives and Japanese officials, and bilateral government-to-government contacts on the subject, have proved unfruitful. In September 1995, the United States joined the EU and Canada in initiating WTO dispute settlement proceedings. The panel has met with the disputing parties twice, and its report is expected in July 1996. Under WTO rules, Japan will not be able to block adoption of the panel report.

Racehorses

The Japan Racing Association (JRA) is permitted by the Government of Japan to restrict participation of foreign horses in Japanese races. In addition, only Japanese residents may register with the JRA as racehorse owners in Japan. The United States and other countries have pressed Japan to liberalize access for foreign horses, with some modest success. In 1995, six JRA races were opened to foreign racehorses with race experience outside Japan. The JRA has announced that it will increase this number to twelve by 1999. The U.S. Government will continue to press Japan for further liberalization.

Rice

Under the minimum access agreement of the Uruguay Round, Japan committed to import four percent (379,000 tons, milled rice basis, or 426,000 tons, brown rice basis) of Japan's total domestic rice consumption in JFY 1995. Within this import commitment, Japan also has established a Simultaneous Buy- Sell (SBS) system for some imported rice, allowing importers and exporters to set quality and other requirements, subject to Food Agency (Ministry of Agriculture, Forestry and Fisheries (MAFF)) approval. In addition, Japan has agreed to double the amount of imported rice to eight percent of domestic consumption by JFY 2000.

During JFY 1995, Japan imported 408,794 tons of rice (actual tonnage basis). Of this amount, 193,715 tons (47.4 percent) originated in the United States. Of the total, 188,000 tons of rice entered under the Food Agency's "ordinary import" system (U.S. share: 47.2 percent), and 5,715 tons were imported under the SBS system (U.S. share: 53.4 percent). Japan also imported 3,000 tons of rice flour for use in textile dyeing, and 1,200 tons of bumped rice for the manufacture of breakfast cereal.

The U.S. Government has worked closely this year with the Food Agency, as well as other agencies of the MAFF, to assure that the Japanese rice tender system does not operate in a way that is prejudicial against U.S. growers. Both the U.S. Government and U.S. industry expect to continue to work closely with Japanese importers and the MAFF during JFY 1996 to obtain the maximum possible access for U.S. rice

Import Clearance Barriers

Slow import clearance into Japan hinders access by Japanese companies and consumers to competitive U.S. products. U.S. air cargo companies incur high costs in processing imports into Japan and face bottlenecks in clearance procedures as well. The problem has become increasingly important as more U.S. exporters try to become "just in time" suppliers to Japanese companies and as more U.S. mail-order companies market aggressively in Japan. In 1990, a joint U.S.-Japan working group reviewed U.S. and Japanese import procedures and issued a final report stating that Japan would make efforts to promote pre-arrival processing and reduce import clearance time to 24 hours.

Results have been disappointing. While Japan now accepts electronic submission of customs data prior to the arrival of cargo, importers that submit their data early receive no benefit in faster processing or clearance. U.S. Customs encourages importers to file their documents prior to arrival of the cargo and, prior to arrival, advises the importers when no physical examination will be required. Japan also committed to reduce import clearance time to 24 hours. While the time required to process customs paperwork has dropped to less than one day, overall import processing time (from arrival of merchandise at port to release by Japanese Customs) remains 2.9 days (4.8 days for sea cargo and 1.7 days for air cargo). U.S. Customs clears over 90 percent of air cargo within 30 minutes of arrival.

For many commodities, import clearance requires approval from other agencies in addition to customs. The Japanese cargo clearance system has made progress in automating customs procedures, but there has been little progress to integrate the requirements of other agencies. The speed of import clearance is controlled by the agency with the slowest procedures. The United States continues to request that all import clearance procedures be coordinated to assure expeditious clearance.

STANDARDS, TESTING, LABELING AND CERTIFICATION

Standards, testing, labeling and certification problems hamper market access in Japan. In some cases, advances in technology make Japanese standards outdated and restrictive. Japanese industry often supports safety and other standards that are unique and restrict competition. In some areas, the Government of Japan has simplified, harmonized and eliminated restrictive standards to follow international practices.

The principal organization that adjudicates standards and certification disputes between foreign companies and the Government of Japan is the Office of the Trade and Investment Ombudsman (OTO). In 1994, the OTO chairmanship was transferred to the Prime Minister's office, and the OTO was authorized to recommend actions to appropriate ministries. Because the OTO's recommendations do not have the power of law and the OTO has no enforcement authority, these recommendations have not resulted in greater success for U.S. firms taking cases to the OTO.

The American Chamber of Commerce in Japan raised six issues with the OTO: liberalization for sales promotion; higher weight allowances for sea containers; acceptance of clinical data by independent research organizations; fewer restrictions on herbal ingredients; reforms in Japan's drug control and licensing system; and changes in biodegradation tests for new chemicals. The OTO Advisory Committee has agreed to investigate all six issues, and in early 1995, the OTO met with foreign interests and relevant ministries on the first three issues. The United States has raised some two dozen issues with the OTO. The results from the OTO process generally have been unsatisfactory.

Since OTO recommendations do not have the force of law, Japanese Government agencies frequently ignore or reject them, as in the case of large-class, foreign-made motorcycles. The OTO has made most progress in technical areas where complainants made strong cases and where Japanese Government bureaucratic resistance to change was light.

Pharmaceuticals/Medical Devices

The Administration continues to actively pursue improved medical and pharmaceutical product market access in the context of the Market-Oriented Sector-Selective (MOSS) Medical Equipment and Pharmaceutical talks. One issue under regular discussion in the MOSS is reimbursement rates under Japan's national health insurance system for U.S. medical equipment and pharmaceutical products. The United States is concerned that reimbursement prices in Japan often do not adequately compensate firms for the costs inherent in developing and marketing new, innovative medical equipment and pharmaceutical products in Japan. Japan is currently in the midst of a biannual price revision which will affect reimbursement prices for a wide range of U.S. products. This project should be completed by April 1, 1996. The United States is carefully monitoring this process through consultations with industry and through the MOSS.

At a recent MOSS meeting, Japan announced its intention to reduce the "R-Zone" for medical devices from the current 15 percent to a lower level. If implemented, this action will make it even more difficult for U.S. firms to sell their products in Japan at reasonable prices. Japan did not adequately consult with U.S. industry or the U.S. Government prior to making this announcement. At present, the U.S. Government is working to resolve this issue. In addition, the U.S. Government is concerned with a wide variety of other obstacles faced by U.S. pharmaceutical and medical equipment manufacturers when they seek to market their products in Japan. These range from a slow and sometimes non-transparent approvals process to regulations that prevent certain products from being sold in hard gelatin capsules in Japan.

The U.S. medical products industry continues to support Japan's deregulation initiatives. For the second year in a row, it provided Japan with a list of regulations that inhibit the ability of foreign firms to do business in Japan. The U.S. Government also included extensive deregulation suggestions in this section in the November 1995 U.S. deregulation submission to the Government of Japan. Several of these issues have also been raised in the MOSS process.

Food Additives

Processed food product imports are often hampered by rigid and restrictive "use" standards that are applied to additives that are generally recognized as safe in every other part of the world. As part of the first general revision of the Food Sanitation Law in 23 years, Japan is moving to bring its positive list for food additives in line with WTO Sanitary and Phytosanitary (SPS) measures, but regulation of chemically-synthesized food additives remains unusually strict. The U.S. Government encourages U.S. firms and industry associations to file applications with Japan's Ministry of Health & Welfare in order to initiate approval processes for new food additive approvals.

Pesticides Residue

The Ministry of Health & Welfare continues to establish new residue standards for pesticides, including full notification to the WTO and provision for comment and review. The U.S. Government is providing scientific data pertaining to relevant U.S. and international standards for the chemicals concerned.

Japan is currently in the process of adding residue standards for an additional thirty chemicals to its pesticide registration list. Once these chemicals are subjected to the WTO notification/comment procedures, they are expected to be finalized in Japan later this year and become effective in early 1997.

While the the Government of Japan has made some progress in establishing residue standards in line with internationally recognized tolerance levels, more government action remains necessary to help counter misleading information regarding the safety of imported food and agricultural products.

Fresh Fruits and Vegetables

Japan restricts, for phytosanitary reasons, the entry of numerous U.S. fresh fruits and vegetables, such as pears and tomatoes. Japan currently has phytosanitary barriers on the following U.S. agricultural products: cabbage, eggplant, pears, peppers, stone fruit, sweet potatoes and tomatoes. Some products, like potatoes, are banned outright due to Government of Japan concerns about the golden nematode and potato wart disease.

In the cases of cherries, nectarines and apples, phytosanitary protocols include only specific limited product varieties, while excluding other, almost identical varieties. This occurs despite evidence that treatment effective against pests for one variety can easily be extended to new varieties. Under the current system, new varieties must undergo costly and time consuming additional scientific research and testing to be allowed entry under a phytosanitary protocol.

For some products, Japan requires inspection at the U.S. growing site by Japanese Government inspectors, even though the Agriculture Ministry does not provide enough inspectors to do the job. The United States is pressing the Government of Japan to add more inspectors or to allow U.S. Government personnel to do some inspections under Japanese Government supervision. The insufficient number of Japanese inspectors restrains increased trade.

In many cases, instead of basing phytosanitary policies on sound science, Japan simply maintains a policy of "zero tolerance" for many products. Japan requires fumigation of imported fresh fruits and vegetables if, upon import inspection, a shipment is found to be infested with live insects, regardless of whether such insects, such as scales and aphids, are already present in Japan. California avocados with Latania scale are sprayed with hydrogen cyanide upon entry into Japan, even if the pest is dead. Periodic technical discussions are held between U.S. Government and Japanse Government plant quarantine authorities to establish safeguard measures that will facilitate exports of restricted items to Japan. Progress has been slow.

GOVERNMENT PROCUREMENT

Japan increased efforts to open its government procurement markets to imported goods and services with action plans in the mid-1980s, and "voluntary measures" in 1991 and 1994. The 1994 initiative improved bid notification and information dissemination, and included specific procedural reforms for procuring medical technology and telecommunications products and services.

The United States has negotiated bilateral agreements with Japan to help improve foreign firms' access to six Japanese public sector markets for computers, telecommunications equipment and services, medical equipment, satellites, major construction projects, and supercomputers. Structural problems and an entrenched legacy of restrictive "Buy Japanese" purchasing practices, especially at the local level, still hamper foreign firms seeking market access. Barriers also affect purchases subject to formerly GATT and now WTO Government Procurement Agreement requirements.

Lack of uniform, centralized procurement processes and difficulty in establishing long-term relationships with Japanese government procurement officials hurt foreign firms in Japan. Japanese law specifies general government contracting procedures, but details are governed by internal notices, which differ by ministry and entity. The Government of Japan is developing a standardized bid format for all ministries. While Japan reports procurement to the WTO, there is no monitoring of Japan's "voluntary" changes or their impact on public sector markets outside of the areas covered by bilateral agreements.

