Bold moves halt tariff stalemate, save Lexus brand

Lexus was a mere 5 years old. It was gaining share and building the reputation that Toyota Motor Corp. had dreamed of. Then, suddenly, the brand's very existence was at risk.

The United States, Lexus' only market, was threatening to impose 100 percent import tariffs on Japanese luxury cars.

"Our forecast was for disaster, and we were preparing for disaster," says Yale Gieszl, who ran Toyota Motor Sales U.S.A. at the time.

The origins of the 1995 crisis lay in Japan's persistently large trade surplus with the United States. Most of the surplus resulted from Japan's exports of autos and auto parts.

U.S.-Japan trade disputes, often over cars, had been around since the 1970s. In 1981, Japan bowed to pressure from the United States and signed on to what was inaccurately known as a Voluntary Restraint Agreement. In a move that was by no means voluntary, Japanese carmakers' exports were capped by a series of annual quotas, starting in 1982.

The agreement expired in 1984 but was immediately replaced by a similar quota system known as voluntary export restraints. Those quotas, raised annually, continued until 1994.

Since the restraints only covered cars, Japanese automakers responded by selling trucks by the hundreds of thousands. It also prompted most of the Japanese companies to build factories in America.

But the trade gap kept growing. In 1995, President Bill Clinton's administration came up with a proposed cure for the trade imbalance. And this time, it was going to hurt.

On May 18, Clinton proposed the 100 percent tax on Japanese luxury cars, effective June 28. The tariff would have applied to three cars in Nissan's still-small Infiniti lineup, plus two nameplates each at Mazda and Honda's Acura brand and a single Mitsubishi nameplate.

Every Lexus would have been hit by the 100 percent duty. Toyota, more than any other company, was in the cross hairs.

Toyota's old strategy for dealing with trade disputes — let the government handle it — had fallen flat.

It had served the company well in the past. Japan's Ministry of International Trade and Industry had displayed a superb ability to judge the tripwires of Washington's patience.

U.S. representatives and senators might thunder that the growing trade gap would not be tolerated. But if it were not an election year, the Japanese bureaucrats would nod politely. If it was election season and Congress was inclined to demonstrate that it was taking action, Japan's trade ministry seemed to know just when the boiling point was approaching, and they'd reach an agreement on beef or oranges or airline routes.

Ministry officials had denounced the so-called voluntary restraints as damaging to free trade. But they, and the auto industry, could live with the quotas.

The ministry was in charge of doling out the quotas. So it now had an extra lever of authority over the auto industry in Japan. Both Mitsubishi and Honda had begun building cars years earlier in defiance of ministry instructions. Both companies were harshly limited under the quotas.

The carmakers, meanwhile, dealt with the quotas in an economically rational manner. If they couldn't raise their volumes, they would raise their profits on every unit they sold. They filled as much of their quotas as they could with their top-of-the-line models and piled on the expensive factory options.

That pushed up the prices of Japanese cars during the 1980s. Some U.S. dealers charged as much as a $2,000 premium for a $7,000 Toyota. Demand still outstripped supply. Free-trade advocates, led by the editorial page of The Wall Street Journal, blasted the quotas, saying they hurt American consumers more than they helped the American automakers.

Many Americans agreed. When the quotas finally expired in 1994, few in Congress called for them to be extended.

But when Clinton proposed that every Lexus buyer also would have to buy the government a car, too, that was a different ballgame. For arguably the first time, the U.S. government was proposing a policy to address the automotive trade gap that would have hurt the Japanese carmakers, especially Toyota, more than it would have hurt American consumers.

After all, Lexus shoppers driven off by a 100 percent tax could have walked across the street to a Mercedes-Benz or Audi dealership. It was a different situation from the days of the second oil crisis, when small cars from Toyota and Honda were in short supply, and the Big 3's offerings did not match the fuel efficiency of a Corolla or Civic.

