Abenomics and Japan’s Trade Policy in a New Era

01/04/2018

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Mireya Solís, Shujiro Urata

Abstract

Trade policy, in particular, the Trans-Pacific Partnership Agreement (TPP), has been a centerpiece of the Abe administration’s economic strategy. The TPP’s contributions to Japan’s growth strategy include: (i) creating trade and investment opportunities abroad for Japanese companies through ambitious liberalization targets; (ii) advancing domestic reforms – with the largest service and agricultural liberalization commitments to date; and (iii) increasing bargaining leverage in other trade negotiations. But the domestic reform goals of Abenomics in agriculture have come up short due to opposition from domestic lobbies. American trade politics – which culminated in the US withdrawal from the TPP – have upended the goals of trade policy under Abenomics. Japan’s best option in this new environment is to deliver on high quality, multi-party trade agreements: concluding negotiations with Europe; scaling up the ambition of Regional Comprehensive Economic Partnership; and salvaging a TPP 11. The merits of a bilateral free trade agreement with the USA will depend on how the Trump administration operationalizes its America First policy.

1 Introduction

Japanese Prime Minister Shinzo Abe must have been disappointed with the decision of the newly inaugurated US President Donald Trump to withdraw the USA from the Trans-Pacific Partnership (TPP).1Nevertheless, Prime Minister Abe is still hopeful for the return of the USA, since the TPP, a high level and comprehensive free trade agreement (FTA) that involves 12 Asia-Pacific countries, has been central to his administration’s economic and foreign policy strategies. The central aim of Abenomics is to recover the Japanese economy from a long recession, and among trade policy instruments, FTAs are expected to play an important role. Under this strategy, the total share of trade covered by FTAs is targeted to increase to 70% by 2018 from 19% in 2013. The TPP was given special attention for its potential to become a new rules framework for the Asia-Pacific region. The 2016 Japan Revitalization Strategy heralded the historically significant signing of the TPP agreement in February 2016 (Prime Minister’s Office [Japan], 2016). The TPP was also an important foreign policy to strengthen Japan’s alliance with the USA. One of the important challenges for Abe, after returning to the prime ministership in 2012, was to rebuild a good relationship with the USA, since it had worsened under the Democratic Party of Japan (DPJ) government. The importance of this goal increased as Japan’s relationship with China became more problematic. In light of these developments, the present paper evaluates Japan’s trade policy under Abenomics, focusing on both the outcomes of the TPP negotiations and the set of alternative trade policies, now that the original TPP is not likely to be enacted. Section 2 reviews Japan’s recent trade policy, and Section 3 offers an overview of the outcomes of the TPP’s negotiations. Section 4 discusses the potential direction of US trade policy under President Trump, as it has brought into question the viability of the TPP project, while Section 5 makes suggestions for Japan’s trade policy in light of the emerging trade environment. Section 6 concludes with an evaluation of Japan’s trade policy under Abenomics.

2 Japan’s New Trade Policy: FTAs

Japan became interested in FTAs in the late 1990s, as it was approached by several countries including Mexico, Singapore, and Korea.2 Previously, Japan had deemed that discriminatory FTAs would undermine the multilateral trade system, which is built upon the basic principle of nondiscrimination that had benefited Japan substantially. But FTAs have become the most important trade policy for many countries as multilateral trade negotiations under the World Trade Organization (WTO) have been in a stalemate. Japan changed its view toward FTAs as an increasingly large number of countries concluded FTAs, resulting in discrimination against Japan. Japan began to establish FTAs actively in the early 2000s. As of the end of June 2017, Japan had 15 FTAs (14 bilateral FTAs and 1 regional FTA with the Association of Southeast Asian Nations [ASEAN]). Japan is involved with three mega-FTAs: the TPP; the Regional Comprehensive Economic Partnership (RCEP) which involves 16 East Asian countries including Japan and China; and the Japan–European Union (EU) FTA. The RCEP and the Japan–EU FTA are currently under negotiation. For Japan, the TPP is the most important initiative because of its high quality and comprehensive coverage, and its geopolitical implications.

3 The TPP: The Most Important Trade Initiative for Abenomics

Japan joined the TPP negotiations in July 2013, 3 years and 4 months after the negotiations began. Japanese leaders showed interest much earlier but strong opposition, mainly from the agriculture sector, prevented the Japanese government from joining. The negotiations had to overcome a number of difficult issues, but a deal was struck on October 5, 2015. This section reviews Japan’s involvement in the negotiations and examines possible impacts of the TPP on the Japanese economy.

