How will the TPP Change the Japanese Economy?

Now that a broad agreement has finally been reached on the Trans-Pacific Partnership (TPP), can we expect it to accelerate Japan's economic growth? In March 2013, I wrote an article "Estimating the TPP's Expected Growth Effects" for the RIETI website. In it, I argued that the TPP would raise Japan's per capita gross domestic product (GDP) growth rate by about 1.5 percentage points. This estimate was rather high compared to the government's preliminary calculations in 2013, but if my forecast is correct, the enactment of the TPP would enable Japan to easily meet the Shinzo Abe administration's nominal GDP goal of 600 trillion yen.

The reason we can expect such a prominent growth effect from the TPP is that, in addition to deregulation of trade in goods, the deregulation of trade in services (retail, finance, intellectual property, etc.) and foreign investment will have a major impact on the economy. Moreover, the further economic integration will bring more face-to-face communication across borders. Therefore, the TPP will be to contribute to perpetual economic growth by promoting innovation through fully utilizing outsiders' knowledge (refer to the link above for details).

Viewed from such perspective, the recent broad agreement on the TPP is a big step forward, in that the TPP would not only lower tariffs on automotive and other products but also deregulate trade in services and foreign investment. In the areas of foreign investment and service trade such as retail and finance, parties to the TPP as a rule would use negative listing. In other words, all business areas would be deregulated other than those specifically listed by each country. In Vietnam and Malaysia, regulations on foreign capital would be eased. This will encourage Japanese firms to enter overseas markets and further deepen Japanese firms' production networks in Asia, and should increase the income of the Japanese people. Stronger protection of intellectual property rights in member nations should also raise exports of Japanese technology and copyrighted property.

However, additional policies are necessary to enjoy the maximum benefit from the TPP. For example, my estimates on the TPP take into account that small and medium enterprises (SMEs) with technological strength start exporting, further enhancing their technological capabilities by using foreign knowledge, and continuing to grow. However, as I showed in my RIETI Discussion Paper (Note 1), although many SMEs are potentially competitive enough to enter foreign markets, in fact, they do not do so because of insufficient information or manpower or concerns about the risk. In addition, many of those already exporting are not taking advantage of existing economic partnership agreements (EPAs), due to lack of information and the complexity of the application procedures for obtaining a certificate of origin for utilizing EPAs (Note 2). Therefore, unless the government supports SMEs for obtaining more information (e.g., seminars to promote exporting and explaining how to utilize EPAs) and simplify the application procedures for obtaining certificates of origin, it is very possible that the TPP will not be fully utilized. Furthermore, because firm size matters to enter foreign markets efficiently, the government needs to support SMEs to promote mergers and acquisitions (M&A) to expand their firm size.

Another key factor is the effect of foreign direct investment (FDI) in Japan. Empirical research shows that knowledge spillovers from FDI in research and development (R&D) activities in Japan will increase the productivity of Japanese firms (Note 3). If the TPP increases FDI in Japan, it would bring new knowledge and information from overseas and prime the pump for innovation in Japan. The FDI will have a major economic impact on Japan as it would also increase employment.

However, FDI inflows to Japan were equivalent to a mere 0.1% of GDP in 2010-2013 on average, significantly lower than the Organisation for Economic Co-operation and Development (OECD) average of 1.9%. Clearly, there is room for FDI to Japan to grow. However, unlike FDI to Malaysia or Vietnam where the TPP would vastly accelerate deregulation, while FDI to Japan is already deregulated legally to a large extent. Therefore, even though the TPP would create a more transparent environment for investment and the rising Japan's expectations for growth would give a boost, it is not necessarily clear if the TPP would bring much more FDI to Japan as expected (Note 4).

Therefore, to ensure that the TPP significantly increases FDI to Japan, it needs to be combined with other new policies. In particular, there are very few foreign firms in Japan that invest in areas outside Tokyo, because scarcely any information about these regional economies is available outside Japan. Attracting foreign firms to the regional areas could trigger regional revitalization by, for example, organizing investment seminars that provide information on regional economies, including specific technology and knowledge of universities and SMEs in the regions. Preparing an environment in regional areas to make living easier for non-Japanese to settle there would also be helpful, for example, by providing more English signboards and increasing the number of international schools.

In fact, promoting internationalization of SMEs and expanding FDI to Japan, as described above, are among the measures that the Abe administration has advocated in its Japan Revitalization Strategy. The establishment of the TPP would be a good opportunity to actively promote measures to support industry-industry and university-industry partnerships as well as ties between Japan's outlying regions and foreign firms. By doing so, Japan could maximize the economic benefit of the TPP.

On the other hand, if Japan adopts protectionist policies for protecting agriculture and other domestic industries, the TPP will be of limited effect. Protected industries become exclusive to safeguard their economic rents. Any innovation that can be achieved by ties with outsiders will be nipped in the bud.

The history of deregulation in agriculture shows that domestic production did not fall all that much after the partial deregulation of imports of cherries in 1977 and beef in 1990 (Note 5). That is because farmers learned to be more efficient and successfully differentiated their products. High-quality domestic products could coexist with cheaper imports in the domestic market. So even if the TPP lowers agricultural tariffs, it could in fact make Japan's agriculture competitive. In that sense, it was most unfortunate that Japan retained trade barriers on products like rice and dairy, thereby missing an opportunity to make production of such agricultural products competitive.

However, even with agricultural products with lowered tariffs, it is necessary to make good use of the wisdom of outsiders by actively collaborating with private sectors and universities and keeping close linkages with overseas to bring innovation and improve its production efficiency, in order for Japan's agriculture to become more competitive. The government should support agriculture, forestry and fishery, as well as manufacturing and service sectors, to utilize such linkages, thereby maximizing the effect of the TPP.