The WTO Government Procurement Code took effect January 1, 1996. With recent government procurement agreements, the United States and Japan have extended Code coverage bilaterally for central governments, subcentral governments (including prefectures) and government-owned enterprises. Local and prefectural government procurements have posed major difficulties for foreign firms as they lack uniform procurement procedures, limit access to information on planned projects, and hinder foreign firms' participation in early development of systems. The implementation of the WTO Government Procurement Agreement by prefectures and the twelve designated cities in 1996 should improve the procurement environment at the subcentral and local level. This also raises the value of goods and services procurements that Japan will cover under the WTO, especially for public works. In addition, under the 1994 agreements, the Japanese Government has agreed to urge local and prefectural governments to adopt more transparent procedures and to give full consideration to foreign suppliers.

Because Japan has not included its National Space Development Agency and its electrical power generation entities in this coverage, the United States has not covered NASA and U.S. government-owned power generation entities with respect to Japan.

Quasi-governmental entities and third sector projects (Japanese government and private sector joint ventures) are not covered by Japan's WTO Procurement Code commitments or Action Plans, but they increasingly purchase services and goods that formerly were the responsibility of national and local governments. Official Japanese data show that there are 6,659 quasi-government entities with more than 25 percent local government equity. (The figure would be higher if entities with central government equity were included.) Without coverage under the WTO Government Procurement Code, bilateral agreements, and Japanese Action Plans, the United States is concerned that a large amount of potential procurements of U.S. goods and services by quasi-governmental entities and third sector projects will be lost.

Computers

The United States and Japan signed a government procurement agreement on computers January 22, 1992, which commits Japan to adopt non-discriminatory and transparent measures in order to expand government purchases of competitive foreign computer products and services. The agreement makes procedural improvements in Japan's public sector computer products and services procurement regime and calls for an annual review to assess implementation.

The agreement commits Japan to assess its implementation of the measures based on hard data -- including annual purchasing data for all Japanese public sector procurements -- broken down by foreign computer manufacturers and domestic computer manufacturers, and the level of participation of foreign computer firms in Japan's public and private sectors.

The most recent U.S. industry survey revealed that total foreign share of the Japanese public sector computer market grew from nine percent in 1993 to 14 percent in 1994. Foreign share of the public sector market, however, still falls far below the foreign share of Japan's private sector computer market, which reached 37 percent in 1994.

With regard to specific segments of the market, foreign share of the Japanese national government procurement market doubled from 6 percent in 1993 to 12 percent in 1994. This segment of the market accounts for almost 40 percent of the total Japanese public sector computer market. Foreign share in Japan's quasi-government computer procurement market declined, however, from 33 percent in 1993 to 21 percent in 1994. Foreign share grew slowly in the local government computer market. The United States placed Japan on the Title VII Government Procurement "watch list" in 1995 due to continued discriminatory practices in the computer sector. The two Governments held consultations in February 1996 to discuss these data and other implementation issues.

In particular, at these consultations the United States raised the potentially serious implementation problem of deep discounting of prices on personal computers and related equipment by Japanese computer companies in their sales to Japanese public sector entities covered under the agreement. The agreement provides detailed rules on procedures entities must follow should they suspect that companies are submitting "unfair bids." These procedures include voiding the bid, preventing the bidder from resubmitting a bid on that procurement, publicly announcing the name of the bidder, and providing information to the Japan Fair Trade Commission. At the 1996 consultations, the Government of Japan agreed to look into this matter and provide a detailed response. The U.S. Government will continue to monitor closely the situation with regard to pricing and take steps as necessary to ensure Japanese compliance with the Agreement.

Major Projects Arrangement

The United States-Japan Major Projects Arrangement (MPA), signed in 1991, is discussed under the title "Construction, Architectural, and Engineering Services."

Medical Technology

The United States concluded a medical technology agreement with Japan on October 1, 1994, under the Framework in order to improve representation of U.S. medical device manufacturers in Japan, and to increase sales of U.S.-made medical technology products in the Japanese market, particularly in the government procurement market. U.S. firms are highly competitive in medical technology throughout the world, and hold a global market share of 52 percent. In Japan, however, the market share of U.S. industry is at the relatively low level of about 21 percent, reflecting the existence of substantial market access barriers in this sector. The nontransparent nature of Japanese government procurement of foreign medical technologies has been a significant obstacle to increased market access by foreign firms.

The 1994 agreement calls for the Framework goal of a "substantial" increase in access and sales of foreign competitive products and services. In accordance with the Framework, the medical technology agreement includes a set of five quantitative and five qualitative criteria to assess the implementation of this agreement, including: yearly measurement of the number of Japanese entities procuring foreign products and services; the number and value of contracts awarded each year as a result of a decrease in single tendering; and the results of reviews conducted by the Procurement Review Board.

The medical technology agreement and accompanying exchange of letters represent an important step forward in the ability of foreign firms to sell medical technology products and services to Japan's public sector. The agreement is designed to give foreign medical technology companies improved access to Japan's $2.6 billion government procurement market. The agreement also provides for the head of each entity to encourage its procuring officials to consider positively the procurement of foreign medical technology products and services.

Another key element of the agreement is the requirement that Japanese medical technology procurement decisions for purchases above a threshold be made on the basis of overall greatest value, instead of the current minimum price system. The threshold will be reduced in value over a four-year period from 800,000 SDRs to 385,000 SDRs. For the first time, equipment cost of these items will be calculated on a life-cycle basis. This means that the highly sophisticated medical technology products manufactured by foreign firms will not be excluded automatically because of initial price. The technical excellence of those products, and the value they provide over the long term, will now be taken into account.

Also for the first time, the agreement requires government hospitals in Japan to make procurement information public, regardless of value. Each hospital will publish, on an annual basis, information on the top ten medical technology products it plans to purchase during the upcoming year. Previously, this important information had not been readily available.

The agreement also contains both a comprehensive complaint mechanism and procedures for dealing with unfair bids. In the accompanying exchange of letters, the U.S. Government has received assurances from the Government of Japan that it will provide adequate budgets -- and therefore sales opportunities -- for the purchase of foreign medical technology products and services.

The agreement went into effect on November 1, 1994. A review of the agreement was held in July 1995 to assess preliminary market share data and progress in the implementation of procedures to establish more transparent tendering practices. Because the review was held less than nine months after the signing of the agreement, only preliminary data were available to assess the foreign share of Japan's public sector medical equipment market. The Japanese Government calculated a foreign equipment market share of 42.5 percent. This figure includes sales of foreign products by Japanese distributors, all imports, including those from overseas Japanese production facilities, and all products sold under foreign brand-name regardless of location of manufacture or capital affiliation. The U.S. Government could clearly identify only 18 percent of the market as being held by foreign firms, although this figure almost certainly undercounts the foreign share since sales of U.S. products by Japanese distributors are particularly difficult to track. The next review should allow for more precise examination of market shares and will be held in the summer of 1996.

The review also found that the Japanese Government had made good progress toward implementing the transparent and open procurement procedures called for in the agreement. Few procedural concerns were identified by U.S. firms and the issues that were raised were satisfactorily addressed during the review.

Satellites

The U.S.-Japan satellite procurement agreement was signed June 15, 1990. The agreement was negotiated under the Super 301 provisions of U.S. trade law. It binds the Japanese Government to open non-R&D satellite procurements to foreign satellite makers. It also enables foreign suppliers to compete in procurement for broadcast satellites by the government-owned television/radio service (NHK) and NTT. To continue encouraging Japan to open this market, the U.S. Government requested in its November 1995 deregulation submission that the Government of Japan bring restrictions regarding earth stations into accordance with international standards.

Since the agreement went into force, U.S. firms have been awarded a number of contracts. In December 1991, a U.S. firm won its first open satellite contract for two geostationary communication satellites valued at $600 million. A second contract with NHK, valued at $70 million, also was awarded to a U.S. firm in September, 1992. In addition, another U.S. firm was selected to build NHK's BS-4 series follow-on broadcast satellite. In 1993, NTT awarded a $350 million contract for two INSTAR communications satellites to a U.S. firm for launch in 1995.

A potential issue of concern has been raised regarding procurement of two mission demonstration satellites by Japan's National Space Development Agency. The U.S. Government is currently looking into this matter.

Supercomputers

Japan's public sector supercomputer market has been the focus of extensive bilateral negotiations. Japan failed to live up to its obligations under the 1987 Supercomputer Arrangement, prompting the U.S. in 1989 to cite Japan under U.S. Super 301 provisions for effectively denying access to its public sector procurement.

Subsequent negotiations produced the June 1990 U.S.-Japan Supercomputer Arrangement, which contains detailed procedures for an open, transparent, and non-discriminatory public procurement process and requires Japanese Government procurements to be based on competitive factors. The 1990 arrangement had little success in its first three years: U.S. firms won only 3 of 11 Japanese Government supercomputer procurements. All three U.S. machines were selected in uncontested bidding and did not appear to be based on application of the arrangement's procedures. In particular, the United States had concerns about bid specifications, benchmark testing, and the setting of bid prices. There also were concerns about the arrangement's protest mechanism, which in 1992 in the first and only bid challenge, failed to demonstrate adequately that the system in question met all the bid requirements.

In April 1993, the U.S. Government began a special review of Japan's compliance with the arrangement under section 306 of the 1974 Trade Act. Subsequently, U.S. supercomputer sales in Japan's public sector market began to improve. In the JFY 1993 procurement cycle, the Japanese Government bought six U.S. supercomputers out of a total of 14 awards, all in uncontested bids. In the JFY 1994 cycle, the Japanese Government purchased six U.S. supercomputers out of 13 awards. The U.S. also won for the first time in head-to-head competition with a Japanese competitor. Nonetheless, concerns over Japan's conduct of the procurement process persisted and the section 306 review, which has no statutory limitation, was extended in April 1994 and again in April 1995.

The positive trend in Japanese Government supercomputer procurement witnessed in JFY 1993 and 1994 was reversed in JFY 1995, during which U.S. firms won only one of 11 Japanese Government procurements. Moreover, the United States has serious concerns about the conduct of the procurement process in two specific procurements.

U.S. Government officials raised these concerns at the latest review of the U.S.-Japan Supercomputer Arrangement held in February 1996. In particular, the U.S. Government posed questions on bid specifications, the conduct of benchmark testing, and the ability of the winning supplier to deliver the machine by the delivery deadline. Additionally, the United States raised concerns over discounting of prices by Japanese companies in their sale of supercomputers to Japanese public sector entities covered by the arrangement.

The arrangement provides detailed procedures that entities must follow with regard to each of these procedures. On "unfair bids," these procedures include voiding the bid, preventing the bidder from resubmitting a bid on that procurement, publicly announcing the name of the bidder, and providing information to the Japan Fair Trade Commission. On benchmarking, the procedures require the supplier with the winning bid to deliver the machine by the announced delivery date or the entire procurement must be rebid. At the February 1996 consultations, the Japanese Government agreed to look into these matters and to provide a response to the United States. In addition, the Government of Japan agreed to work with the U.S. Government to confirm delivery of two JFY 1995 procurements of concern to the United States. The U.S. Government will continue vigorously monitoring this Arrangement and, as necessary, take steps to ensure Japanese compliance with its measures.

Telecommunications

NTT Arrangement: The 1994 Improvement Measures of NTT Procurement Procedures, the fifth renewal of the NTT Procurement Agreement will be in force until September 30, 1997. Under this latest renewal, NTT agreed to improve its procurement procedures to provide greater transparency and more timely notice for foreign suppliers. The improved measures are intended to increase reliance on international standards and to improve the impartiality of the process by reducing single-tender sourcing and incorporating a number of objective criteria for assessing progress under the measures. In addition, three NTT subsidiaries -- NTT Data Communications Systems Corporation (NTT Data), NTT Mobile Communications Network, Inc. (NTT DoCoMo) and NTT Power and Building Facilities, Inc. (NTT Facilities) -- have agreed voluntarily to adopt these procedural improvements fully.