3.1 Entering the TPP negotiations

DPJ Prime Minister Naoto Kan first expressed interest in Japan joining the TPP in October 2010. Faced with the long recession and lagging internationalization, Kan argued for the need to open the Japanese economy and society in order to regain vitality and dynamism (Prime Minister’s Office [Japan], 2010). Kan also thought the TPP might help restore Japan’s relations with the USA, which had deteriorated under the previous DPJ Prime Minister, Yukio Hatoyama, who had called for the establishment of an East Asian community excluding the USA and complicated the issue of US base relocation in Okinawa. Despite his keen interest, Kan could not make a bid for TPP membership because of strong opposition, and he only made an announcement at the Asia-Pacific Economic Cooperation meetings in Yokohama in November 2010 that his government would start collecting necessary information and engage in pre-negotiation consultations with TPP countries. There was no progress on the TPP front until the DPJ’s Yoshihiko Noda became Prime Minister in September 2011 because the Kan government was occupied with the Great East Japan Earthquake, which hit the northeastern part of Japan on March 11, 2011, and its aftermath. Prime Minister Noda decided to begin pre-negotiation consultations with TPP members in November 2011. But his initiative did not prosper due to strong opposition within the DPJ fueled by the resistance primarily from the agriculture sector, but also from the medical service and insurance service sectors. The Liberal Democratic Party’s (LDP) Shinzo Abe became prime minister for the second time in December 2012 after the LDP won the Lower House general election. Abe was very interested in joining the TPP negotiations to enable Japan to participate in making the economic rules for the Asia-Pacific, and to find a path back to economic growth. Despite his very strong interest, Abe could not decide to join the negotiations right away because there was very strong opposition from LDP members. The LDP made a pledge during the Lower House election campaign to oppose joining the TPP negotiations as long as “tariff elimination without exception” was a precondition. The LDP also included additional conditions for joining the TPP negotiations in their election campaign: rejection of numerical export targets for manufactured products such as automobiles; defense of the national health insurance system; protection of food safety standards; rejection of investor-state dispute settlement (ISDS) that damages sovereign rights; and consideration of Japan’s special characteristics in negotiating government procurement, and financial services. Abe wanted to make sure that the USA understood the LDP’s position on the TPP during his first meeting with President Obama in February 2013. Abe felt reassured that the elimination of tariffs on all products was not a requirement for joining the TPP negotiations by referring to the joint statement: “Recognizing that both countries have bilateral trade sensitivities, such as certain agricultural products for Japan and certain manufactured products for the USA, the two Governments confirm that, as the final outcome will be determined during the negotiations, it is not required to make a prior commitment to unilaterally eliminate all tariffs upon joining the TPP negotiations” (Ministry of Foreign Affairs [Japan], 2013). Japan and the USA agreed to hold bilateral negotiations in parallel to the TPP talks to address the issues concerning non-tariff measures in nine areas including insurance, investment and competition policies. The two countries confirmed that they would continue to negotiate on issues related to distribution of automobiles and auto safety in Japan, while the USA would maintain tariffs on imported automobiles from Japan and the tariffs would be eliminated gradually within the longest period permitted under the TPP.

