Japan's Trade Policy: What is the problem?

Faculty Fellow, RIETI

The time has come for Japan to have a clear insight into the state of trade policy (or external economic policy as often referred to recently). This is because significant changes occurred in trade policy tools as Japanese companies moved to accelerate their international business operations. Needless to say, Japan is no longer the primary production base for most of the nation's leading manufacturers and quite a few of them keep only research centers or, at most, mother factories in Japan. Furthermore, the number of companies with more non-Japanese employees than Japanese employees is on the rise.

Traditionally, the World Trade Organization (WTO) and multilateralism have been the central axis of Japan's trade policy. However, the current round of WTO negotiations under the Doha Development Agenda (DDA), which began in 2002 and kept missing deadlines, is now way behind schedule and completely adrift. Meanwhile, shortly after the turn of the century, the Japanese government stepped up efforts to pursue trade liberalization through bilateral arrangements, which resulted in the conclusion of economic partnership agreements (EPAs) with 12 countries, mostly member states of the Association of Southeast Asian Nations (ASEAN). Japan is not alone in seeking trade liberalization through bilateral channels. Not only the United States and the European Union but also South Korea and many other countries around the world have been vigorously seeking to forge similar bilateral arrangements, namely, free trade agreements (FTAs), with their trade partners. South Korea, which has already concluded negotiations with the U.S. and the EU, is slated to enter negotiations with China next year. In contrast, Japan has been extremely slow to move forward. Its EPA talks with India and Peru have been heavy going(*1), negotiations with Australia have stalled, and talks with South Korea have been broken off. The formation of an EPA with China, which is much awaited by the Japanese business community, or those with other major trade partners such as the U.S. and the EU, is nowhere in sight. Unquestionably, Japan is now standing at a crossroad in its EPA policy. So what exactly are the challenges we face today?

Is multilateralism a matter of course?

Many people, both within and outside the government, believe that an international economic regime should be multilateral in nature as is the case for the WTO. Is this idea absolutely correct?

Liberalization under a multilateral framework surely has an enormous impact because trade across virtually all countries and regions in the world will be liberalized at once. The achievement of the current WTO regime is not limited to tariff reductions. It has been a vehicle for eliminating non-trade barriers (food safety regulations, government procurement requirements, etc.), promoting service sector liberalization, and imposing stricter disciplines to provide greater protection for intellectual property rights.

In comparison, EPAs are primarily focused on eliminating import tariffs (not immediately but within 10 years). Liberalization measures under an EPA are rarely extended to non-trade areas, and the scope of beneficiaries to the benefits of liberalization is limited to the countries party to that specific EPA. Furthermore, even if a country established a network of bilateral FTAs, arrangements akin to EPAs, through painstaking efforts, those FTAs may become subject to renegotiation anytime. That is, the country would be compelled to amend and improve its FTA with a certain country if an FTA with more favorable terms is concluded between that country and another country or region. Compared to agreements under the WTO, FTAs are more cumbersome to create and maintain, and yet, their effects are limited. It is obvious that FTAs are no match for the WTO in terms of efficiency. Thus, it would be best to have a multilateral system. But the question is whether multilateral frameworks such as the WTO will be as workable in the future as they have been to date.

Since the end of World War II, international trade has been liberalized under the auspices of the General Agreement on Tariffs and Trade (GATT) and the WTO. Under this postwar regime, an international agreement was typically formed among advanced countries - namely, the U.S. and the member countries of the EU (previously, the European Community), with Japan joining them from the GATT Uruguay Round negotiations in the 1980s - and developing countries were invited to join only after the agreement was reached, with advanced countries offering aid and assistance as an incentive (bait).

In creating a multilateral agreement, it is important that accord is reached among the main players and that other countries (followers) have an incentive to join the agreement. Looking in detail and leaving the GATT aside, there are very few areas in which a multilateral agreement has been reached since the end of World War II. This is because the two world superpowers, the U.S. and the Soviet Union, were in a hostile relationship and it was no easy task to form any agreement between those main players. The GATT, a rare example of multilateral agreements reached in postwar years, could be concluded because the Soviet Union was not part of that agreement.