Foreign firms' share of NTT purchases of telecom products was about 10 percent in JFY 1994 (about $1.01 billion, at the then-current exchange rate of Yen 100 to $1). Foreign share of NTT's telecom product procurement increased by only one percentage point, from approximately nine percent in JFY 1993.

With increases of only one percent per year, there is still significant room for removing obstacles in the NTT procurement process, the single, largest purchaser in Japan's public and private telecommunications equipment markets. U.S. industry continues to report: anticompetitive preferences shown to traditional NTT suppliers; continued NTT reliance on Japan-specific and NTT-specific standards, as opposed to international standards; use of inadequately documented product specifications; lack of access to critical pre- solicitation phases of major NTT procurements; and the absence of clearly defined criteria for bid evaluations. The relatively low level of U.S. firms' sales to NTT, considering U.S. firms' global competitiveness and approximately 25 percent share of the world market, is indicative of these problems. The United States continues to monitor this sector closely and will hold a bilateral review of the improved measures in mid-1996 with the Government of Japan.

Public Sector Procurement Agreement on Telecommunications Products and Services: The 1994 U.S.-Japan Public Sector Procurement Agreement on Telecommunications Products and Services was intended to improve access and sales for foreign telecommunications firms selling to Japan's public sector. Pursuant to the agreement, Japan has introduced procedures to eliminate barriers such as: obstacles to participation in pre-solicitation and specification-drafting for large-scale telecommunications procurements; ambiguous award criteria that do not use greatest overall value in making procurement decisions; excessive sole sourcing; and the absence of an effective bid protest mechanism. The public sector procurement agreement also has quantitative and qualitative criteria for measuring progress: annual value and share of foreign products; annual numbers of entities buying foreign products and services; annual numbers and values for contracts awarded as a result of single tendering; and new subcontracting opportunities for foreign suppliers.

U.S. firms expect these provisions to improve their access to Japan's public sector telecommunications market but continue to have concerns about implementation, notably Japan's weak commitment to award bids in line with international standards and on the basis of function rather than design. Concerns also remain about inadequate access to advance information on bids and agencies' long-term procurement plans, as well as early participation in designing bid specifications.

The agreement was reviewed for the first time in July 1995. At that time, preliminary data showed a welcome decline in sole-source bids, but little improvement in foreign market share. U.S. data, based on announcements in the government publication Kampo, showed that foreign firms had approximately a three percent share of central government procurements in 1994, a low figure considering U.S. firms' competitiveness in the global telecommunications market.

PROTECTION OF INTELLECTUAL PROPERTY RIGHTS

Since 1989, Japan has been placed on the Special 301 "priority watch list" of countries from which the United States sought stronger intellectual property rights (IPR) protection. IPR has been the focus of U.S.-Japan discussions in a number of fora, bilaterally and multilaterally. The United States' most recent concern is Japan's failure to implement its WTO obligation to provide protection for pre-existing sound recordings produced between 1946 and 1971. As a result, USTR initiated WTO dispute settlement proceedings against Japan on February 9, 1996. Another major concern is the practice of Japanese courts interpreting patents very narrowly, allowing competitors to conduct activity that would be considered infringing in the United States and in most other countries.

Sound Recordings

In 1995, the U.S. became aware that Japan, in implementing its Uruguay Round obligations, had failed to adequately address the protection of pre-existing sound recordings. Japan is willing to protect under its copyright law pre-existing foreign sound recordings only from 1971 onward. This appears to be in violation of Japan's obligations under TRIPs Article 14.6, which applies the provisions of Berne Article 18 to the protection of sound recordings. Berne Article 18 generally requires that a country must protect the pre- existing works originating of other Berne member-countries if those works have not fallen into the public domain in the country of origin -- in this case the United States -- and have not enjoyed a full term of protection in the country providing the retroactive protection -- in the case Japan. These TRIPs obligations for Japan (and other for other developed countries) became effective on January 1, 1996.

The U.S. Government consulted extensively with Japan in 1995 to address this issue. Unable to reach a solution, on February 9, 1996, the United States initiated proceedings under the WTO Dispute Settlement Understanding against Japan for its failure to adequately protect sound recording copyrights of American artists.

Other Copyright Issues

U.S. computer software groups are very concerned about the significant problem of end-user piracy in the computer software industry in Japan. The Government of Japan's failure to initiate investigations of those responsible, or to prosecuting pirates vigorously, acts as a barrier to trade.

Patents

The Japanese patent philosophy historically has encouraged technology sharing over proprietary use. As an outgrowth of this philosophy, foreign companies face a series of obstacles in trying to obtain patent rights in Japan, including: narrow claims and patent interpretation; patent-flooding; a difficult and very slow judicial appeals process; pre-grant opposition to a lengthy review process; and a Japanese language filing requirement. These specific problems have been of particular concern to U.S. applicants for patent rights in Japan, some of which are addressed by two agreements signed during 1994.

IPR Agreements: During 1994, two bilateral agreements on IPR were concluded under the Framework. The first agreement, signed on January 20, 1994, addressed a number of outstanding issues: including permission to file patent applications with the JPO in English; correction of translation errors after patent issuance; and changes in the U.S. patent term from 17 to 20 years.

On August 16, 1994 a second agreement was signed with specific provisions to revise the Japanese patent "opposition" system. Under this agreement, the JPO agreed to: by April 1, 1995 introduce legislation to end the practice of allowing third parties to oppose a competitor's patent before it is granted and to hear all opposition claims at the same time; by January 1, 1996 establish an accelerated patent examination procedure that will enable applicants to obtain disposition of their patent applications within 36 months, upon request; and by July 1, 1995 end the practice of awarding dependent patent compulsory licenses in cases other than where anticompetitive practices have been found. Compulsory licensing has been used in the past to force patent holders to license the use of their technology to competitors, thus limiting their exclusive rights in their inventions.

The agreement also requires the United States PTO to publish pending patent applications 18 months after filing and expand reexamination proceedings to allow greater participation by third parties. Legislation implementing these provisions in the United States has not yet been enacted.

Remaining Problems: There are some very significant problems with the Japanese patent system not covered by the above agreements. Two important examples are narrow patent claiminterpretation before the Japan Patent Office and narrow patent claim interpretation in the courts, both of which have caused serious problems for U.S. innovators in Japan.

During 1995, Japan modified its patent examination guidelines in a manner that may alleviate some U.S. concerns about narrow patent issuances by the JPO. In the past, Japan limited the scope of patent claims to cover only what had been specifically "reduced to practice" and described in the application; i.e., a claim could be no broader than the specific examples actually made and listed in the application. In contrast, the U.S. and most other countries permit claims to be broader than the actual examples provided: (1) the applicant clearly describes how one skilled in the art can make the products described by the "prophetic example;" and (2) that these examples are not otherwise known to the public. The ability to base claims on prophetic examples is particularly important in the chemical area, where thousands of variations are possible and listing each is impractical.

The Government of Japan has confirmed: (1) the issuance of revised guidelines to JPO examiners directing them to grant patents based on prophetic as well as working examples; and, importantly, (2) application of the new guidelines to outstanding patent applications, some of which have been pending for many years. Some U.S. companies have hundreds of such pending applications.

Concerns remain about the narrow patent interpretation practices in Japanese courts. As a general practice, Japanese courts consider only literal infringement of patents; competitors can avoid liability for infringement in Japan by slightly changing an element of the invention -- even if the resulting product is substantially similar to the patented product. In contrast, courts in the United States and in most other countries as general practice will find infringement if the defendant has either literally infringed the patent or has done essentially what is claimed by the patent -- that is, infringement will be found even if the infringer has deviated from the patent in certain marginal and unimportant ways. This latter practice is known as the "doctrine of equivalents."

This doctrine has been used by Japanese courts, but only in limited instances and rarely in the chemicals industry. Three recent instances of narrow patent claim interpretation in the courts in Japan were cited by biotechnology industry spokespersons as responsible for losses of $500 million per year per product. In each of the cited instances, U.S. companies were unable to assert the degree of exclusivity that they have asserted in the United States for claims of similar scope, and their Japanese competitors were able to continue marketing their products.

Another problem has been the prevalence of "patent-flooding" in which companies in Japan will flood the patent office with applications that deviate marginally from a particular invention, thereby threatening potential claims of that invention with infringement and scaring off potential competitors.

The history of the "Kilby" patent illustrates many of these problems. The patent, which relates to the invention of the integrated circuit, took almost 30 years to issue because of delays in the JPO. The patent finally was issued in 1989. In 1994, the Tokyo District Court held in effect that the patent covers only a laboratory prototype of the invention. Under that extremely narrow interpretation, the patent is unenforceable against any past or present commercial product. The case calls into question whether U.S. companies can enforce their Japanese patents (particularly those relating to pioneer inventions) even if the patent-issuance process is improved.

Trademarks

The trademark registration process remains slow, requiring over three years to register a trademark in Japan versus slightly more than one year in the U.S. Protection of well-known marks remains weak.

Trade Secrets

Japan's protection of trade secrets is inadequate because Japanese courts require disclosure of trade secrets when a case is brought to them. This puts the owner of a trade secret in the untenable position of being unable to protect the trade secret without disclosing it publicly. An amendment to Japan's Civil Procedures Act, which should be enacted by the Diet later this year, should improve the protection of trade secrets in Japanese courts by excluding court records containing trade secrets from public access. However, this legislation does not adequately address the problem. Court discussions of trade secrets will remain open to the public and there are no confidentiality obligations on the part of parties to the case or their attorneys. Thus protection of trade secrets in Japan's courts will continue to be considerably weaker than in the courts of the United States and other countries.

SERVICES BARRIERS

Construction, Architectural, and Engineering Services

For the past two years, the Government of Japan has made efforts to reform its public works bidding system in accordance with its 1994 "Action Plan on Reform of the Bidding and Contracting Procedures for Public Works." This Action Plan, coupled with additional understandings contained in an exchange of letters between Commerce Secretary Ron Brown and Japanese Ambassador Takazu Kuriyama, constitutes the 1994 U.S.-Japan Public Works Agreement.

Under the 1994 agreement, Japan must utilize open and competitive procurement procedures when making construction-related procurements that are valued at or above the WTO government procurement thresholds. Prior to this agreement, Japan had utilized a designated bidding system which unfairly favored Japanese domestic companies and effectively closed Japan's public works market to any foreign participation. As of April 1, 1995, central and quasi-governmental entities in Japan began utilizing the new open and competitive procedures.

In late July 1995, at the first annual review of the agreement to assess the impact of the reform measures on Japan's public works market, the U.S. Government acknowledged that 1994 had been a transition period, but expressed dissatisfaction with the limited business awarded to U.S. firms and voiced an expectation of increased future business for U.S. and other foreign firms. In addition, the United States offered a number of procedural recommendations with the aim of facilitating greater foreign participation in Japan's public works market at both the central and the local government levels.

Since this review, U.S. firms have enjoyed some success, but overall there has been little improvement in the participation of foreign firms in the Japanese public works market. The U.S. Government continues to be concerned over the implementation of the agreement. It is monitoring Japan's efforts intensively and pursuing aggressively U.S. interests in cases where implementation may be improved.