3.2 TPP negotiations

The TPP negotiations were complex and time consuming due to both broad issue coverage and high level of liberalization, as well as the very different levels of economic development among negotiating members.3 Despite the difficult odds, TPP countries successfully reached a conclusion due to the strong political commitment of the leaders of the negotiating countries, which was revealed by the intensity of the negotiations: 19 formal negotiations and a series of additional meetings involving chief negotiators, ministers, and leaders. Overall, the most difficult issues included market access in goods, particularly in agricultural products between Japan and the USA, and intellectual property rights (IPRs), specifically the period of data protection for biologic drugs. The USA (anticipating benefits for its competitive pharmaceutical industry) argued for 12 years, while Australia, New Zealand, and several other countries representing the users of drugs advocated for 5 years. A compromise between the two sides was reached with a protection period of 8 years. Other difficult issues that persisted until the end of the negotiations included state-owned enterprises (SOEs), and investor-state dispute settlement (ISDS). Market access in agricultural goods was a challenging negotiation for Japan and the USA. Among Japan’s five “sacred” agricultural products, market access issues for rice, wheat, and dairy products were resolved, as Japan provided special and preferential treatment for the imports from the USA by increasing import quotas. But negotiations remained stalled until the end on beef and pork. The USA was in a disadvantageous situation vis-à-vis Australia concerning beef and pork exports to Japan due to the tariff preferences awarded through the Australia–Japan FTA. It should be noted that the successful conclusion of the Australia–Japan FTA under the Abe administration contributed to the successful conclusion of the TPP negotiations because it put pressure on the USA to reach an agreement without a delay. Under the Australia–Japan FTA, the tariff rate on Japan’s beef imports from Australia will decline from 38.5% (ad valorem equivalent of the specific tariff) to 19.5% (frozen beef in 18 years) and 23.5% (chilled beef in 15 years). The USA demanded a larger reduction in tariff rates on beef imports. After intense negotiations, Japan agreed to lower the tariff to 9% after 16 years. Turning to pork imports, the USA demanded the abolishment of the gate price system. Under the price system, the Japanese government sets a standard import price and collects a levy, which is equivalent to the difference between the standard import price and the cost, insurance, and freight import price when the cost, insurance, and freight import price is lower than the standard import price. The gate price system practically maintains the pork price in the Japanese market at least as high as the standard import price, making it a very effective protective system for Japanese pork growers. The negotiations resulted in an agreement that maintained the gate price system, but reduced the tariff rate. It should be noted that it was agreed that a special safeguard system would be introduced for both beef and pork imports in order to moderate the negative impacts that may result from increased imports. These compromises reflect Abe’s strong political commitment to the success of the TPP. The Abe administration established the TPP Headquarters in the Cabinet Secretariat and appointed Akira Amari as minister in charge of TPP negotiations. The TPP Policy Unit, which is staffed by approximately 100 officials, is composed of two teams; one is in charge of TPP negotiations and the other deals with domestic issues. Before the TPP, FTA negotiations were conducted by government officials from four ministries: the Ministry of Foreign Affairs (MOFA), the Ministry of Finance, the Ministry of Economy, Trade and Industry, and the Ministry of Agriculture, Forestry and Fisheries. Although the chief negotiator came from MOFA, a unified Japanese government position was not achieved due to the different positions of the ministries. The designation of a TPP minister, who enjoys strong support from Prime Minister Abe, enabled the Japanese government to achieve a unified position in the TPP negotiations, so that it could overcome the fierce opposition from the agricultural sector.

3.3 The TPP agreement

The TPP aims to be a 21st century model agreement with comprehensive coverage and a high level of liberalization. It has 30 chapters and it contains a number of new issues and greater depth of coverage compared to other FTAs. They include labor, environment, SOEs, regulatory coherence, transparency, and anti-corruption. These issues have been recognized as barriers to free and fair business activities, but they were difficult to incorporate into FTAs because of opposition mainly from developing countries. In the following, we examine some of the important achievements of the TPP.

3.4 Market access

Achieving a free and open business environment was an important objective.4 However, as has been discussed earlier, market access talks were challenging. Table 1 shows the current level of tariff protection for the TPP 12 countries and their commitments on market access in goods, or tariff reduction/elimination. The figures under the headings “Final Bound” and “Most Favored Nation (MFN) Applied” indicate the shares of products with zero tariffs in the total number of products (tariff lines) registered under the WTO. In Table 1, MFN Applied indicates the actual practice, while Final Bound indicates each country’s formal pledges which cannot be increased. For example, for Singapore’s agricultural products, 99.8% of the tariff line products have zero tariffs in practice, but Singapore can raise tariffs on 95.9% of tariff lines without violating WTO commitments because only 4.1% of tariff lines are bound to zero. All TPP 12 members with the exception of Japan committed to eliminate tariffs on virtually all products with or without transition periods in the TPP. Considering the limited commitment on tariff elimination under the WTO, the commitment made by the TPP members to realize an open market is remarkable. Having discussed high levels of trade liberalization under the TPP, it should be noted that as much as 19% of agricultural products will remain protected for Japan. This outcome may be a victory for the negotiators, but it will certainly not bring about the agricultural reform sought by the Abe administration.5
Table 1. Tariff elimination rate under Trans-Pacific Partnership (TPP) (%)
Actual figures (2015) TPP commitments
Agricultural products Manufactured products Total Agricultural products Manufactured products
Final bound MFN applied Final bound MFN applied Eventual elimination Immediate elimination Eventual elimination Immediate elimination Eventual elimination
  1. Source: WTO Tariff Profiles, and Japanese Government, Cabinet Secretariat, TPP Section.
Australia 31.3 77.0 18.8 45.9 100 99.5 100 91.8 99.8
Brunei 0.0 98.5 0.0 78.5 100 98.6 100 70.2 96.4
Canada 46.0 59.6 25.8 78.5 99 86.2 94.1 96.9 100
Chile 0.0 0.0 0.0 0.3 100 96.3 99.5 94.7 100
Japan 34.1 36.5 55.9 55.7 95 51.3 81 95.3 100
Malaysia 12.9 75.0 5.0 64.1 100 96.7 99.6 78.8 100
Mexico 0.4 19.6 0.3 55.2 99 74.1 96.4 77 99.6
New Zealand 54.8 72.4 46.4 62.5 100 97.7 100 93.9 100
Peru 0.0 52.6 2.2 70.0 99 82.1 96 80.2 100
Singapore 4.1 99.8 17.0 100.0 100 100 100 100 100
USA 30.2 30.8 47.4 48.4 100 55.5 98.8 90.9 100
Vietnam 8.7 15.5 15.0 38.8 100 42.6 99.4 70.2 100
The adoption of cumulative rules of origin in the TPP facilitates the construction and use of production networks/supply chains in TPP member countries, as intermediate goods/parts and components sourced in TPP member countries are treated as TPP products and, thus, can be traded tariff-free. The agreement on government procurement enables foreign suppliers to bid for central government procurement contracts in TPP member countries. These markets are open to WTO members that are parties to the Government Procurement Agreement (GPA). Among the TPP members, only Japan, New Zealand, Singapore, and the USA are GPA members. Hence, the TPP opened the government procurement markets of the remaining eight countries.

