The New Landscape of World Trade with Mega-FTAs and Japan's Strategy (Summary)

As the Doha Round negotiations continue to stagnate, moves toward extensive cross-regional economic partnerships called mega FTAs such as the Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership (RCEP) are accelerating around the world in a bid to set international trade rules. Under the banner of the Global Outreach Strategy, which is one of the cornerstones of its “Japan is Back” campaign, the Japanese government is engaged in negotiations to establish strategic trade relationships and promote economic collaboration. In light of these circumstances, RIETI held a special seminar titled "The New Landscape of World Trade with Mega FTAs and Japan's Strategy."

In the seminar, Peter A. Petri (Professor, Brandeis International Business School) and Urata Shujiro (Faculty Fellow, RIETI/Waseda University), who are among the top U.S. and Japanese experts on international trade, considered empirically the impacts of economic partnerships on the growth of the Japanese and world economy.

FUJITA Masahisa, President and Chief Research Officer, RIETI (Professor, Konan University / Adjunct Professor, Institute of Economic Research, Kyoto University)

In order to bring the Japanese economy onto a full-fledged growth path, it is vital to incorporate the growth of the world and rapidly expanding emerging Asian economies and promote trade, investment, and business activities by leveraging Japan’s scientific-technological capabilities. The government is involved actively in negotiations to establish a worldwide “network of economic partnerships” amid the accelerating shift towards mega FTAs, such as the TPP and the RCEP.

The Research Institute of Economy, Trade and Industry (RIETI) has established its mission to undertake theoretical and empirical research to create a grand design of putting the Japanese economy on a growth path and solidifying sustainable growth in the future. To this end, it has been conducting research activity by always keeping in mind our three priority viewpoints: 1) incorporating the growth of the world economy, 2) developing new growth areas, and 3) responding to changes in society and creating new economic and social systems for sustainable growth. I hope that today’s seminar may help you reach a better understanding.

Peter A. Petri (Carl Shapiro Professor of International Finance, Brandeis International Business School)

The TPP will require close cooperation between the United States, Japan, and other countries to bring this important project for the world economy to a conclusion. The global community has not done a good job in making new rules for international trade over the last 20 years since the last major international trade negotiation, the Uruguay Round, was concluded. We require new ways to address large changes since then, and the TPP promises to be part of the strategy to achieve that.

The TPP consists of 12 negotiating members, of which Japan is a member and is the biggest economy outside of the United States. It is an impressive group of economies consisting of roughly 40% of the world gross domestic product (GDP), and has a diverse membership ranging from very advanced economies such as Japan, the United States, and Singapore to economies just at the beginning stages of industrialization such as Vietnam.

Two other large negotiations underway include the RCEP with 26% of the world GDP and the Transatlantic Trade and Investment Partnership (TTIP), which is the negotiation between the United States and Europe, with 44% of the world GDP. Altogether, 77% of the world GDP currently is involved in these negotiations—in effect, we are beginning to revise the rules of the world trading system from the bottom up. We are at a very important and unusual period in the world trading system where we are switching from an old set of rules based on top-down global negotiations to a new set of rules based on regional groupings of very important countries trying to set the rules.

The TPP is the most advanced of all of the negotiations that are underway including the RCEP and the TTIP. Therefore, the TPP will set the rules, have a dynamic influence on the trade rules that countries make thereafter, and have an important impact on the world trading system. The benefits of this will be seen through increased trade, investment, and exchanges of technology and knowhow. The TPP itself has grown to 12 countries, and likely will grow further to 16 countries, although not necessarily before the current negotiations are concluded. The TPP will be important to specific industries, and, for these reasons, the political environment in many countries is very sensitive to how the negotiations will evolve.

There have been two important periods historically when trade suddenly blossomed—at the beginning of the 20th century, and more recently since the end of World War II. These periods saw substantial trade compared to GDP and unusually rapid economic growth. While the linkages are not completely clear, trade growth has been very closely associated historically with economic growth and prosperity. Currently, trade growth has been slowing after a very long period of growth. Better trade rules and a more integrated system of global economic relationships are now needed to help spur another period of rapid economic growth.