The existing Major Projects Arrangement (MPA) -- first negotiated in 1988 and broadened in 1991 -- will remain in effect until all 36 projects covered by the MPA are completed. The U.S. Government has followed closely the progress on these MPA projects, with special emphasis on up-coming procurements for the Chubu New International Airport and the Kansai International Airport. The Chubu New International Airport is an "if and when" MPA project. This obligates Japan to promptly designate the Chubu New International Airport as a full-fledged MPA project as soon as the Government of Japan decides to proceed with the development of the project. By doing so, both foreign and domestic companies will benefit from the use of open and competitive procedures on procurements of goods and services that meet the MPA thesholds.

The U.S. Government is very concerned about indications that Japanese airport authorities may be proceeding with airport development plans without first properly designating the Chubu New International Airport as an MPA project. Already four contracts have been awarded to Japanese companies through the use of the designated bidding system. It is at this early stage of planning that critical decisions affecting the final outcome of the project are made. By continuing to delay the designation of the Chubu New International Airport as an MPA project, Japan has severely limited the ability of foreign firms to make a contribution at the early planning stages of the airport project and, consequently, has handicapped foreign firms' ability to take on a meaningful role in the design and construction of the airport.

The U.S. Government is insisting that Japan honor its commitments under the MPA to designate the Chubu New International Airport as an MPA project as soon as it proceeds with airport development plans and to open procurements to foreign firms. The United States will continue to actively support U.S. firms and to maintain vigilance to ensure that U.S. and other foreign firms have ready access to market opportunities afforded by this agreement.

Financial Services

Japanese financial markets traditionally have been highly segmented and strictly regulated, and as such, have restricted the entry of foreign financial services firms and discouraged the introduction of innovative products, in which foreign firms may have enjoyed a competitive advantage. Some of the restrictions that have impeded access include the use of administrative guidance, keiretsu relationships, lack of transparency, inadequate disclosure, the use of a positive list to define a security, and lengthy processing of applications for new products. These restrictions have hindered the emergence of a fully competitive market for financial services in Japan.

With a view to eliminating or reducing these barriers, the United States and Japan on February 13, 1995, concluded a comprehensive financial services agreement, "Measures by the Government of Japan and the Government of the United States Regarding Financial Services." This agreement features an extensive package of market-opening actions in the key areas of asset management, corporate securities, and cross-border financial transactions.

In the area of asset management, Japan agreed to:

• Provide complete, unrestricted access to the $200 billion public pension fund market for investment advisory companies (IACs) and to expand access to the private pension fund market substantially. Recently, Japan announced that it will increase market access for IACs to the $375 billion Employee Pension Fund market by lifting the ceiling on market access from 1/3 to 1/2 on April 1, 1996. The ceiling will be removed altogether in 1999;
• Eliminate the balanced fund requirements on the bulk of pension assets open to management by IACs, thus enabling both IACs and trust banks to sell specialized fund management services;
• Move toward market value accounting for pension liabilities and disclosure of fund manager performance on a market value basis, which will allow fund managers to compete for management mandates on the basis of relative performance and not affiliation; and
• Permit dual licensing of an investment trust business and a discretionary investment management business to operate as one entity.

In the area of corporate securities underwriting and sales, the agreement creates greater opportunities for foreign financial firms to participate in underwriting domestic securities issues for Japanese issuers. In this regard, Japan has committed to:

• Liberalize restrictions on the introduction of new financial instruments;
• Introduce a domestic asset-backed securities market in Japan; and
• Eliminate restrictions on the offshore securitization of Japanese assets.

With respect to cross-border financial transactions, the agreement promotes further integration of Japan's capital market with global capital markets by creating virtually unlimited opportunities for qualifying Japanese corporate investors to invest abroad, and for Japanese issuers of securities to tap foreign capital markets without restriction on either the size or type of instrument being issued. Specific commitments include the elimination of restrictions on securities offerings by residents and non-residents, and the elimination of seasoning requirements on non-resident offers of euro-yen issues.

The agreement also features comprehensive obligations, building on the new Japanese Administrative Procedure Law, to provide transparency in financial regulations and protection from administrative abuse.

In the year since the agreement was signed, the Japanese Government has implemented the vast majority of the commitments made within the specified timeframe. In some instances, the timetable for implementation was accelerated. In a few other areas, additional actions either have been taken or announced for future implementation by the Japanese Government to improve the liberalization of Japanese financial markets.

The U.S. Government is currently monitoring the agreement to ensure that implementation remains on schedule and assessing the impact of the actions undertaken, using the qualitative and quantitative criteria included in the agreement. The U.S. and Japanese Governments have held two review meetings (in May 1995 and in February 1996) since the agreement was signed. At the most recent follow-up meeting in February 1996, the U.S. Government emphasized the need for further improvements in financial disclosure and transparency.

Insurance

Japan is the world's second largest market for insurance with more than $382 billion in total premiums in JFY 1994. While foreign share of other G-7 countries' domestic insurance markets ranges from 10 to 33 percent, foreign firms' share in Japan was only 3.3 percent. More specifically, foreign share in Japan was roughly 3.1 percent of life insurance premiums and 4.2 percent of non-life premiums. Unable to compete freely in the primary life and non-life sectors of the Japanese insurance market largely due to restrictive government regulations, foreign firms have developed a presence in the so-called "third sector" (e.g., personal accident, sickness, and nursing care insurance) which comprises only 4.7 percent of Japan's overall insurance market. Foreign share of the third sector market was 35.7 percent in JFY 1994. (The vast amount of insurance sold by the Japanese Ministry of Post and Telecommunications is not included in the calculation of these figures. Including premiums collected by Japan's postal service would significantly lower foreign market share.)

In consideration of the low market penetration by foreign firms and the Ministry of Finance's (MOF) plans to implement the first major reform of Japan's insurance business law in over 50 years, insurance was designated as a priority sector under the Framework in 1993. On October 11, 1994, U.S. and Japanese officials concluded the U.S.-Japan insurance agreement. The agreement commits Japan to enhance regulatory transparency, strengthen antitrust enforcement and undertake specific liberalization measures. With regard to the third sector, Japan agreed not to allow radical change in the business environment of the third sector until foreign, medium and small insurers were first given a reasonable period to fully compete in a deregulated environment in the primary life and non-life sectors. In addition, the agreement calls for the completion by March, 1995 of a study of insurance purchasing practices among keiretsu-affiliated firms and the role of case agents in these purchases. The agreement also sets forth MOF's intention to allow insurance brokers to operate in Japan and its commitment to institute a notification system for certain insurance products.

The Japanese Diet passed the new Insurance Business Law (IBL) in June, 1995. The IBL will likely come into force on April 1, 1996 and grants MOF sufficient authority to fully implement the measures contained in the insurance agreement, including measures relating to the third sector. MOF is currently in the final stages of drafting ordinances required to implement the IBL.

The first review of the insurance agreement was held in September 1995 at which the United States raised a number of concerns relating to MOF's implementation of the agreement. In particular, U.S. Government officials called for MOF to fully and faithfully implement the measures relating to the third sector and transparency, and to make utmost efforts to conclude the keiretsu study.

Despite receiving repeated assurances from MOF on these issues, the United States remains seriously concerned about MOF's implementation of this agreement. MOF does not appear to have fully and equally informed foreign insurers and intermediaries of planned actions, some of which will negatively impact foreign firms. Furthermore, the keiretsu study called for in the agreement has not begun despite its March 1995 deadline.

Finally, the U.S. is gravely concerned about MOF's intentions to permit certain activities of Japanese insurance subsidiaries in the third sector, without first fulfilling the conditions established in the agreement with respect to deregulation of the primary life and non-life sectors. This linkage, i.e., the implementation of meaningful broad-based deregulation of the primary sectors prior to allowing expanded entry into the third sector by the Japanese insurance subsidiaries, is a fundamental aspect of the insurance agreement. This linkage was agreed to by both governments to prevent immediate, discriminatory and selective deregulation of the third sector, while retaining protections for large Japanese insurance firms in the primary life and non- life sectors, which constitute roughly 90 percent of Japan's insurance market.

The U.S. Government believes that properly implemented deregulation of Japan's insurance markets will introduce much needed competition, and result in a costs savings and greater product choice for Japanese business and consumers. The U.S. Government spelled out in concrete terms a detailed vision, to be implemented in phases, of substantial deregulation of the Japan's primary life and non-life sectors. Specifically, the U.S. called on MOF to initially implement meaningful deregulation of Japan's large and sophisticated commercial fire market, and to allow for innovation in the marketing of automobile insurance. Later deregulation would eventually result in broad application of a notification system.

Despite our efforts, MOF has yet to put forward concrete and meaningful proposals for deregulation of the primary sectors. In fact, MOF appears determined to resist timely and meaningful deregulation. For example, a February 29 Kampo announcement sets forth a threshold of yen 30 billion insured risk for commercial fire insurance above which firms will be allowed to innovative based on price. Unfortunately, this "market opening" on the part of MOF applies to less than two percent of this important market segment.

U.S. and Japanese officials have met on numerous occasions, and at various levels, to ensure the Japanese Government's full implementation of the provisions of the agreement. The U.S. places resolution of these outstanding issues at the top of our trade agenda with Japan.

Legal Services

The United States remains concerned about a number of issues affecting the ability of foreign lawyers to practice law in Japan, including: (1) the prohibition against foreign lawyers employing or entering into partnerships or other fee-sharing arrangements with Japanese lawyers and quasi-legal professionals; (2) restrictions on the legal experience that is counted toward satisfying the five-year requirement; and (3) restrictions on foreign lawyers' ability to represent parties in arbitration proceedings under Japanese law.

Japanese commitments under the General Agreement on Trade in Services (GATS) and revisions to the Special Measures Law permitting limited forms of "joint enterprises" do not fully address these concerns. The Japanese Government has indicated that it will submit legislation to the Diet in the spring of 1996 that would permit foreign lawyers to represent parties without restrictions in international arbitration proceedings conducted in Japan.

Legal services was raised in January and February 1995, as well as during February 1996 deregulation and competition policy consultations with Japan. Legal services was also included in the 1995 U.S. Government deregulation submission to the Japanese Government.

Telecommunications Services

Several U.S. firms are preparing to enter the local telephone service market in conjunction with offering cable TV services (cable telephony). These firms face a major obstacle in obtaining fair interconnection to NTT's local network that would permit these new entrants to effectively serve cable telephony subscribers. NTT, the monopoly provider, has little incentive to negotiate competitive interconnection rates. The Japanese Ministry of Posts and Telecommunications (MPT) has limited authority over interconnection. The United States has urged MPT to facilitate expeditious, transparent, non-discriminatory and cost-based market entry by requiring NTT to adopt pro-competitive interconnection rules. MPT plans to introduce new rules by 1997.

The United States is currently negotiating with Japan and about 70 other countries to liberalize basic telecommunications services through the World Trade Organization's Negotiating Group on Basic Telecommunications (NGBT). In bilateral discussions in conjunction with both the NGBT and Japan's deregulation measures, the United States has requested that Japan permit 100 percent foreign investment in basic services. To date, Japan has offered 33 percent foreign investment in new common carriers, and 20 percent foreign investment in NTT and KDD. The NGBT oversees a drafting group preparing a text on regulatory principles in which the U.S. and Japan participate. In this drafting group, fair and economical interconnection, along with other competitive regulatory principles providing for transparent, cost-based and non-discriminatory access to the basic services market, is treated as a critical component for effective competition in basic services.