3.5 Services and investment

The TPP ensures national treatment to foreign service providers and foreign investors. In other words, foreign firms are not discriminated against vis-à-vis local firms in TPP member countries. However, sensitive areas such as the defense sector are excluded from this treatment based on the negative list approach, which allows for a more liberalizing outcome by explicitly designating excluded sectors (a positive list approach only opens sectors explicitly listed). It is noteworthy that the TPP prohibits the application of a number of restrictions by the government on the behavior of foreign firms. They include the prohibition of performance requirements such as technology transfer requirements and restrictions on transfer of funds. Special treatment of SOEs that creates unfair competitive advantage is not permitted in the TPP. Leveling the playing field with SOEs enables foreign firms to expand their business in Malaysia and Vietnam where SOEs dominate in their respective markets. The agreement on IPRs and the adoption of ISDS aims to encourage foreign direct investment flows with protection of intellectual assets and enforcement of obligations on the part of host country governments. This examination of the TPP’s features indicates that the agreement, if enacted, is likely to result in an expansion of trade in goods and services and investment by Japanese firms, contributing to the recovery of the Japanese economy, as envisaged by Prime Minister Abe.

3.6 Impact of the TPP on the Japanese economy

Several studies have examined the possible impact of the TPP on the Japanese economy by using a general computable equilibrium model (CGE), which mimics the system and functioning of actual economic activities involving consumers, producers, and the government. These studies assume elimination of tariffs on goods. Some studies include other policies such as the elimination of non-tariff measures and liberalization of trade in services and investment. The Japanese government analyzed the possible impact of the TPP on the Japanese economy by using a Global Trade Analysis Project model that takes into account tariff reductions/elimination, trade facilitation, and the elimination of non-tariff barriers (Cabinet Secretariat, 2015). This study showed that the TPP would increase Japan’s gross domestic product (GDP) by 2.59% (13.6 trillion yen) and employment by 1.25% (795,000 workers). For the agricultural sector, a decline in production of 130–210 billion yen is projected. The simulation assumed the following growth mechanism. First, tariff reductions/elimination, trade facilitation, and the elimination of non-tariff barriers would result in an expansion of trade, which in turn increases labor productivity. Second, an increase in labor productivity would increase wages, which in turn increases the labor supply. Third, increases in wages and labor supply would result in an increase in income, and, thus, higher savings. An increase in savings would augment capital stock, which in turn expands production capacity. The Cabinet Office study justifies these assumptions by providing supportive evidence from previous studies. However, the realization of some of these assumptions requires domestic policy reforms and it may take time for the effects to be fully worked out. Indeed, the simulation results of the impact of tariff elimination alone showed a 0.66% increase in GDP (Prime Minister’s Office [Japan], 2013). Other simulation studies also show positive impacts of the TPP on the Japanese economy, but the size of the increase varies widely among them depending on the assumptions and the mechanisms of the models used in the analyses. Petri and Plummer (2016) show that Japan’s real income rising by 2.5% by applying a CGE model that incorporates heterogeneous firm behavior, which is one of the most remarkable recent developments in the area of theoretical and empirical economics. Their model introduces a mechanism under which increased competition resulting from liberalization improves productivity of the country by weeding out non-competitive firms. Indeed, this is the mechanism that yields the largest impact. Kawasaki (2014a) and Gilbert et al. (2016) obtain estimates of the increase in real income of 1.6% and 0.31%, respectively. Kawasaki included both reductions/elimination of tariff and non-tariff measures, while Gilbert et al. only consider reduction/elimination of tariffs. One of Kawasaki’s most important findings is that a large contribution from FTAs to economic growth comes from the opening of the home market, while the opening of the FTA partners’ markets provides relatively only a small contribution, indicating the importance of domestic policy reform. Abe’s decision to prioritize the TPP negotiations above all other trade initiatives suffered a significant setback when President Trump withdrew the USA from the trade agreement. American trade politics, therefore, has emerged as a critical factor impacting on the success of Japanese trade policy under Abenomics and will continue to loom large as Japan adjusts its trade strategy to cope with the new direction in US trade policy.

