August 7, 2012

Recently, the European Commission requested a mandate from the members of the European Union to open negotiations on a free trade agreement with Japan. At the same time, EU Trade Commissioner De Gucht called on Tokyo to first dismantle certain trade barriers. So are the major exporters on the cusp of a historic breakthrough in their trade relations?

159 years have passed since Commodore Matthew Perry of the United States and his "black ships" steamed into Edo (Tokyo) harbour. Within a year he succeeded in prising open the door to trade with Japan, which hitherto had been closed to all but China and the Netherlands. However, this opening of Japan via gunboat diplomacy did not last. During the past century Japan pursued a mercantilist approach to economic policy for a long time. Heavily regulated domestic competition, industrial policy and the strong barriers protecting the Japanese market led to economic isolation. Imports and foreign investment continue to play a virtually negligible role even today.

The country's economic opening remains an issue. In this context observers can look back on a long history of gaiatsu, or foreign pressure, on Japan. The main achievement in several multilateral trade rounds has been a reduction of tariffs. In bilateral relations, the US sought vehemently, but largely unsuccessfully, under presidents Reagan, Bush and Clinton to have Japan lift its behind-the-border barriers, and the EU has had similar aims in a strategic dialogue for over fifteen years, but has yet to achieve a satisfactory result.

But something is afoot in Tokyo. About 15 years ago Japanese policymakers refocused on a strategy of striking free trade agreements (FTAs). Last year, in fact, negotiations were scheduled with China and South Korea, and there is talk of joining the Trans-Pacific Partnership initiative launched by the US. For years Tokyo has been seeking an agreement with the EU – and more intensively than ever since the EU signed an FTA with Korea. Nonetheless, so far only about 20% of external trade is covered by preferential trade arrangements. Fears of Japan's trade clout have faded anyway. Since the mid-1990s Japan has lost half of its world market shares, now down to roughly 5% (Germany: 9%). In fact, the trade balance has slipped into deficit, even though this was triggered by energy imports in the wake of Fukushima. The importance of reciprocal trade between the EU and Japan has also been on the decline for years. Worth EUR 143 bn in 2010, their trade is very largely based on industrial products. Absorbing 4% of EU exports that year, Japan ranked 7th among the EU's trade partners, while conversely at 11% the EU ranked no less than 3rd following China and the US. In vehicle trade, Japanese makers sell roughly three times as many cars in the EU as EU makers do in Japan. Japanese investment in the EU is quite significant (totalling EUR 129 bn in 2011), but EU businesses have only invested slightly more than EUR 90 bn in Japan. Only 2% of direct investment from the EU has flowed to Japan.

The impact assessment done for the European Commission, like the scoping exercise previously, has shown substantial economic potential waiting to be tapped. In the medium term, GDP in both regions could expand by three-quarters of a percentage point. If an FTA is reached, trade is likely to grow by at least 25%, but probably by closer to one-third. Virtually all industries could benefit if markets opened substantially. The impact would be roughly neutral for the EU auto industry if Japan actually opened its market and, for example, accepted the EU makers' technical standards, whereas the Japanese chemicals industry would have to reckon with production losses. Much could be gained if Japan deregulated its procurement market. Government ownership and anti-competitive regulations pertaining to postal, telecommunications and financial services could also be eliminated. The EU would mainly have to remove some high tariff rates, such as on cars, and address a few technical barriers in goods trade; however, unequal efforts would be on the cards – Japan would have to do a very great deal, while the EU would not need to do nearly as much.

Despite these opportunities, European business leaders are still overwhelmingly sceptical as to whether Tokyo can legislate the entire regulatory transition at the expense of established interest groups. Moreover, Brussels and, especially, Berlin are demanding that longstanding barriers be dismantled in advance of any agreement on truly new trade chapters. And, indeed, the centralised management of the opening process, which was partly possible in Korea, will probably be a much more difficult proposition in Japan. Europe needs more growth and new jobs via trade liberalisation, and Japan urgently needs greater momentum in its external economy. If Tokyo really learns how to get its act together, European hopes could become reality. Until then, scepticism will remain well founded, and it is up to Japan to change this. If the governments in the EU give the go-ahead, difficult negotiations will lie ahead at any rate. And the outcome? Anybody's guess.

Klaus Deutsch (+49) 30 3407 3682

 

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