In addition, in bilateral discussions on deregulation of the Japanese telecommunications market, the United States has urged that Japan clarify and streamline licensing procedures for new telecommunications service entrants, such as through eliminating the requirement for new entrants to submit detailed business plans in their applications to the Ministry of Post and Telecommunications and eliminating MPT's role in granting or denying applications based on its estimates of market demand. Rather, MPT should rely on competitors to determine what, when and at what prices to bring services to the market.

INVESTMENT BARRIERS

Japan's stock of inward foreign direct investment (FDI), relative to the overall Japanese economy, remains minuscule compared to that of other industrialized countries. As recently as 1991, the OECD estimated Japan's share in the total inward foreign direct investment in 1991 to be under 1.5 percent compared to 36 percent hosted by the United States. Moreover, Japan's outward investment flows dwarf investment into Japan: the ratio has been around ten to one throughout the 1990s. Investment flows are far more balanced in other OECD countries: the ratio of outward to inward investment is below two in every case, and substantially so in most. In 1994, Japanese overseas FDI was $41 billion; Japan's inward FDI was only one-tenth of that amount, $4.2 billion. Japan's lack of receptivity to foreign investment is a major trade barrier.

Acknowledging that its inward investment lags far behind that of other industrialized economies, Japan has taken some steps to address the problem. In July 1994, the Government of Japan established the Japan Investment Council (JIC), chaired by the Prime Minister and charged with: promoting measures to improve Japan's investment climate; coordinating policies of ministries and agencies concerned with investment; and disseminating information on investment-related measures. In June 1995, the JIC released a statement on investment that provided a positive orientation toward FDI and listed useful policy measures. The Japan External Trade Organization (JETRO), in a 1995 White Paper, urged the Japanese Government to offer foreign firms improved tax breaks in order to encourage foreign direct investment. The JETRO report noted that "whereas Japan has 15.4 times as much cumulative direct investment abroad as foreign investment at home, U.S. external investment is just 1.2 times the foreign investment within the country and the figure for Britain is 1.3."

Although most direct legal restrictions on foreign direct investment have been eliminated, considerable bureaucratic obstacles remain. Japan's low FDI level reflects longstanding exclusionary business practices, extraordinarily high market entry costs, discriminatory use of bureaucratic discretion, and the cumulative effect of years of formal restrictions on inward investment. While Japan's foreign exchange laws have shifted to ex-post notification of planned investment in most cases, numerous sectors (e.g. agriculture, mining, forestry, fishing) still require prior notification to Government of Japan Ministries. Most foreign firms feel compelled to engage in extensive consultations before undertaking investments in these sectors.

Difficulty in acquiring existing Japanese firms and doubt as to whether firms, once acquired, can continue normal business patterns with other Japanese companies, make market access through mergers and acquisitions -- an approach favored by U.S. and European companies -- much more difficult in Japan than in other countries. Ties between government and industry, reluctance to break long-term buyer-supplier relationships, cross-shareholding among allied companies, low percentages of publicly-traded common stock relative to total capital in many companies, unwillingness of other members of a keiretsu to allow a member to come under foreign control, and difficulties foreign firms encounter in hiring and retaining employees, all inhibit direct foreign investment.

Investment agreement: In July 1995, the U.S. and Japan signed an agreement on the "Policies and Measures Regarding Inward Direct Investment and Buyer-Supplier Relationships." The agreement contains inward FDI-related policies the Japanese Government has instituted during the course of the investment negotiations and commits Japan to take the following additional actions to promote FDI in Japan:

• to expand efforts to inform foreign firms about FDI-related financial and tax incentives and to broaden lending and eligibility criteria under these programs;
• to extend the 1992 "Inward Investment Law" and to make its multi-billion dollar Private Participation Promotion ("minkatsu") programs, including low interest loans and tax incentives, available to foreign investors;
• to analyze the barriers to foreign participation in mergers and acquisitions, and propose measures to improve the climate for this participation; and
• to strengthen the FDI promotion roles of such organizations as the Japan Investment Council, Office of the Trade Ombudsman, JETRO, and the Foreign Investment in Japan Development Corporation.

The agreement will be reviewed semi-annually over the next two years, or at any time upon request of either Government.

In late 1995, in response to U.S. concerns raised during follow-up investment consultations, the Japanese Government extended the "Inward Investment Law" from May 1996 to May 2006. In addition, MITI lowered the interest rate charged by the Japan Development Bank (JDB) to foreign investors in high- technology projects. Furthermore, effective April 1, 1996, the eligibility for "designated inward investor- status" (which foreign firms need to obtain tax incentives) will be extended from the first five years to the first eight years of operation of a foreign firm in Japan. Also effective April 1, the JDB will be allowed to lend to foreign affiliated firms for M&A related expenses. Finally, the Government of Japan recommended to the Diet that

foreign affiliates be allowed to carry-over investment-related losses made in the first five years of operation, not just the first three, and that these losses may be carried forward 10 years. The Diet will make a determination on the loss carry forward by the end of March 1996.

Japan Fair Trade Commission Scrutiny of International Contracts

Japan's Antimonopoly Act provides that "no entrepreneur shall enter into an international agreement or an international contract which contains such matters as constitute unreasonable restraint of trade or unfair trade practices." The Antimonopoly Act also allows the JFTC to require that it be notified of and review certain types of international contracts. The term "international contract" generally refers to a contract between a foreign party and a Japanese party. These provisions have been used in the past to challenge terms in international contracts in a manner that disadvantages the foreign parties. These provisions in the Antimonopoly Act also have led to greater JFTC scrutiny of contracts involving foreign parties than of contracts solely between Japanese parties.

In 1992, the JFTC revised regulations specifying types of international contracts subject to notification. This resulted in substantial decreases in the numbers of notifications, although not complete elimination of the requirement, as requested by the United States. The JFTC has assured the United States that enforcement of the Act's international contract notification provisions will not discriminate against U.S. parties to such contracts. The United States continues to monitor this area closely. The United States is particularly concerned about the continued notification requirement for certain international joint venture contracts, and called for elimination of this requirement during the Framework negotiations.

ANTI-COMPETITIVE PRACTICES

Japan's competition law -- the 1947 Antimonopoly Act (AMA) -- prohibits price-fixing, bid rigging, market allocations and group boycotts, as well as a range of other unfair trade practices. The Japan Fair Trade Commission (JFTC) enforces the AMA.

JFTC antimonopoly enforcement historically has been weak. There have been some recent improvements due to U.S. efforts under the 1989-91 Structural Impediments Initiative, the Framework, and annual bilateral antitrust consultations. However, Japanese legal remedies and antimonopoly enforcement efforts still fall far short of that needed to ensure that Japanese markets are open to competition from U.S. and other foreign competitors. Criminal prosecution of antimonopoly violations, for example, is sporadic and inadequate. Few cases have been prosecuted in the last five years, and no individuals actually have been imprisoned. Infrequent use of the Antimonopoly Act's criminal provisions undermines its potential as a deterrent.

In 1991, the JFTC issued antimonopoly guidelines on unlawful distribution and corporate business practices, which it followed up with surveys on automobile distribution, auto parts procurements, flat glass and paper, among others. These surveys uncovered numerous business practices that the JFTC judged to impede competition. Despite the guidelines, JFTC surveys, and anecdotal and structural evidence of uncompetitive markets and exclusionary practices, the JFTC has not used its enforcement powers aggressively to eliminate anticompetitive practices that exclude foreign goods and services from Japanese markets.

On March 1, 1995, the JFTC created a "Task Force on Import Restrictions and Internal-External Price Gaps" which is responsible for investigating and taking enforcement action against anticompetitive practices that restrict imports, such as import cartels and group boycott activities. However, this Task Force has yet to take any visible concrete actions to address these problems.

In October 1995, the JFTC published updated guidelines concerning the activities of Japanese trade associations. These are intended to clarify antimonopoly rules in this area so as to prevent industry associations from engaging in ant-icompetitive business activities that impede foreign companies from competing successfully in Japan.

The Government of Japan is considering submitting legislation to the Diet this spring that would eliminate the AMA's ban on holding companies. This provision was included in the original AMA to prevent the re-emergence of the pre-war zaibatsu. Change in this area that is too permissive could lead to a strengthening of Japan's keiretsu groups and an increase in the barriers faced by U.S. and other foreign firms in Japan.

In February 1996, the Japanese Government submitted legislation to the Diet that would upgrade and strengthen the JFTC's organization and bureaucratic status in the Japanese Government. The proposed legislation, if enacted, would be a positive development but will not adequately strengthen Japan's antimonopoly system unless supplemented by a substantial increase in the number of JFTC investigators and by significant additional measures to strengthen the JFTC's ability and willingness to enforce the AMA in an aggressive manner.

(For further description of competition policy concerns in particular sectors, see the discussion of autos, auto parts, film, paper, and glass. See also the discussion of distribution, marketing practice restrictions and JFTC scrutiny of international contracts.)

OTHER BARRIERS

Aerospace

The Government of Japan offers Japanese firms incentives, such as interest rate subsidies and preferential loans, for aircraft and engine development. Policy and regulations allow MITI to nurture the Japanese aerospace industry by importing, developing, and distributing new technology and by apportioning work among Japanese manufacturers. Despite the focus on development, however, long term prospects for Japan's aerospace industry are far from certain. In 1995, Japan announced that a domestically designed and produced mid-size passenger jet (the YSX project) was being put on hold indefinitely.

The lack of a dynamic and aggressive domestic aviation industry severely restricts development of aviation-related infrastructure or any kind of business or general (i.e., "non-airline") aviation in Japan. Sales of U.S. business jets, light aircraft, air traffic technology and equipment, airport-use equipment, and services remain far below that generally expected in a nation with an economy as developed as Japan's. Japanese demand for helicopters is also stifled by restrictive flight rules and lack of heliports. Nonetheless, Japan has become a major supplier to foreign aircraft assemblers by supplying fuselage sections for large civil aircraft and is increasing emphasis on electronics, composites and other high value-added components.

The United States continues to monitor implementation of the 1977 Bilateral Airworthiness Agreement, which facilitates the mutual acceptance of aircraft airworthiness certificates. Japan still requires a Japanese airworthiness certificate for any aircraft imported into Japan (although inspection may be done in Japan or in the United States). Japan is still reviewing certification procedures and may submit a deregulation proposal to the national legislature in March, 1996.

The U.S. also continues to push for increased access to Japan's major airports for business jets.

Amorphous Metals

The September 1990 U.S.-Japan Amorphous Metals Agreement addresses market barriers and unfair trade practices hindering U.S. firms from marketing amorphous metals technology in Japan's $100 million utilities market. Pursuant to the agreement, Japanese steelmakers have implemented a stay on the domestic production and sales of amorphous metals until 1997, and Japanese utility companies have field-tested U.S.-made transformers with amorphous metal cores to verify performance. The United States is monitoring closely implementation of a key remaining element of the agreement: Japanese utility companies' commitment to make purchasing decisions based on the Edison Electrical Institute's "total life cycle levelized annual cost" evaluation method.