4 A Pivot in US Trade Policy?

The growing divisiveness in US trade politics and the onset of the Trump administration embracing a swift departure toward an “America First” trade policy have profound consequences for Japan’s trade policy goals under Abenomics. This section addresses some of the main factors contributing to the trade backlash in the American political debate and the main tenets of the Trump trade philosophy. The new American administration has already followed through on one major policy decision – withdrawal from the TPP, but there is greater uncertainty regarding the implementation of other campaign pledges on the trade front. Hence, Japanese trade policy must adapt to a new trade environment – where the USA is no longer championing multilateral economic diplomacy and where the disruptive impact of protectionist policies looms larger. Since the enactment of the North American Free Trade Agreement (NAFTA) in 1994, the consensus on the merits of free trade policies has increasingly eroded. The reasons for trade skeptics to object to the deep integration agenda are varied, they range from concern over the loss of regulations to protect the environment and consumers, the legal arbitration recourse made available to foreign investors, complaints about the lack of negotiation transparency, and worries about asymmetrical bargaining outcomes in North–South FTAs. But no issue has galvanized the US political debate on trade as much as the impact of trade agreements on wages and employment. The notion that the American worker has been the casualty of globalization began to gain traction during the NAFTA period when opponents predicted major job losses due to unfair competition with cheap Mexican labor. The evidence proved otherwise. In the first years of NAFTA’s implementation, the US unemployment rate decreased, and there was a gain in manufacturing jobs. More recently, it has been China’s insertion into the world economy – as it gained WTO membership in 2001 – that has animated skepticism on the merits of trade. Import competition from China had a significant impact on specific US manufacturing sectors such as apparel and furniture, and overall Autor et al. (2016) estimate that it was responsible for up to one sixth of the 5.8 million jobs lost in manufacturing jobs from 1999 to 2011. But it is the other finding of the “China trade shock” which provides the most insight in understanding the fraying consensus on trade: displaced workers have faced a much more difficult and prolonged transition than previously reckoned – with long spells of unemployment, wage losses, and the lack of opportunities in depressed communities. Moreover, of the social programs available to laid-off workers, trade adjustment assistance has played a marginal role (Autor et al., 2016). The traditional case for trade – highlighting broad aggregate gains in economic welfare, while acknowledging concentrated costs – fails to resonate in a context of increased inequality, stagnation in middle-class income, falling rates of labor market participation, and lessened geographical and social mobility (Solís, 2017a).6 These adverse socio-economic trends have created fertile ground for scapegoating trade with the consequent misdiagnosis of the root problems and ineffective policy responses. The vast majority of manufacturing job losses (87%) were caused by technological change (e.g. automation), but both trade and technology have helped spur efficiency, innovation, and productivity (Hicks & Devaraj, 2015). Rather than attempting to block economic change, it would be more effective to address the growing skill deficits in the workforce and to encourage genuine labor mobility to enable workers to acquire new skills, enter new fields and occupations, and tap into the economic opportunity that comes with geographical mobility.7 Repairing the nation’s safety net did not headline the 2016 presidential election. Instead, a critical view of the impact of trade agreements prevailed, with candidates from both parties reneging on the TPP. But it was Trump’s protectionist message – calling for renegotiation or exit from existing FTAs and threatening punitive tariffs on main trade partners such as China or Mexico, which gained the most traction in the swath of Rust Belt states that hold a large share of Electoral College votes (Hendrix, 2016).8 The findings on the electoral traction of a protectionist platform is important because it lowers the prospects for a future correction course in the Trump administration toward the conventional parameters of postwar US foreign policy, for instance endorsing free trade as a source of economic prosperity and American influence abroad. In this case, electoral politics reinforce long-held nationalistic views on trade policy of the new president and many of his trade advisors. Listed below is a highlight of the main threads in the Trump trade doctrine, as can be gleaned from public speeches, position papers, media interviews, and social media commentary (tweets).
  • Trade is zero-sum and the USA is losing the race. The losers (drained by import competition and the overseas relocation of industry) suffer de-industrialization and the extinction of job opportunities. In his inaugural presidential address, Trump talked about the carnage suffered by American workers because of international trade and offshoring, and asserted that protection can lead to prosperity (White House, 2017).
  • Reducing/eliminating the trade deficit is the end goal of trade policy. Asserting that GDP expansion is driven by the growth in consumption, investment, government spending, and net exports, Trump’s trade advisors (Navarro & Ross, 2016) conclude that when a country imports more than it exports it lowers its economic growth.9
  • A shift in priorities/resources from governance to enforcement, from rules to results. The American trade deficit reflects both flawed trade agreements and rampant cheating by US trade partners. Therefore, enforcement of trade disciplines will be pursued with renewed vigor. Signaling a potential return to a results-oriented trade policy, Trump’s trade advisors hinted at “automatic triggers” to reopen trade agreements if the bilateral trade deficit expands (Mufson, 2017).
  • A preference for bilateral negotiations over multilateral deals. The preference for one-on-one negotiations comes from the notion that bilateral talks enhance American bargaining advantage as the largest consumer market. It also underscores that rulemaking is not at the heart of the trade strategy since multiparty deals are much better suited for dissemination of standards.
  • The renationalization of manufacturing is a desirable/achievable goal. The goal is not only to revive industries in decline (such as coal and steel) but also to return to the homeland advanced manufacturing that currently operates across the global supply chain (Donnan, 2017).
  • The comeback of unilateralism. In Trump’s trade circles, there is deep skepticism toward the value of the WTO to advance US interests. During the presidential campaign, Trump alluded to the possible withdrawal from the multilateral trading body. Trump’s trade advisors have complained that the one country, one vote rule violates US sovereignty because it gives equal weight to nations of disproportionate economic power (Navarro & Ross, 2016, p. 12). The first trade policy report from the Office of the US Trade Representative to Congress under the Trump administration admonishes that the US may not abide by a negative finding from a WTO dispute settlement panel if it considers it runs counter to its sovereignty. And it goes on to emphasize the value of US trade laws, including section 301 (permitting the unilateral imposition of sanctions on countries deemed to engage in unfair trading practices), to aggressively “encourage true market competition” (Office of the United States Trade Representative, 2017, p. 4).
Importantly, the list above is a composite of the Trump administration trade rhetoric, which is yet to be operationalized into policy. The extent to which these precepts infuse actual trade initiatives will hinge on a number of factors: the buy-in or pushback from Congress, the mobilization of the private sector, and the responses from trading partners (Dadush, 2017). But one major decision has already been implemented – withdrawal from the TPP – which directly impinges on the core initiative of Abenomics’ trade policy.

