Toward the Conclusion of a Japan-Mexico FTA

Consulting Fellow, RIETI

Japan and Mexico had been negotiating for a bilateral economic partnership agreement (EPA) with an aim to seal an accord in time for the mid-October meeting between Prime Minister Koizumi Junichiro and Mexican President Vincente Fox. The ministerial talks held ahead of the summit meeting failed to strike a deal and the two countries agreed to continue negotiations, reportedly, due to Japan's refusal to liberalize imports of some agricultural products.

Using numerical simulation based on economic models, this paper will consider the effects of the failure to proceed with the liberalization of certain goods in the free trade agreement (FTA), which is a vital part of the EPA.

The conclusion of a Japan-Mexico FTA could result in increases of approximately 0.03% in Japan's real GDP and approximately 1.08% in Mexico's real GDP

According to the computable general equilibrium (CGE) model of global trade used in this paper, trade liberalization including a reduction in tariff rates results in increased trade volume through the lowering of the prices of traded goods. In addition, reductions in import prices not only increase production in the exporting country, but also permit more efficient use of production resources in the importing country by reducing domestic market distortions caused by trade barriers. The combination of these effects leads to increases in production, income, and standards of living in both countries concluding the FTA. Furthermore, trade liberalization can be expected to have dynamic economic effects, for example, increased productivity as a result of heightened competition in low-priced imports, as well as economic growth due to increased investment.

Theoretically, the trade creation effects in both countries concluding an FTA could lead to trade diversion effects, with imports from each FTA-member country replacing those from other efficient territories. However, empirical research and modeling analyses conducted to this point have indicated that the overall benefits from trade creation effects outweigh the drawbacks of any trade diversion effects.

In fact, according to our modeling analysis, as cited in the Final Report of the Japan-Mexico Joint Study Group on the Strengthening of Bilateral Economic Relations completed in July 2002, if trade were to be liberalized in all fields through the conclusion of a Japan-Mexico FTA, Japan's real GDP would increase by approximately 0.03 percentage points, while Mexico's real GDP would increase by approximately 1.08 percentage points.

On the other hand, changes brought about by trade liberalization are noticeably greater on an industry level than on the macroeconomic levels of trade and production. For example, according to our modeling analysis, while Japan's exports to Mexico of transportation equipment such as motor vehicles could expand threefold, Japan's imports from Mexico of meat such as pork may increase by fivefold (for details, refer to KAWASAKI [2003], "WTO and a Free Trade Area in Asia," in Chapter 7 of Japan's Trade Policy and WTO, ed. by IWATA Kazumasa, Nihon Keizai Shimbun, Inc. [in Japanese]).

For this reason, it is understandable that interested parties in both countries fear the effects of these large changes. The economic effects shown in the modeling analysis are predicated on the success of adjustments to the industrial structures of both nations. Should labor adjustments between industries fail, unemployment would result, making the economic benefits shown in the modeling calculations less likely.

However, it is vital to note that trade liberalization with specific countries has only limited effects on the overall production of each country. In fact, in terms of Japan's macroeconomic production volumes, it is estimated that production of transportation equipment would increase by only 0.2 percentage points, while meat production would decrease by only 0.6 percentage points.

FTA negotiations between the two countries are negotiations in politics and foreign-relations which transcend the economic sphere of trade

In order to conclude an FTA between two countries that complies with the WTO Agreement, which is an international set of rules for such agreements, it is necessary to cover a substantial number of fields. It is not possible to exempt a large number of fields from the scope of liberalization.

However, we devised separate estimates to determine the degree of economic effects from the FTA, assuming hypothetically that Japan would exclude the liberalization of meat imports and that Mexico would exclude the liberalization of imports of transportation equipment.

The results indicated that if Japan did not liberalize meat imports, the macroeconomic effects on the real GDP in each country would decrease by slightly less than ten percentage points. On the other hand, we estimated that if Mexico did not liberalize imports of transportation equipment, the economic effects on the real GDP in each country would decrease by 30 to 40 percentage points.

The results of these estimations seem to confirm, first of all, that the macroeconomic effects of trade liberalization in inefficient fields benefit not only the exporting country but the importing country as well. Furthermore, we can also interpret these results as indications that when we compare the importance of the liberalization of meat imports in Japan with the importance of the liberalization of transportation equipment imports in Mexico, the latter is likely to have far greater impact. Failure to liberalize trade in transportation equipment due to an inability to liberalize meat trade would be very costly to both countries.

It is a fact that trade liberalization restricted to two countries has smaller economic effects than multilateral trade liberalization. The promotion of two-country FTAs is a second-best solution, and should ideally represent a step toward the realization of wider-ranging worldwide trade liberalization, rather than the final goal itself. However, at a time when progress in trade liberalization at the WTO level is not necessarily promising, regional arrangements may be considered a realistic means of liberalizing trade.

FTA negotiations between the two countries can be regarded as negotiations in politics and foreign-relations which transcend the economic sphere of trade. Negotiations should not focus merely on attempts to determine how to protect specific domestic industries and what compromises should be made for the sake of international harmony. Rather, it is necessary to take the offensive in negotiations, focusing on what to draw out from other nations.

It is vital to keep in mind that economic modeling analysis involves certain limitations. Experimental results must be interpreted within certain boundaries. However, experimentation based to a certain degree on the importance of negotiations difficult for both sides, analyzed quantitatively, remains an effective means of inferring the economic effects of the negotiations, and can also be considered an effective means of promoting negotiations.

November 11, 2003

November 11, 2003