The most optimistic outcome would be for the TPP negotiations to end sometime this year. If this happens, the RCEP is also likely reach a conclusion fairly soon, and so are the TTIP and South Korea-China negotiations. It is unclear whether China would join the TPP or how it would cooperate with countries that have made these large steps for the trading system, but its deeper engagement with these efforts is likely. It’s also possible that the World Trade Organization (WTO) would conclude more plurilateral agreements based on the regional negotiations than it has in the past.

But there is still a long way to go to this optimistic outcome. In the TPP negotiations themselves, countries will not give away their best concessions until they can see the outlines of a favorable final deal. The text of the agreement essentially has been written, but there are still many “bracketed” options and now the governments themselves must make very tough decisions and commitments. One of the TPP’s challenges will be to reach agreement on issues such as supply chains, electronic commerce, the internet, and the rise of emerging market economies. The TPP also must deal with the issue of establishing benefits for different groups of countries with very different income levels, technologies, and so forth. This was a central problem with previous negotiations such as the Doha Round, which attempted to address the concerns of many developing countries, but, in the process, failed to motivate advanced countries and businesses who did not see how it would serve their interests.

The TPP is trying to provide good manufacturing opportunities, better technology transfer for developing countries, and serve the interests of advanced countries in services, intellectual property, and investment. Such a mutually beneficial deal is required to accelerate trade and growth in both developing and developed economies. Finally, what is unique about the TPP is that it recognizes the declining relevance of tariffs and border measures, and addresses the increasingly important role of “behind the border” measures such as regulations, standards, and procedures that are incompatible among different economies. Points of contention regarding the TPP negotiations include intellectual property, agriculture, investment, services, government procurement, and so on. This reflects the enormity of this agreement and the fact that negotiations have come down to only a few key disagreements. There has been a tremendous amount of progress.

Over the last three years along with Professor Michael Plummer and Dr. Fan Zhai, I have undertaken extensive efforts to model the effects of the TPP to calculate how it would affect the different economies participating in it. We work with a computable general equilibrium model, and have made a number of innovations in the model and added new data and mechanisms to make it more suitable to 21st century trade agreements. In our model, we started with a baseline which predicts how the world economy might evolve over the next 15 years. This gives us a way to understand how the economies will change before trade policy changes are added. Next, we add the effects of the trade policy. It’s a big model which includes a substantial amount of data such as information from the World Bank, a consortium of model builders, and many other sources to describe the world economy. The results are not perfect, but, at a minimum, give a picture of the impact expected from trade agreements.

We compute large income gains from the mega-regional trade agreements. The greatest benefits would result if all economies of the Asia-Pacific region were included in a regional agreement, yielding annual benefits of $2.3 trillion per year. Even if things stop with the smaller TPP group, the benefits would be $223 billion, of which we estimate that Japan would gain almost half. In that configuration, by being outside the negotiations, China would lose some of its exports to countries such as Vietnam and Malaysia, which are part of the TPP network. The TPP16, which would also include South Korea and three Southeast Asian countries, would almost double the global benefits, increase the benefits for both Japan and the United States, and increase the business that is diverted from China to Southeast Asian producers.

The RCEP would be more valuable for the world as a whole because it would give the three major East Asian economies—China, Japan and Korea—very good access to each other’s markets. In our calculations, the RCEP comes out as a major winner. In that scenario, however, Japan would not do quite as well as it would under the TPP12 or TPP16 configurations, because it already has reasonable agreements with many Asian economies. What I would highlight from this picture is that, for Japan, while all of these agreements are very important, the TPP is especially important because it includes the United States. But what is even more significant is that all agreements combined are the most beneficial. A free trade agreement across the Asia-Pacific region would lead to income gains much greater than that of any trade agreement concluded in the past.

Under the TPP, China would lose, but only a small fraction of a percent of its overall GDP. Thus, the TPP is not a trade block that benefits by taking trade away from other trade partners. Rather, the vast majority of the benefits that it produces come from expanding trade and improving productivity among the members of the TPP group of economies. Considerable change likely will happen, and, in many countries, very strong new sectors will develop as a result of these agreements.