5 Reassessing Japan’s Trade Choices for the Future

The recalibration of Japan’s trade strategy must factor in significant trends in the new environment: the abdication of US leadership in advocating multilateral trade frameworks, the slowdown of international trade (with the added headwind of policy uncertainty), and the potential escalation of protectionism.10This would mark a shift from the existing trend among G20 countries of relying on WTO legal restrictive measures (e.g. anti-dumping) to the cascading effects of retaliation to a large country’s overtly discriminatory policies, such as punitive tariffs, extensive buy national clauses, border taxes imposed on companies that outsource production, or import restrictions on products such as steel and aluminum on national security grounds. Japan’s best response in this difficult climate is to reinvigorate its multiparty trade negotiations advocating for high quality liberalization. One immediate priority is to finalize the Japan–EU FTA after both parties reached an agreement in principle on July 6, 2017. The deal reflects compromises on government procurement (Japan agreeing to eliminate the “operational safety clause” hindering bids in rail transportation), dairy (e.g. Japan providing expanded access for cheese and wine) and automobiles (with the EU slated to eliminate tariffs on cars in 7 years). The importance of the Japan–EU FTA goes beyond its expected economic gains (covering almost 10% of Japanese trade, it is estimated to generate income gains of 0.8% of GDP) (Kawasaki, 2014b; Solís, 2017b). The negotiation milestone was delivered on the eve of the G20 summit in Hamburg, to offer a reaffirmation from major economies on the benefits of trade liberalization, and drew a stark contrast with the Trump administration’s approach to trade policy. However, significant challenges still loom ahead in bringing this mega trade agreement to fruition. For one, both parties have yet to agree on key issues: data flows and investment protection (Japan endorses ISDS, while the EU has adopted an investment court system which Japan has not incorporated in any of its FTAs). The hurdles to ratification are high in the aftermath of the European Court ruling that trade agreements that incorporate portfolio investment and investor protection disciplines must also be approved by national and regional parliaments. A second vector in Japan’s relaunched trade policy should be to salvage the TPP project. The US withdrawal from the TPP means that Japan can no longer use this trade agreement to fulfill the geopolitical goals of deepening the US alliance by overcoming divisive market access issues and jointly supplying governance to the Asia-Pacific region at a time of rising Chinese influence. It also means that preferential access to the US market through the TPP is off the table. Far from being meaningless, a TPP 11 (a TPP agreement without the USA) serves well Japan’s economic and geopolitical interests. A recent simulation study by Kawasaki (2017) shows that in a TPP 11, Japan’s income gains through tariff reductions fall from 0.24% to 0.07% of GDP, but the largest payoff for Japan has always centered on reducing non-tariff barriers, and in this area the reduction in benefits is much smaller (from 1.13% to 1.04% of GDP). Overall, the decrease in expected income gains from losing the US market is not marked: from 1.37% to 1.11% of GDP. This result reflects two fundamental facts. First, the terms of access to the American market (not just its overall size) is crucially important. The USA has low average most-favored-nation tariffs, and in the TPP it played hardcore defense in areas of competitive interest for Japan (autos and trucks with liberalization pushed back decades). Second, the competitiveness gains for Japan mostly derive from its own domestic reforms tied to liberalization (e.g. services) and the adoption of behind-the-border rules (investment and IPR) that enhance the operation of its global supply chains. Geopolitically, a relaunched TPP (TPP 11) helps Japan position itself vis-à-vis the other great trading powers in the region: it prevents China from becoming the single focal point of integration and preserves an economic rulebook that helps deter Chinese mercantilist practices. But it also discourages a US inward turn by raising the costs of American marginalization from mega trade deals, while keeping open the option of a future US return to the TPP. At the aggregate level, the trade diversion effects of a TPP 11 on the American economy will not be large, but the costs of exclusion will be significant for specific economic sectors. For example, without the TPP, American beef producers will face a much higher tariff in the Japanese market than Australian producers. These trade diversion costs will increase as other trade agreements materialize. For example, a study by the Council of Economic Advisors (2016) found that in the absence of the TPP, a modest outcome in RCEP would still disadvantage American firms in 35 industrial sectors with annual goods exports of $5.3 billion to Japan because of trade diversion effects. These cumulative disadvantages may help mobilize the American private sector and Congress to come back to the TPP. Delivering a TPP 11 will require political will and creative diplomacy. It will likely involve one or more of the following steps: amending the ratification clause so that US participation