Automobiles and Auto Parts

Japan's domestic motor vehicle sales were approximately 6.87 million units in 1995, valued at about 12.7 trillion yen. Imported motor vehicle sales reached a record 388,162 units in 1995, up 28.8 percent from 1994. This growth can be attributed to the strong yen, the popularity of newly introduced small cars and recreational vehicles, and significant imports from Japanese transplants in the United States.

Although sales of imported autos have increased three years in a row and set records during the last two years, import penetration is still only 5.6 percent of total auto sales. Total U.S. imports to Japan were 143,232 vehicles, or 2.1 percent of the market. If Japanese transplant figures are subtracted, the figure decreases to 0.85 percent. Sales in Japan of Big Three vehicles originating in North America were only 58,469 units.

In 1995, the share of imported cars -- excluding minicars (engines less than 660 cc) -- in the overall Japanese auto market was 7.5 percent, and in the imported passenger car market was 10.2 percent, according to the Japan Automobile Importers Association (JAIA). Although this level is still considerably below the level of foreign penetration in Europe and the U.S., it remains highly significant: imported passenger cars were less than five percent of the total market as late as the early 1990s, and topped ten percent for the first time in 1995.

U.S. access to the motor vehicle market is restricted primarily through Japanese auto manufacturers' control over dealer networks. Japanese auto manufacturers maintain their control through financial ties (equity, loans, rebates, personnel transfers to dealerships), by allocating the most desirable models, and through other forms of cooperation and technical support. In many respects, dealers function as captive distributors of vehicle manufacturers rather than independent businesses. This system tends to keep dealers marginally profitable and highly dependent on a single manufacturer. The U.S. and Japanese governments discussed this issue during the U.S.-Japan auto and auto parts talks, and signed an agreement in August 1995.

The United States is closely monitoring implementation of the agreement, structural characteristics of the distribution system, and certification and homologation costs (which drive up the unit cost of imported autos). Despite U.S. auto makers'substantial investments in improving their local distribution system as well as in marketing right-hand-drive models suitable for the Japanese market, the growth of foreign controlled franchised dealerships since the signature of the automotive agreement has been slower than expected.

Auto parts: In 1995, Japan's automotive parts market was valued at about $141 billion; of which, the parts aftermarket accounted for about $53 billion. The U.S. share of the total Japanese parts market was estimated to have been about 1.3 percent, while sales to the aftermarket were well under 0.5 percent. Close Japanese intercorporate relations make it difficult for foreign automotive parts suppliers to compete with Japanese- owned suppliers for business from Japanese motor vehicle makers. Complex, strict and often obscure regulations governing vehicle inspection, modification and repair have in the past sharply restricted and to a large extent continue to limit foreign suppliers' access to the replacement parts aftermarket and encourage consumers to have vehicles repaired at auto dealerships or certified garages that use almost exclusively manufacturer-origin "genuine" replacement (OE) parts. Because parts distributors/wholesalers seldom stock non-OE parts, dealers and garages have no choice but to use genuine parts. Since parts price surveys have shown that these OE parts cost almost three times as much as similar parts sold in the United States, this creates windfall profits for OE parts suppliers at an enormous cost to Japanese consumers.

Regulations limiting where and by whom repairs may be made further restrict creation of a competitive, independent parts aftermarket. For example, parts deemed essential to vehicle safety ("critical parts") cannot be replaced without inspection by a Transport Ministry (MOT) official, unless repairs are done at a certified garage. Consumers may replace critical parts themselves, but must then take the vehicle to a MOT Land Office for a costly inspection. Non-certified garages are prohibited from replacing any part that involves disassembly of critical parts.

These regulations create strong incentives for consumers to use only certified garages, simply for convenience's sake. Certified garages depend heavily on vehicle manufacturers and OE suppliers for their business and, as a rule, do not stock foreign aftermarket parts. In addition, in order to sell in OE manufacturers' channels, a foreign supplier must be accepted by each Japanese vehicle manufacturer as a potential supplier for a given vehicle model, and then must go through an expensive and lengthy approval process.

Market-opening negotiations: Market-Oriented Sector-Selective (MOSS) auto talks began in 1986. The U.S. and Japan agreed in 1990 to a Market-Oriented Cooperation Plan (MOCP) to develop long-term business relations between Japanese vehicle makers and U.S. auto parts suppliers. Japanese auto makers periodically update and issue import expansion and U.S. supplier outreach programs. In 1992, Japanese vehicle makers announced voluntary plans to expand U.S. auto parts purchases to $19 billion by JFY 1994: $15 billion for use in Japanese-owned plants in the United States and $4 billion for use in Japan. Japanese automakers exceeded the goals for purchases in the U.S. by $2.0 billion, but fell $1.0 billion short for parts used in Japan..

In 1993, the United States and Japan agreed to include motor vehicles and parts under the Framework talks. In August 1995, after nearly two years of negotiations, the U.S. and Japan signed a market opening agreement with the following provisions:

• Japanese vehicle manufacturers will increase production in the U.S., including efforts to build transmission and engine parts, and increase local content for vehicles made in the United States.
• Japanese Government and industry will help develop dealer networks for aftermarket parts in Japan by promoting business connections among dealers and manufacturers, by publicly informing dealers of their options, and by establishing key contacts in both government and industry for problem resolution.
• Japan will relax regulations on personnel, space and tool requirements for certified garages; let garages pool resources to do inspection services; allow specialized garages, like brake shops, to operate outside the inspection system; reduce and more narrowly define the number of critical parts; and provide a review and complaint system to remove specific parts from regulation.
• Japan will deregulate sixteen standards and certification barriers and streamline the Type Designation System.
• Equal access to data registration information will allow U.S. vehicle makers to analyze competitors' customer bases and, thus, expand their marketing efforts.

As a result of the automotive agreement with Japan, in the fall of 1995 the Japanese Ministry of Transportation eliminated most restrictions on external modification of vehicles (e.g., the addition of side mirrors), and eliminated the following four parts from the "critical parts lists" (i.e., parts whose replacement had to be certified by an agent of the MOT): shock absorbers, struts, power steering equipment, and trailer hitches. This action by MOT was an important beginning to substantial deregulation in the auto parts aftermarket.

The Agreement indicates that MOT will undertake a year long study of further deregulation of "critical parts" -- a study due to be completed in September of 1996. The regulation by MOT of critical parts items such as brake parts and clutch assemblies continues to constitute an important barrier to the sale of American auto parts in Japan. Deregulation of these and other critical parts in September will be very important for expanded participation of American suppliers in the Japanese aftermarket.

Equally significant to American auto parts suppliers will be the conditions under which the Japanese garage system is opened to independent participation. By limiting the authorizations for compulsory inspections to garages that are closely linked to Japanese automobile manufacturers, MOT regulations have been an important deterrent to foreign participation in the huge Japanese replacement parts market. Substantial liberalization of the garage system is due under the U.S.-Japan Automotive Agreement in early 1997. The U.S. Government will be working closely with MOT during the year to ensure that this deregulation is meaningful and complete.

Extensive Japanese trade promotion programs, including a 39 billion yen dealership program, extended loans to importers, and tax breaks for imports are also expected to improve the overall import climate. A public MOT commitment to guard against discrimination against U.S. products and to help introduce imported products into repair garages may give imports an extra boost. As of mid-March 1996, thirteen pending standards and certification issues had been resolved.

Cellular Telephones

Beginning with the MOSS talks in 1985, the United States and Japan have signed a series of telecommunications trade agreements. The 1989 Third-Party Radio and Cellular Telephone Agreement, negotiated pursuant to a 1988 Trade Act Section 1377 review, addresses market access to the cellular telephone and third-party radio communications markets. Not withstanding this agreement, problems preventing U.S. cellular systems' technology from entering Japan's cellular service market emerged in 1992 and 1993. In March 1994, the two Governments reached agreement to provide U.S. technology access to, and opportunities to compete in, the Japanese cellular telephone market in the Tokyo-Nagoya area comparable to those opportunities enjoyed by Japanese competitors. The agreement includes a highly detailed schedule of commitments on infrastructure deployment and marketing efforts designed to ensure full implementation. In addition, the Japanese Government committed to monitor and oversee completion of the system and to confirm compliance.

At the last quarterly review in late 1995, implementation of the 1994 agreement was determined to be complete. Subscribers to the U.S. technology system exceeded estimates, resulting in an outcome under the agreement that has thus far benefited all parties concerned. Specifically, subscribers to the North America TACs system have grown dramatically: when the agreement was signed in February 1994, there were only 22,000 subscribers to this system; by the end of 1995, subscribership had jumped to over 600,000.

International Value-Added Network Services/Network Channeling Termination Equipment

A 1990 agreement largely resolved issues involving liberalized trade treatment for suppliers of digital network channel terminating equipment (NCTE) and liberalized regulation for providers of international value-added network services (IVANS). Supplemental accords were signed in April and June, 1991. The results of the NCTE agreement and the IVANS accords have generally been satisfactory. Of late, foreign value-added service providers and closed-user group operators doing business in Japan have complained of overly burdensome regulation for Special Type II carriers. The U.S. raised this issue in a recent deregulation submission to the Government of Japan. The regulatory treatment of Special and General Type II carriers (those providing services by leasing lines from Type I carriers (facilities-based) is being reviewed by the Government of Japan in the process of its deregulation measures.

Civil Aviation

U.S. carriers have the lion's share of the passenger sector of the U.S.-Japan civil aviation market -- a result of their greater competitiveness compared to Japanese carriers. U.S. carriers also are highly competitive in the cargo sector, holding a market share of 55 percent. With nearly 40 percent of U.S. exports to Japan moving by air, Japan is by far the largest bilateral air freight market for U.S. carriers. Seeking to revise the 1952 bilateral agreement, Japan advocates restraints on growth of U.S. carriers' services, both in the bilateral market and to Asia-Pacific destinations "beyond" Japan, in addition to expansion of rights for Japanese carriers to and beyond the U.S. While U.S. incumbent carriers (Northwest, United and Federal Express) have been allowed limited expansion of services to and beyond Kansai International Airport after it opened in September 1994, the Japanese Government, seeking to open talks on passenger services, has not allowed other U.S. carriers to serve the new airport.

In July 1995, the U.S. and Japan agreed to begin all-cargo negotiations with the aim of reaching a new agreement, by March 1996, that effects further liberalization and equality through expansion of opportunities for both sides. Those discussions began in September 1995. The United States has emphasized that U.S. carriers should be allowed to exercise fully their rights under the existing bilateral aviation agreement. The United States has pursued expansion, rather than restriction, of opportunities for U.S. and Japanese carriers alike. The Japanese have sought to restrict the rights of Northwest, United and Federal Express to operate cargo services to Japan and beyond to other Asian countries. The Japanese also have been reluctant to provide new rights to other U.S. carriers to expand their existing services or initiate services in the market.

Deregulation

Reducing and eliminating restrictive or outdated regulations in Japan can improve market-driven competition, leading to greater access by foreign firms, lower costs for Japanese consumers, and increased efficiency throughout the Japanese economy. A timely elimination of regulatory barriers, more vigorous and consistent competition policy enforcement, and greater transparency of administrative procedures are needed to address Japan's broad structural problems which impede the sales of foreign goods and services and discourage foreign direct investment.