The main players under the current WTO regime are not limited to advanced economies in the Western bloc, such as the U.S. and the EU. After entering the 21st century, emerging economies - particularly, China, India, and Brazil - rapidly rose and took central stage. These countries are not followers that are readily "hooked by bait." In the past several years, the Group of Twenty (G20) has come under the spotlight on the international stage and is symbolic of the rise of emerging economies. Thus, in creating a multilateral agreement, it is necessary to have not only advanced but also emerging economies involved in a consensus-forming process. However, emerging economies are far from being in agreement with one another (Some people even predict that the spotlight will once more be turned on the Group of Eight (G8) because of G20's inability to efficiently make decisions). Undoubtedly, emerging economies have secured their places as main players in the area of international economy (while Japan's status is, unfortunately, becoming precarious). However, a new, expanded framework for decision making that includes both emerging economies and advanced economies has yet to be established. Regarding the WTO Doha Development Agenda, it had been expected that the U.S. and the EU would reach an agreement by around 2003, quickly leading to a WTO-wide interim agreement. As it turns out, however, even after all these years, an interim agreement has yet to be reached. A similar pattern is observed in the post-Kyoto Protocol negotiations, another multilateral initiative to create a new framework for regulating greenhouse gas (GHG) emissions. When multilateral efforts continue to fail, countries naturally try to solve pending issues by means of bilateral or regional arrangements. The rapid proliferation of FTAs observed in recent years is a prime example of the phenomenon. Even though we do acknowledge the effectiveness of a multilateral approach in addressing trade issues, the reality is that we have no choice but to find a way out through bilateral or regional FTAs.

Challenges for Japan

(1) What is the purpose of trade policy?
Liberalization achieved under the WTO is applicable to all WTO members including Japan. For instance, when trade in certain products is liberalized, both the export of those products from Japan to China and those from the U.S. to China are equally liberalized, and China must apply the same treatment to the products whether they were made in Japan or the U.S. Such is how things work under the WTO, a mechanism to which we have long been accustomed. But this is not the case with FTAs. For instance, if Japan concludes an FTA with China, tariffs on substantially all trade between the two countries will be eliminated within 10 years whereby Japanese exporters will be able to export to China free from tariffs. However, exporters from other countries, those without an FTA with China, will remain subject to tariffs. The opposite will happen if Japan remains outside China's network of FTAs. What must be kept in mind here is that, as a basis for granting tariff-free treatment, the applicable FTA differs depending on the place of production and the place of destination. That is, even if Japan concludes FTAs with countries that are major importers of goods produced by Japanese companies, tariff-free treatment granted by those FTAs would not be applicable to those produced by Japanese companies' manufacturing subsidiaries in various locations around the world. On the other hand, if the government of a country in which Japanese companies' manufacturing subsidiaries operate concludes an FTA with the government of a consumption country, goods produced by those subsidiaries would be subject to preferential treatment under the FTA. As we enter the era of FTAs, we are being forced to consider for what purpose (or for whose benefit) the government's trade policy should be implemented, an issue we have not bothered to consider in the era of multilateralism.

The question was unnecessary in the past when Japanese companies primarily operated in and exported from Japan, and so long as liberalization measures were determined and implemented multilaterally under the framework of the WTO/GATT. Today, however, it has become almost a regular situation for Japanese companies to operate overseas and liberalization schemes are being determined and implemented primarily on a bilateral basis. Under such circumstances, it is imperative for the Japanese government to develop and implement policy support measures by setting eyes not only on Japanese companies' trade and investment activities to and from Japan but also on their trade and investment activities between countries outside Japan (hereinafter, "outside-to-outside operations"). It is necessary and justifiable for the government to support such outside-to-outside operations because helping Japanese companies with their overseas operations will benefit the Japanese economy, for instance, in the form of dividend receipts from overseas.

Now, if outside-to-outside operations are the prime focus of government support for Japanese companies, how should we define government initiatives to support exports and investments from Japan, which have been fundamental in formulating trade policy? In the next section, I will discuss the meaning of such conventional support initiatives.

In Japan, as in other countries, Japanese and foreign companies operate and support the backbone of the national economy. That is, most Japanese people earn their living in Japan, particularly by working for companies based in Japan. Needless to say, the purpose of Japan's trade policy is to improve the living of the Japanese people. But then, does this mean that the Japanese government should be protecting companies operating in Japan? The answer is no. In the world of FTAs, unless Japan liberalizes imports and investments from foreign countries, Japan's exports and investments to those countries will not be liberalized in accordance with the rule of reciprocity. This would not be a problem if the entire spectrum of production and other activities were to take place within national boundaries. In reality, however, goods produced in Japan are typically exported to overseas countries. And it is not only final goods that are exported. Indeed, companies export various kinds of parts and components, which will be further processed or incorporated into other products for re-export to other countries, which may be the final destination or yet another stopping point. Under such circumstances, if Japan were to close its market, it would be left outside international production and distribution networks, in which case many Japanese companies would find themselves with no choice but to leave the country. Obviously, this is not what Japanese people want. We must be fully aware that if Japan remains unable to break the impasse in efforts to expand its EPA network, its attraction as a place for doing business will be lost and the Japanese economy will be negatively impacted.