is no longer required to achieve a critical mass, engaging in surgical renegotiation to encourage developing Southeast Asian members to remain in a TPP 11, and encouraging the admission of new members across the Asia-Pacific (Urata, 2017; Solís, 2017c).11 Securing ambitious trade agreements in East Asia is also a high priority for Japan. The RCEP – comprising a third of world GDP – has the potential to deliver significant gains from trade liberalization. With 16 members from the Indo-Pacific region, RCEP differs from the TPP in terms of membership, scope, and modalities of negotiation. Based on the principle of ASEAN centrality, RCEP aims to build from the network of ASEAN + 1 FTAs to achieve further liberalization that is WTO consistent. But the launch of RCEP was also enabled by a fundamental understanding between China and Japan – which had been pushing different blueprints for region-wide integration – spurred by Japan’s interest in the TPP (Solís & Katada, 2015). Reflecting the wide diversity in levels of development, RCEP embraces the notion of special and differential treatment, flexibility in implementation, and has a narrower scope (e.g. no provisions on government procurement, environment and labor, and SOEs). A leadership deficit has resulted in protracted negotiations and has clouded the prospects for ambitious outcomes. India has offered very conservative offers on tariff elimination, creating the prospects of a lowest common denominator effect. ASEAN has opted for a two-track process first caucusing among its members before discussing topics with the rest of RCEP members, which encumbers negotiations (Elms, 2016b). China did not play a leadership role in the ASEAN-centric initiative, opting instead to push for signature initiatives such as the Asian Infrastructure Investment Bank and One Belt, One Road (Ye, 2015). Japan attached utmost priority to the TPP talks, as can be discerned from the creation of a TPP headquarters to pool elite bureaucrats with access to the Prime Minister’s Office, but made no equivalent effort for RCEP talks. The uncertain fate of the TPP and a potential American turn inward create an opportunity for RCEP members to reinvest in achieving a significant liberalization outcome. Japan and other like-minded countries like Australia, New Zealand, Singapore, and possibly South Korea have an incentive to rebalance priorities and push for ambitious outcomes for an RCEP that could be the sole standard-bearer for the region. Their efforts could find a more receptive ASEAN as it seeks to attract investment at a time of rising protectionist threats to the global supply chain, as well as a more responsive China eager to deliver on RCEP to buttress its credentials as champion of economic multilateralism. A reinvigorated RCEP should also aim to establish clear accession protocols to expand its reach beyond the region and possibly include members of the Pacific Alliance, which have recently expressed interest (e.g. Chile and Peru). Japan’s trade strategy for the new era must also fashion a response to a likely entreaty by the Trump administration to negotiate a bilateral FTA. Vice President Mike Pence already alluded to the desirability of such a bilateral deal during the first meeting of the High Level Economic Dialogue in April 2017. But his Japanese counterpart – Deputy Prime Minister Taro Aso – stressed instead the merits of drafting rules for the Asia-Pacific through the TPP. How the USA and Japan will address this disconnect on the trade agenda will be of key importance. Given the depth of trade and investment links between both countries (Japan is the second largest foreign investor in the USA and its fourth largest trading partner, and the USA is the largest foreign investor in Japan and its second largest trading partner), a bilateral agreement could be a good option now that the USA has ruled out participation in the TPP. However, such a trade deal would only offer a positive opportunity provided it builds on the standards of the TPP and provides further opportunities for mutual liberalization on sensitive issues (e.g. agriculture for Japan and autos for the USA). At this juncture, the prospects for steady progress toward that end are far from certain. Japanese officials have consistently signaled that no further concessions on market access in agriculture are possible. Negotiations over market opening in automobiles may prove contentious given the Trump administration’s fixation on trade deficits, and the fact that auto imports are by far the largest component of the bilateral trade deficit vis-à-vis Japan. Therefore, a wait-and-see response is advisable until the Trump administration operationalizes its America First trade policy. Binding rules on currency manipulation, further tightening of rules of origin, one-sided demands for Japanese market opening without reciprocal concessions, and the adoption of automatic triggers to correct bilateral trade deficits would severely limit the benefits for Japan and could present insurmountable negotiation challenges. Under such a scenario, Japan could still engage in productive bilateral dialogue on the broader economic complementarities with the USA (e.g. infrastructure and energy). In the long term, Tokyo should deploy a trade strategy that creates an incentive structure for the USA to reengage in multilateral economic diplomacy by delivering on its own mega trade deals.

