Vicious cycle between closed networks and economic stagnation
U.S. President-elect Donald Trump has announced his intention to withdraw from the Trans-Pacific Partnership agreement (TPP). A wave of protectionist policies is rising around the world, as evidenced, for example, by Britain's decision to leave the European Union (EU) and Indonesia's imposition of export restrictions to raw mining resources. Against this background, at the Asia-Pacific Economic Cooperation (APEC) meeting held on November 20, 2016, Japan's Prime Minister Shinzo Abe stressed that free trade is the wellspring of growth in the world economy, and expressed his opinion that protectionism should be opposed by economic policies that promote inclusive growth (as reported in the Nihon Keizai Shimbun on November 21, 2016). I would like to express my wholehearted agreement with Prime Minister Abe's statements. Further, Japan must form a bulwark to protect globalization and contribute to world development.
A great deal of empirical research supports the prime minister's contention that free trade promotes economic growth. This is not merely because free trade leads industries with comparative advantage to efficient production, as David Ricardo claimed. Engaging with overseas "outsiders" via trade enables domestic businesses to absorb new knowledge, which has a significant effect in promoting innovation. In addition, foreign direct investment (FDI) can also promote innovation, as it establishes ties with the outside world.
The fact that trade and investment stimulate innovation and result in social development is also clear from Japan's experience at the end of the Tokugawa Shogunate when it transformed from a closed to an open economy and thus achieved rapid growth thereafter. My own estimates, taking into consideration the effect of this type of innovation, indicate that the TPP has the potential to boost Japan's per capita gross domestic product (GDP) by 1.5 percentage points. (http://www.rieti.go.jp/en/special/policy-update/048.html)
However, because establishing and sustaining ties with outsiders such as overseas companies entail costs, individual and corporate networks tend to remain closed. New knowledge does not flow into a closed economy, and the economy becomes stagnant. It can be the case that people seek the cause of this situation in outsiders, e.g., in imports or capital flows from overseas, with the result that the economy becomes even more closed. If this situation of network closure and economic stagnation sparks a vicious cycle, it will be difficult to correct the increasing depth of economic insularity, leading to significant economic and social losses. History shows us that this situation on a global scale led to the formation of economic blocs, eventually contributing to the start of the Second World War.
Toward greater openness in Japan itself
It is essential that President-elect Trump's intention to withdraw from the TPP and Brexit do not initiate a vicious cycle that leads to this type of chaos; Japan must play the historically vital role of preventing this direction. However, there is something that Japan must first achieve in order to make this possible.
First, Japan itself must become more open. During the recent U.S. election, Trump declared that the TPP was unfair in that it would lower U.S. tariffs on Japanese automobiles, while Japan's tariffs on U.S. beef would remain in place. This is not a wholly misguided argument. As a result of Japan's establishment of "sanctuaries" during the TPP negotiations, import barriers for products including rice, dairy products, and meat were to remain. Clearly, these barriers had a negative effect on U.S. motivation for participation in the TPP.
In fact, the benefits of the TPP to the United States were not particularly large. According to estimates by Professor John Gilbert of Utah State University and others, U.S. GDP would only increase by 0.02% as a result of the TPP as agreed upon (Note 1). Compared to estimated increases of 0.3% for Japan and 1.6% for Malaysia, the benefits to be reaped by the United States were very small. This is because while the U.S. agricultural production would increase, production in industries including textiles and automobiles would decline. The widespread support for President-elect Trump, an opponent of the TPP, can be understood as the result of dissatisfaction that the agreement would take jobs from U.S. manufacturers, and that the majority of U.S. citizens would not adequately benefit from it.
At present, with the United States having decided to withdraw from the TPP, the best orientation for Japan would be to aim toward a bilateral economic partnership agreement between Japan and the United States, and, beyond this, to focus on the realization of the Free Trade Area of the Asia-Pacific (FTAAP), an agreement involving a greater number of nations than the TPP. In order to expand the scope of free trade agreements and halt the growth of protectionism in the world economy by this means, it will first be necessary for Japan to become more open and liberalize its trade barriers without seeking to establish sanctuaries. Japan must also remove both explicit and implicit barriers to foreign investment and accept a greater amount of inward investment, which is currently extremely low by global standards.
Promotion of non-protectionist, inclusive policy
Nevertheless, politically speaking, the liberalization of the industries that have been set aside hitherto as sanctuaries will not be an easy matter. Naturally, the people involved in the sanctuary industries are opposed to liberalization. However, as already noted, the liberalization of trade and investment will considerably boost Japan's GDP as a whole. Therefore, under the inclusive policies espoused by Abe, it would be more than possible for all Japanese citizens to enjoy the benefits brought by the liberalization of trade and investment.
However, these inclusive policies must not involve protectionism. This could dampen motivation among producers and cause economic stagnation, canceling out the benefits of trade and investment liberalization. Because of this, the implementation of redistributive policies that promote initiatives among producers will be an important factor. For example, rather than establishing barriers to participation in transactions in agricultural land, the provision of fixed subsidies to farmers for specific periods would enable the redistribution of income in a manner that would not rob farmers of the incentive to realize innovations. In this way, it could be possible to transform Japanese agriculture into an internationally competitive industry over the medium to long term through technological innovation involving the use of IT and big data.
Policies that support the establishment of a diverse range of ties are also inclusive. Small and medium-sized enterprises (SMEs) and micro-enterprises lack the manpower and the information required to establish connections with outsiders such as overseas companies and research institutions. Support from the government for the provision of information or for business matching in order to assist SMEs in expanding overseas, and initiatives such as the establishment of networks between farmers, companies, and universities in order to expand sales channels and realize innovation, can ensure that the benefits of liberalization extend to every area of the economy.
By means of such policies, it would be possible to build institutions that enable all citizens to enjoy the fruits of growth under globalization. It is sincerely hoped that the Japanese government will implement such policies and announce this to the world, working to prevent the closure of economic networks and the destruction that might ensue.
November 25, 2016