All of us, whether in the public or private sector, must recognize and always remember that the ultimate goal of Japan's trade policy is to promote the growth of the Japanese economy and maintain domestic employment.

(2) Rebuilding Japan's decision making mechanism
A major challenge in supporting companies' outside-to-outside operations is a "tool search," that is, identifying available support options and determining which one is the best. However, in order to remove regulatory constraints to achieve truly free trade, it is imperative to address Japan's deep-rooted problem of inefficient decision making.

In the past, the Japanese government has used multilateral agreements, such as those under the WTO/GATT, as leverage to change domestic policies. For instance, in becoming a member of the WTO at the time of its launch in 1995, the thorniest issue for Japan was the liberalization of trade in agricultural produce, particularly, rice. However, after much controversy and opposition, it was concluded that it would be inevitable for Japan to lift its ban on rice imports conditional on the provision of subsidies to rice farmers for the sake of joining the WTO as a founding member. Also in 2008, when the WTO members were close to reaching an interim agreement, it had been assumed that Japan would agree to further liberalization of agricultural trade, once again conditional on the provision of subsidies to affected farmers. The pattern commonly observed is as follows. When multilateral negotiations, whether under the WTO or the GATT, came close to an agreement, there emerged a compelling atmosphere within Japan, that is, people began to feel that if other members were agreeing to liberalize, Japan would have to do the same, hence leading to the formation of a national consensus with even protectionists agreeing to accept an international agreement conditional on the provision of domestic subsidies to affected parties. In contrast, FTAs/EPAs are mostly bilateral, meaning that Japan would be dealing with just one country. Even in those of a greater scope, the number of countries involved is 10 at most (eight ongoing negotiations for the Trans-Pacific Partnership, TPP), whereby any initiatives pursued under such arrangements cannot be described as a "major global trend." Furthermore, none of the EPAs that have been concluded to date involved the provision of new subsidies by the Japanese government and it is presumed that the Japanese government has been working under the logic that the provision of subsidies is justifiable only when they are given as compensation for following world trends. Should it be the case, Japan would be able to conclude an EPA only with countries for which agriculture would not be an issue (which I believe is the reason why no progress has been made in EPA negotiations with Australia). Countries concluding an EPA/FTA are typically required to commit to the elimination or significant reduction of import tariffs. Even though they are given a grace period of about 10 years, it is expected that a certain segment of population - farmers or otherwise - will suffer a considerable impact. Thus, it is necessary for Japan to establish a new decision making mechanism that allows for the use of subsidies or other impact alleviation measures in concluding EPAs/FTAs. If not, Japan will fall into a state of isolation from the global wave of EPAs/FTAs (which is gradually becoming a reality).

Staying outside the growing networks of FTAs between and among countries around the world is tantamount to refusing to become a member of a multilateral regime for liberalization. When Japan lagged behind the U.S., the EU, and many other countries in concluding an FTA with Mexico, it left Japanese companies at a disadvantage when doing business in and with Mexico for years (though this problem has since been resolved with the subsequent conclusion of the Japan-Mexico EPA). In fact, when a number of FTAs are in existence around the world, staying away from them is tantamount to not becoming a member of the WTO in terms of the effect on a country. What if this situation happens to many countries? It would be necessary to take appropriate measures based on the accurate understanding of the differences between the WTO and FTAs.


We tend to believe that a multilateral agreement, which provides a uniform rule for the global community, is a natural state of affairs, as our image of how things should be is based on how things are done in our country. However, in a world of cutthroat competition, countries fight to get ahead by providing better business environments. After all, the WTO, a rare example of a multilateral agreement, could only be concluded because the world was then dominated by two pillars that were able to agree with each other - i.e. the U.S. and Western Europe. Today, we should not completely rule out the possibility of a multilateral agreement, which may be concluded as a result of countries becoming exhausted by a war of attrition called the FTA race. What is certain, however, is that the era in which advanced Western nations including Japan could take a lead has gone and we now live in a world where emerging economies are also main players. How we can achieve a multilateral agreement in such a multi-polar world is a significant challenge in its own right. However, before looking into this question, Japan needs to clarify the concept of a trade policy that can efficiently cope with the changing environment of the global economy and accelerate efforts to create a national mechanism to enable the implementation of new, efficient trade policy.

August 17, 2010

Update: In early November, new EPA policy is expected to be issued by the Japanese government and prior to this, Prime Minister Kan and other ministers have indicated a very positive attitude toward Japanese participation in the TPP talks.

  1. This September, EPA talks with India were completed, three years after they started.

August 17, 2010

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