6 Conclusions

The Abe administration has deemed the TPP and other FTAs as essential components of its growth strategy. As the TPP received top priority in Abenomics’ trade policy, the US withdrawal from the agreement means it is no longer possible to meet the Abenomics target of 70% FTA coverage by 2018, and more broadly, it negates the geopolitical gains of deepening US–Japan relations through an Asia-Pacific trade deal. This major reversal notwithstanding, trade policy under Abenomics has achieved important milestones. The trade deal concluded with Australia in 2014, the TPP agreement finalized in 2015, and the agreement in principle with the EU reached in 2017 showcased a Japan now capable of concluding trade deals with large agricultural exporters that slash more agricultural tariffs than ever before, pool larger markets for trade and investment, and codify behind-the-border rules that streamline the operation of Japanese supply chains. Yet, the most significant weakness of trade policy under Abenomics is also evident in all these trade initiatives: the insufficient push for domestic reform due to the political decision of the Abe government to play defensive in agricultural liberalization/modernization in order to protect the core interests of the agricultural lobby. In this new and more uncertain era, the Abe government should capitalize on its stronger credibility to negotiate ambitious trade agreements to bring to life other mega FTAs including a TPP 11, RCEP, and the finalization of the Japan–EU FTA. These trade initiatives are important in their own right, but they will also be helpful in creating an incentive structure for the USA to return to multilateral trade deals as the costs of exclusion begin to pile up. But it is also equally important for the Abe government to display greater zeal in carrying out necessary domestic policy reform since it yields the largest economic gains and provides the groundwork for Japan to successfully negotiate high quality FTAs.

Mireya Solís is a senior fellow at the Brookings Institution and holds the Philip Knight Chair in Japan Studies. She is also co-director, with Richard Bush, of the Center for East Asia Policy Studies. 

Shujiro Urata, Graduate School of Asia-Pacific Studies, Waseda University, 1-21-1 Nishiwaseda, Shinjuku, Tokyo 169-0051, Japan. 

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The article was originally posted here.