The Framework established the Deregulation and Competition Policy Working Group as the overarching forum for addressing these issues. In 1994 and again on November 21, 1995, the United States presented Japan with lengthy and detailed submissions containing specific deregulation, competition policy and administrative reform recommendations. Also in November 1995, the American Chamber of Commerce in Japan and the European Union submitted detailed deregulation recommendations to the Japanese Government. The U.S. and EU have held discussions on our respective approaches on this issue.

The timing of these submissions was tied to the Japanese Government's efforts to draft and revise a government-wide deregulation action plan. The Government of Japan originally announced a 5-year deregulation action plan in March, 1995; implementation of this plan was subsequently shortened to three years. The Japanese Government is expected to announce the first annual revisions to the action plan in March 1996.

The latest U.S. proposal included recommendations regarding basic principles and processes, deregulation in specific sectors, requests for implementation of significant administrative reforms, and greater competition policy enforcement. In December 1995 and February 1996, the U.S. Government held working level consultations with the Japanese Government to discuss the U.S. submission.

The United States urged Japan to adopt deregulatory principles advocated by the U.S. and major Japanese private sector organizations and advisory groups, and to implement a deregulation program based on certain fundamental principles. Such principles include broad and continuous review; "freedom from regulation in principle, with regulation as the exception" (a commitment urged in Japan as early as 1985 by the government-sponsored Maekawa Commission); enhanced transparency and accountability; prohibition of informal delegation of government authority; and promotion of market mechanisms. The United States also urged Japan to provide for domestic and foreign private sector participation and solicitation of public comments in revising its deregulation action plan. To support monitoring of the action plan, the United States urged Japan to issue an annual report which evaluates progress achieved.

The United States also urged Japan to undertake aggressive administrative reforms to enhance the openness of government practices, including reducing and making more transparent Government of Japan administrative guidance. Such informal measures -- often having the same weight as law -- are a major contributing factor in the Japanese Government's interference in the private sector in a discriminatory and unaccountable fashion. The United States urged Japan to undertake a number of reforms including: adoption of an information disclosure law, adoption of rule making procedures, enhanced transparency of advisory committees, and promotion of the use of the Administrative Procedures Law.

Japan is scheduled to complete a revised action plan for deregulation measures by March 31, 1996. As of February 1996, Japan indicated that it has achieved over half of the deregulation goals stipulated in its original action plan. In fact, Japan has implemented deregulation selectively, frontloading easy to implement changes but reserving the most difficult measures for the last two years of the 3-year plan. Many of the achievements consist of review of regulations with no action proposed other than vague statements of intent to reform with no timetables for concrete action Moreover, Japan has accelerated deregulation that may be problematic to U.S. interests -- such as a proposed lifting of a ban on holding companies discussed above.

Also in February, Japan announced a new imported housing initiative which includes a substantial deregulatory component. To be effective in reducing housing costs in Japan, and in allowing increased import of building materials and techniques, this initiative must be broadly defined. The United States Government expects it to encompass all aspects of housing-related regulations, including, but not limited to, those listed in the construction and wood sections of this report. Announcement of a detailed implementation program and timetable by Japanese Government is expected.

In bilateral meetings on February 1996, the United States expressed its disappointment with the interim ministerial reports issued in January. These reports, which will form the basis for revisions to the action plan, are generally vague and lack significant new deregulation measures. Furthermore, the interim reports did not address many of the U.S. requests, in particular, with respect to administration reform. The United States also urged the Government of Japan to establish firm time lines for implementation of concrete deregulatory actions. The United States will continue to urge Japan to undertake significant deregulation through periodic bilateral consultations.

Distribution

Japan's multi-tiered and highly regulated distribution system serves as a significant barrier to increasing imports and investment in Japan. The complexity and rigidity of the system, with its numerous, small, and vertically integrated retailers and wholesalers, raises the cost of market entry and limits access by U.S. and other foreign firms.

Market entrants seeking to sell both producer and consumer goods face obstacles in Japan due to exclusive relationships among retailers, wholesalers, and producers. Introduction of emerging technologies and services by new companies is stifled by the difficulty companies face in breaking into the market. For example, distribution barriers severely limit access in autos and auto parts, fabricated aluminum, soda ash, flat glass, steel, paper products and processed foods.

Despite improvements, the Large Scale Retail Store Law, which protects small, inefficient retailers, remains a major impediment to consumer imports. MITI eased restrictions in 1994, but the law still limits store hours and days of operation and allows local commercial interests to reduce floor space for new competing retail outlets. While administrative delays have been shortened, the law burdens retailers with a costly and time- consuming application process. The United States continues to press Japan to ease restrictions on the operation of large scale retail stores. Distribution issues are addressed under the Framework's Deregulation and Competition Policy Working Group. In these discussions, the United States has emphasized the importance of a more efficient import processing and distribution system. The United States continues to pursue distribution issues in specific sectoral negotiations and agreements.

Electric Utility Companies' Procurement

Japan's electric utilities are among the largest and most profitable companies in Japan, accounting for ten percent of Japan's total industrial investment. Their annual non-fuel procurement requirements represent a significant market, estimated at about $25 billion. Purchases from foreign firms comprise only a small percentage of total procurement. MITI's Natural Resources and Energy Agency tightly regulates Japan's ten big electric utilities, each of which functions as a monopoly in its respective service area, through the authority provided under the Electric Utilities Industry Law.

Recent regulatory developments include a revision of the Electric Utilities Industry Law, effective December 1, 1995, which introduced limited competition in the power generation market by establishing a framework for independent producers (IPPs). An average 4.21 percent reduction in electricity tariffs took effect January 1, 1996. To cope with cost pressures resulting from these changes, several electric utilities have sent missions abroad to investigate potential suppliers and increase imports.

While these preliminary efforts are encouraging, the following additional steps must be taken to improve openness and transparency in utility company procurement and to help increase electric utilities' imports:

• Sharply increase the number of foreign companies on the product category lists from which utilities solicit estimates under the "competitive quotations method."
• Increase the proportion of procurements done under a "competitive cost estimates method."
• Standardize equipment specifications, which currently differ among utilities.
• Harmonize MITI technical standards with international standards.
• Shorten the time required for type approval of equipment.
• Increase procurements of non-fuel, non-power related foreign goods and services.

In July 1995, the Japanese utility industry took a positive step toward international cooperation by agreeing to participate with foreign suppliers in the New Orleans Association (NOA). NOA provides a forum for U.S. suppliers of power generation, transmission and distribution equipment to develop a greater awareness of American products among the Japanese utilities, and to develop a greater awareness of Japanese procurement procedures and business practices among American suppliers.

Improved dialogue with Japanese utilities is important, but tangible results are the real test. When individual utility companies' procurement practices are evaluated, extreme disparities emerge. Some Japanese electric utilities have large integrated procurement divisions that actively seek substantial quantities of foreign products; other utilities lag far behind.

The United States will monitor closely individual utilities' efforts to achieve fair and open access and evaluate progress in providing real opportunities to foreign suppliers.

Flat Glass

Japan's $4.5 billion flat glass market, the second largest in the world, is a virtual oligopoly dominated by three manufacturers: Asahi Glass, which controls about 50 percent of the market, Nippon Sheet Glass, which controls about 30 percent, and Central Glass, with about 20 percent. Foreign suppliers account for only approximately three percent of the Japanese market.

With few exceptions, wholesalers and distributors in Japan have represented only one Japanese glass manufacturer, thereby significantly restricting competition. Japanese flat glass makers also have controlled many of the 15,000 retail glass stores in Japan, which has allowed them to pressure retailers to curtail their business in imported goods.

In January 1995, the United States and Japan signed an agreement to open the Japanese flat glass market to foreign suppliers. Pursuant to the agreement, Japanese glass distributors publicly stated that they will diversify supply sources to include competitive foreign glass suppliers and that they will not discriminate among suppliers based on capital affiliation. Japanese glass makers also voiced support for diversifying their de facto exclusive distribution networks. The Government of Japan committed to promote increased competition in glass procurement for construction projects based on nondiscriminatory technical and performance specifications and competitive commercial terms.

The agreement includes qualitative and quantitative criteria for measuring progress. The United States is monitoring implementation of all phases of the agreement, especially to ensure that Japanese distributors begin to procure glass from several different manufacturers. Consultations to assess implementation of the agreement are planned at six month intervals. The two Governments conducted the first review of the glass agreement in the Fall of 1995 and will hold the annual review in April 1996.

Thus far, no solid information has been available to indicate the extent of progress under the agreement. Trade statistics have indicated significant increases in imports from the U.S. and some other sources. In connection with the first annual review of the agreement, the Government of Japan is providing new survey data on recent trends in the flat glass market.

However, it is likely that this data will show that much remains to be done to open up the retail/wholesale distribution system to handle competitive foreign glass products; improve access for IJS glass products such as mirrors and automotive glass; and promote the use of energy-efficient insulating glass, where foreign glass companies have a strong competitive advantage. Access to Government of Japan public sector procurement is also a key part of the Agreement, which the U.S. Government is closely monitoring.

Marketing Practice Restrictions

JFTC regulations restrict premiums, sweepstakes and other sales promotions offered to consumers. The regulations cap values for premiums and for prizes in sweepstakes, prize competitions or lotteries.

The JFTC also can authorize establishment of Industry Fair Competition Codes, under which domestic industries agree on sales promotion rules that are even more restrictive than the JFTC's own regulations. At least 52 such Codes in 29 industries have been authorized. These Codes can act as collusive and anticompetitive restrictions on competition in the Japanese market.

These restrictions on prizes, promotionals and other marketing practices restrict legitimate competition, maintain market positions of entranced Japanese firms and impair the ability of foreign firms to enter and compete successfully in the Japanese market.

The U.S. Government has continuously raised this issue in the Framework discussions. In response to calls from the U.S. Government and the American business community, the JFTC announced in June 1995 proposed revisions to its rules on premiums and sales promotions. Specifically, the JFTC announced that it intended to increase ten-fold the maximum prize in open lotteries (not requiring a purchase to enter) and sweepstakes, repeal the special restrictions on premium offers by department stores, repeal the JFTC's special regulations on premium offers by manufacturers to distributors and retailers, eliminate the maximum yen limit on consumer premiums (while retaining the percentage of sales price caps) and clarify a number of other rules.

In August 1995, the U.S. Government submitted written comments to the JFTC on its proposed revisions, calling on the JFTC to go farther in deregulating restrictions on premiums and other sales promotions. The U.S. Government again called for substantial deregulation of these rules in its November 1995 submission to the Government of Japan. However, in February 1996, the JFTC finalized its proposed revisions without change.

Paper and Paper Products

The 1992 U.S.-Japan paper agreement aims at substantially increasing access by competitive foreign producers to Japan's $28 billion paper products market, the world's second largest. Barriers to access include a multi-tiered distribution system which is effectively closed to foreign products and numerous non-market- oriented practices, such as a lack of transparent, written purchase contracts.

Under the 1992 agreement, Japan committed to undertake efforts to encourage use of competitive foreign paper products and establish productive buyer-supplier relationships between foreign paper producers and Japanese consumers. In particular, Japan committed to encourage Japanese consumers in four key end-user segments: pharmaceuticals, cosmetics, publishing, and food processing and packaging. Other provisions called for establishing Antimonopoly Act compliance programs and written purchasing plans throughout the Japanese paper distribution and consumer sector.