The U.S. Senate voted 88-8 in favor of a resolution supporting Clinton's proposed tariff.

Toyota went into crisis mode. It had just six weeks to ensure Lexus' future.

Said Jim Press, who was then Lexus general manager: "The issues were really based on the survival of the Lexus franchise. We had a war room, we had contingency plans. We had to mobilize every asset, from dealers to customers, to offset the protectionist pressure."

"My concern," says Yoshimi Inaba, "was how do we maintain the Lexus dealer network? They and we have invested so much money. How do we make sure Lexus dealers survive?"

At that time, Inaba was group vice president for Toyota Division. He went on to become a group vice president at the parent company before retiring in 2007.

Toyota went so far as to discuss building the Lexus ES in the United States. The near-luxury sedan was the brand's volume leader. Toyota considered immediately starting U.S. assembly, largely using imported parts, and then slowly increasing the car's U.S. parts content.

Inaba recalls the reasoning: "By making it by local production, at least we could sustain the dealer network, so that in better days we could again bounce back."

It didn't come to that. (Indeed, the first Lexus wasn't assembled in North America until September 2003, when the first RX 330 was built in Cambridge, Ontario.) Instead, Toyota jumped into the trade talks directly.

Gieszl, an American, testified before Congress, and so did U.S. dealers, customers and suppliers. But what really turned the tide was some good old Japanese-American know-who and a decision to defy Japan's trade ministry.

Then-Toyota President Tatsuro Toyoda was a friend of Walter Mondale, the U.S. ambassador to Japan. When they met to discuss the crisis, recalled Press: "It was almost like a Noh play, in that both sides wanted a way out but with their dignity. We wanted to find the right solution where both sides could go home with something."

The U.S. administration had vowed to impose the tariffs unless Japan set numerical targets for reducing the trade deficit. The Clinton administration called it "results-oriented trade."

Japan's trade ministry — which had helped rebuild the Japanese economy after World War II with industrial policies that closely managed all aspects of the economy — denounced the U.S. proposal as "managed trade." It absolutely refused to go that route. It was a stalemate.

Then Toyota stepped in. It released numbers showing that it planned to increase sharply its purchases of American parts and increase production of cars in the United States.

Those plans were part of the company's already-conceived, but not yet unveiled, New Global Business Plan, which called for a dramatic increase in foreign manufacturing plants. The U.S. part of the plan called for another assembly plant; a new engine plant; an expansion of Toyota's Georgetown, Ky., factory; and the addition of two or three nameplates to Toyota's U.S. production lineup beyond what had previously been announced.

Toyota also said it would start buying more than 300 small- and medium-sized stamping parts from suppliers in America, replacing ones that it had been importing from Japan. The added factories and vehicles also implied a large increase in Toyota's purchases of U.S.-made parts.

Toyota had been preparing the plan to cope with a strong yen, which had made U.S.-built cars more competitive. "Because of those conditions, it was not only a political decision, it was also a business decision," says Inaba. The threat of a 100 percent tax "really reinforced that and maybe made it quicker."

Other Japanese automakers joined in. Toyota, Nissan, Honda, Mitsubishi and Mazda collectively said they would boost their purchases of American-made parts by nearly $9 billion by 1998 from 1995 levels, with $6.75 billion of that for use in their North American plants.

Toyota and others refrained from calling the numbers hard commitments, but the plan was presented as the quid pro quo for dropping the luxury-car import tariff.

By divulging the figures, Toyota satisfied Clinton's desire for numerical results, not just vague promises, in its trade negotiations.

In upstaging Japan's trade ministry, Toyota also infuriated Japan's bureaucrats.

Toyota's action turned the tide. The two sides reached an agreement June 28, just hours before the tariffs were to go into effect.

Lexus was saved. And Toyota had learned a valuable lesson.

"It was a reminder that we cannot rely on government; we have to act ourselves," says Inaba. "We had to take the leadership."