The sources of economic gain from the TPP agreement are fairly straightforward. Much has to do with increased productivity in member economies—shifts from less to more productive sectors, and, within every industrial sector, shifts from less to more productive firms. There is also evidence that export industries in every country tend to pay 10%-20% more than import competing industries. As strong industries grow, there is a tendency to increase the productivity of labor and wages, which is true for all countries that participate in trade. All countries will export more and develop higher skilled, better paying jobs, resulting in win-win outcomes for the region as a whole. People in some regions and countries, such as the United States, are worried about trade based on the experience of the last decade or two, but that was a period when trade was sharply unbalanced. In that context, the full benefits that normally would accompany a trade agreement and increase both imports and exports are not present. The TPP should do that and benefit workers across the whole region.

China’s position with respect to the TPP has changed substantially over the last year. Rather than being very opposed openly to the TPP project, China has become neutral. It has said officially that it is studying the TPP closely, and some of the announcements of the Third Party Plenum suggest that trade policy and joining regional networks are becoming a priority for the Chinese government. In the meantime, the United States has been conducting negotiations on an investment treaty with China. The United States has not expressed strong interest in bringing China into the TPP negotiations early, but it has been trying to see how much progress can be made. Unofficially, there has been much more interest among both Chinese and U.S. scholars and policy makers. What discussions have revealed is that there are possibilities for huge gains as these large economies develop better rules for trading with one another.

The effects would of course also include large adjustment costs. That means, on the one hand, large benefits, and, on the other hand, costly and painful adjustments and probably strong opposition in both countries. This requires careful planning and action. But the benefits should not be underestimated. Bringing China deeper into the network of international rules would make it easier to solve tensions of other types. One hope is that the political tensions that are evident now in the East China Sea, South China Sea, and elsewhere can be reduced over time as China develops. Among people in China who are thinking 10 or 20 years into the future, there is a very positive exploration of what it would take to make China a more integral part of the international system, which would be beneficial to all.

There are several possible different pathways forward on regional trade agreements. One possibility might be competition between the TPP and the RCEP, which is very unlikely. Rather, they are more likely to complement each other. A second possibility is that the TPP might develop ultimately into the large Free Trade Area of the Asia-Pacific (FTAAP), which is not so remote. However, it requires many things to go right such as the successful conclusion of the TPP, the four additional countries entering, and China eventually joining this process. While not impossible to imagine, this would be very difficult. Another possibility might be parallel efforts which involve all of the major economic connections in the region. It might include the TPP, the RCEP, and even a U.S.-China agreement of some kind. This would dampen the competition among different blocks because each country would have access to everyone else’s markets. In the longer run, it might be converted into a free trade agreement among all regional countries. This would all require the TPP and other projects to get off the ground and be completed first.

Politics is becoming increasingly important in this mix, and deserves closer attention. In the United States, the current administration led by President Barack Obama is very committed to finishing the agreement. One signal of that is the appointment of Mr. Michael B. Froman to head the TPP negotiating effort. Another is that in every one of his State of the Union messages, President Obama has identified trade policy as a priority. At the same time, the administration is now facing an increasing opposition. This is being played out in the debate on trade promotion authority (TPA), a bill that is very important for getting trade legislation passed in the United States. Foreign countries negotiating with the United States want to know whether the administration can pass the agreement.

A bipartisan TPA bill was introduced in the Senate Finance Committee several weeks ago. These bills typically have good bipartisan support, and the Republican leadership has expressed its willingness to vote for it. However, looking toward the elections in November 2014, the Democratic leadership has been unwilling to bring trade promotion authority to Congress at this moment in time. This is because the Democrats are facing a very tough election in November 2014. This does not mean that the trade promotion authority will not happen, or that, even if it doesn’t happen, that there aren’t other way of moving the TPP forward. There is even the possibility that President Obama can move forward independently of Congress in bringing the TPP much closer to conclusion. In that case, Congress might become more willing to vote on trade promotion authority. But it is likely that progress on the TPA will stop until after the November elections.

Most optimistically, President Obama’s trip in April 2014 to Japan could help to resolve some of the key issues on the TPP. After the election in November 2014, another window for U.S. legislative action will open. The bottom line is that the TPP is very likely to happen eventually, but its timing is unclear. American politicians care about what the American people think, and right now they are quite divided. On the one hand if you ask them, “Is U.S. involvement in the global economy good?” a very large majority, maybe 70%, would answer “Yes.” But on the other hand if you ask them, “Should the United States be involved in the world, or should it be looking essentially after its own domestic interests?” about 50% of the people think that the United States should look after its own interests, and only 38% think that it needs to be involved in the world.