The market share of foreign products in the Japanese market was 3.7 percent before the agreement. In October 1994, despite vigorous efforts by U.S. and foreign firms, foreign market share remained stagnant at 3.9 percent. (The 1995 figure will not become available until May.) Strong demand for paper products in the United States and weak demand and low prices in Japan may be contributing factors, but the United States remains concerned about the lack of progress in increasing market access for foreign firms. The United States is particularly concerned by the lack of direct encouragement in the four key end-user sectors. U.S. firms remain skeptical, despite MITI statements that after-transaction price adjustments have been eliminated, and seek GOJ vigilance in enforcing the Antimonopoly Act.

On October 3, 1994, U.S. concerns about Japanese practices in this sector prompted the identification of market access for paper and paper products as a practice that may warrant future identification as a "priority" foreign country practice under the provisions of "Super 301." The U.S. and Japan met in October 1994, and July and September 1995, to discuss how to address problems in this sector. There was no meaningful progress towards resolving our concerns, despite the U.S. having put forward concrete suggestions for enhancing implementation of the paper agreement. Thus, on September 27, 1995 the United States extended the inclusion of Japanese paper practices on the watch list. The United States will continue discussions with Japan aimed at reinvigorating the current agreement.

Consumer Photographic Film and Photographic Paper

Despite the absence of formal barriers, foreign film manufacturers face a variety of informal barriers that restrict access and sale of foreign-produced film and photographic paper in the Japanese market, the second largest film market in the world. These include barriers that prevent foreign firms from obtaining adequate access to the Japanese film distribution network and retail shelf space.

Status of the 301 Case: On July 2, 1995, in response to a petition filed by Eastman Kodak, USTR initiated a section 301 investigation of barriers to access to the Japanese market for consumer photographic film and paper. The petition alleges that during the past 25 years, the Japanese Government has instituted and maintained counterliberalization measures adversely affecting the distribution and sale of foreign-produced film and paper in Japan. The petition also alleges that the Japanese Government not only tolerated, but also actively encouraged and reinforced, systematic anticompetitive practices and that this toleration continues to block foreign access to Japan's market for consumer photographic film and paper. The petition alleges that these barriers have resulted in a cumulative revenue loss of $5.6 billion since 1975.

Japan has refused to consult with the U.S. on this issue subsequent to preliminary discussions held on October 3, arguing that all of the allegations concern private anticompetitive activity and should be handled by the JFTC. On February 21, 1996, the JFTC announced that it would initiate an economic survey of the film sector. The United States is continuing to seek consultations with the Government of Japan, having made it clear that the film issue cannot be resolved unless the full range of market access issues, as well as the anticompetitive practices involved in this case, are addressed.

The U.S. Government is continuing its section 301 investigation and considering its options for resolving this case. USTR must make a determination of whether the Japanese practices are unreasonable, unjustifiable, or discriminatory by July 2, 1996.

Wholesale Distribution: The structure of Japan's film market makes a strong distribution network critical to film manufacturers seeking to operate in the Japanese market. Primary wholesalers or subsidiaries of film manufacturers deliver most of the film that is distributed to the 279,000 outlets that sell film in Japan. About half of all film sales in Japan are made through photospecialty stores (as compared with 3 percent in the U.S.). Another 23 percent are sold through supermarkets and department stores, 8 percent at tourist resorts and parks, 7 percent at convenience stores, 2 percent at drug stores, and the rest through kiosks and other channels.

Japan's four largest film wholesalers have distributed only one brand of Japanese film exclusively since 1975. The Japanese manufacturer maintains close ties to these distributors, known as tokuyakuten, through a variety of means. Because foreign manufacturers have been unable to gain access to this channel, they have attempted to develop parallel distribution networks, but with only limited success. Foreign manufacturers use secondary wholesalers to distribute 15 percent or less of their film, but these wholesalers do not have the national coverage of the tokuyakuten. Moreover, establishing a parallel distribution system is extremely expensive -- Japan is often cited as among the countries with the highest distribution costs in the world. To the extent that foreign manufacturers have maintained or increased their market share over the last ten years, it has been principally as a result of their direct sales -- often of double branded or private-branded film -- to discount stores.

Retail Sales: At the retail level, foreign film is available in only about 36 percent of all outlets and only about half the photospecialty stores. Moreover, even where foreign film is available, consumer choice on types (brand, film speed, number of rolls per package) of foreign film is limited. Foreign film is more readily available in large discount stores, but these stores are located mainly in major metropolitan areas and their number, size, and hours of operation are limited by the Large Scale Retail Store Law.

Limited price competition at the retail level also impedes foreign film sales. While foreign film manufacturers may discount their film at the wholesale level, that discount is not necessarily reflected in the final retail price. Japanese industry journals describe discussions among Japanese retailers of cameras and photospecialty products on ways to stabilize prices and counteract discounting among ostensible competitors.

Liberalization Countermeasures: When the Japanese Government withdrew its formal restrictions on imports and inward investment following international pressure, it simultaneously implemented liberalization countermeasures designed to restrict foreign producers' access to the Japanese market. The liberalization countermeasures were implemented between 1967 and 1984 and included: measures to block or limit foreign direct investment in both new and established enterprises, and restructuring of the distribution sector to prevent foreign products from making inroads into the Japanese market. Because of the perceived need to protect the Japanese film industry from foreign firms, principally Kodak, the film sector was among the very last to be liberalized -- restrictions on foreign investment in existing enterprises remained in effect until 1984. MITI's past protection of this sector continues to have a lingering effect today in the distribution structure for consumer photographic materials.

Semiconductors

The U.S.-Japan Semiconductor Arrangement came into effect on August 1, 1991, replacing the 1986 Semiconductor Arrangement. The current arrangement expires on July 31, 1996.

The arrangement was negotiated to address persistent problems of access to the Japanese semiconductor market. The arrangement calls for increased access for foreign semiconductor suppliers to Japan's semiconductor market under conditions of free and fair competition. It also deters dumping by Japanese suppliers in the U.S. and in third country markets. The arrangement calls for "steady and gradual" improvement in market access over the duration of the arrangement. The arrangement contains the U.S. industry's expectation of foreign market share reaching more than 20 percent by the end of 1992. The 20 percent figure is explicitly recognized by the Japanese Government in the arrangement.

Progress in improving market share under the 1986 semiconductor agreement was insufficient, with foreign market share rising only from 8.6 percent in the third quarter of 1986 to 13.9 percent in the second quarter of 1991. Progress also was slow during the first five quarters of the 1991 arrangement, before market share jumped more than four percentage points to 20.2 percent in the fourth quarter of 1992.

More recently, the steady improvement in the market performance of foreign semiconductors has demonstrated the effectiveness of the efforts being made by all parties under the arrangement. Foreign market share reached 20.7 percent in the fourth quarter of 1993 and the first quarter of 1994 and has steadily increased since then, averaging 22.4 percent in 1994 and 25.4 percent in 1995.

Regularly scheduled government and joint government/industry consultations took place in March and September 1995 and February 1996. Among the areas where the United States suggested that market access for foreign semiconductors could be further improved were: (1) increased foreign participation in the automotive, telecommunications, electronic game, and multimedia semiconductor markets; (2) increase in the number of quality design-ins of foreign semiconductors in key Japanese end-products; and (3) greater usage of foreign semiconductors by small and medium-sized companies.

The United States has made clear that we believe a government agreement in semiconductors must continue in order to preserve and advance the improvements made in market access and industry cooperation. Although progress has been made under the arrangement, more remains to be done. The foreign share of the Japanese market remains relatively low compared to the situation in other markets. For example, Japanese firms held about 78 percent of the Japanese market as compared with only 24 percent in the world market outside of Japan. In the United States, now the world's leading producer of semiconductors, the foreign market share totaled 39 percent in 1995. Moreover, the arrangement is now working well and provides many mutual benefits. Trade tensions have diminished under the arrangement, commercial relations are flourishing, industry relations are harmonious, and cooperation has replaced confrontation. We are concerned that, if the arrangement is not continued, progress might stall or even backslide, and the tensions and frictions that characterized this sector in the past would reemerge.

The issue of extension or continuation is now under discussion with Japan. Thus far, the Government of Japan has opposed any continuation.

Shipbuilding Industry Support

Historically, Japan has provided its shipbuilding and repair industry with extensive subsidies and other forms of assistance, including subsidized restructuring of the shipbuilding industry, Japan Development Bank (JDB) preferential financing for Japanese ship operators (which acquire ships almost exclusively from Japanese shipbuilders), and acceptance of formation of cartels among ship owners.

U.S. shipbuilders have operated without U.S. government subsidies since 1981. On June 8, 1989 the Shipbuilders Council of America filed a section 301 petition, seeking the elimination of subsidies and trade distorting measures for the foreign commercial shipbuilding and repair industry. In response, USTR undertook to negotiate a multilateral agreement in the OECD to eliminate foreign subsidies and injurious pricing practices.

In December 1994, an ad referendum Agreement with Respect to Normal Competitive Conditions in the Shipbuilding and Repair Industry was reached by the Republic of Korea, Japan, the European Union, Finland, Sweden, Norway, and the United States. Negotiated under OECD auspices, the so-called Shipbuilding Agreement requires signatories to align terms and conditions of home credit schemes --such as that of the JDB -- with the OECD Shipbuilding Agreement. The Agreement also requires the elimination of all direct and indirect subsidies for shipbuilding and extends antidumping rules to the industry. The Parties to the Agreement -- the European Union, Japan, Korea, Norway and the United States -- account for approximately 80 percent of global shipbuilding.

The OECD Shipbuilding Agreement originally was scheduled to enter into force on January 1, 1996, after all Parties to the Agreement had ratified it. However, this did not happen because Japan and the United States failed to complete their respective ratification processes. The other Parties to the Agreement (the European Union, Korea and Norway) formally ratified it on December 12, 1995. The Government of Japan has indicated that its delay in ratification was entirely procedural and has expressed full confidence that its process will be completed in the first half of 1996. Consequently, the Parties to the Agreement agreed to extend the ratification date to June 15, 1996, and entry into force to July 15, 1996.

Sea Transport and Freight

Shipping lines in Japan must apply to the quasi-public Japan Harbor Transport Association (JHTA) for permission to schedule port activities. The JHTA controls harbor labor practices. Shipping lines have no JHTA representation.

The "prior consultation system" requires shipping lines to seek JHTA approval for all scheduling and terminal operation changes. Shipping lines can neither change stevedores, which the JHTA assigns in perpetuity, nor request new tenders or open bids. Initially limited to changes that might affect waterfront jobs, prior consultation was expanded to include changes such as vessel replacements, opening new ports and consortia formation.

The JHTA requires all cargo leaving Japan be weighed and measured -- even standardized containers and cargo -- a practice that deviates from the international norm. The JHTA also limits Sunday work. All other countries in Asia, Europe and North America allow Sunday work in ports, particularly for container vessels. These practices result in underutilized facilities, scheduling changes that raise costs, and duplicated work.

Direct Broadcast Satellite Services

U.S. firms seek to serve Japan through Direct Broadcast Satellite (DBS) services using digital communication satellites. These firms have benefited from a partial relaxation of restrictions on broadcasting multiple channels, but the potential for DBS providers remains constrained. A further relaxation of restrictions, which Japan is considering, would permit DBS providers to serve customers with the full range of channels and services available through DBS technology, and would further stimulate the Japanese multimedia and electronics market.