Public perceptions in the United States are turning increasingly isolationist; the wars in Afghanistan and Iraq have clearly made people weary of American involvement abroad. This carries over to trade agreements, and the number of people who think that trade agreements are good has declined from 35% to 22%, and the number who think that trade agreements are harmful has increased from 32% to 45%. There is a kind of general malaise envisioned in this against international involvement through trade agreements.

And if you ask people specifically about how the TPP might affect them, it’s overwhelmingly negative. They are worried that it would have a negative impact on jobs, wages, the environment, food safety, and that it would help large corporations and hurt smaller ones. It doesn’t make sense why people think that their government conspires with other governments to do such bad things, but people are very suspicious and anxious, and worry that any change will probably hurt them. Unfortunately, this is the current political climate. The facts are that we are still coming out of a very severe recession, technological trends have been adverse for workers, large deficits have hurt, and our political system now is very fragmented. But these opinions do not appear to be firmly held, and better economic conditions, a strong government, more cohesive Congress, and greater confidence by the American people could reverse them.

The TPP is a big, positive-sum project. The benefits are large and the ability to conclude the agreement is now within reach. But governments have not made this case strongly enough, and there is strong popular resistance to it in the United States and in other countries, so successful outcomes are by no means assured. Leadership from governments will be a key element in reversing this, and it would be most ideal if the agreement could be concluded this year.

URATA Shujiro (Faculty Fellow, RIETI / Professor of Economics, Graduate School of Asia-Pacific Studies, Waseda University)

After the burst of the bubble economy in the early 1990s, the Japanese economy suffered a low-growth period called the “lost two decades.” However, it has been on a recovery track since the inauguration of the second Shinzo Abe cabinet at the end of 2012. Japan’s GDP was more than five times that of China in 1989, but it was surpassed in 2010. Currently, the nation’s GDP is significantly lower than that of China. On the contrary, the United States’ GDP is increasing steadily, emphasizing the stagnancy of the Japanese economy. For the achievement of economic growth, one of the following will be required: 1) input of labor; 2) input of capital; or 3) improvement of productivity. Considering the fact that Japan’s population will fall below 100 million by 2050, and that the population is aging increasingly, it is unlikely for Japan to achieve economic growth through the “input of labor,” unless there is an influx of labor from overseas. Japan’s savings-to-GDP ratio has fallen from its previous level, but is not significantly lower than that of other developed countries. However, as the savings ratio decreases further in step with the low birth rate and aging society, Japan has a remote chance to increase capital by boosting domestic savings. In addition, due to the low level of direct foreign investments, the “input of capital” also is unlikely to make a significant contribution to the growth of the Japanese economy. The only remaining option is the “improvement of productivity,” for the achievement of which it would be necessary to implement a domestic structural reform and open the market to overseas countries. In view of this, for the development of a brighter future of the Japanese economy, it is necessary for the country to participate in the TPP and other FTAs. Although Japan is viewed as a trading nation, its trade-to-GDP ratio for 2012 was only slightly higher than that of the United States but lower than that of the average of the Asia-Pacific Economic Cooperation (APEC). On the contrary, South Korea has an extremely high level. It is a general rule that the larger the scale of a domestic economy, the lower is the foreign dependency rate. However, even if this is taken into account, Japan’s trade openness is relatively low. What is more evident is that Japan has a very low direct foreign investment-to-GDP ratio. Direct investments not only bring an influx of money but also attract factors that contribute to economic growth, such as management know-how and technologies. In this sense, an expansion of direct foreign investment is one of the key challenges to be addressed.

FTA negotiations are characterized by their response to developing countries. The TPP framework will not offer favorable treatment to developing countries, but an extension of the liberalization deadline apparently is included in the agenda. On the other hand, the RCEP participants are expected to agree to some favorable treatment for developing countries. One of the reasons for the above is that Cambodia, Laos, and Myanmar do not participate in the TPP negotiations but do so in the RCEP talks. These two FTAs are designed for different objectives and compensate each other. In the East Asia region, multiple FTAs currently are underway simultaneously. At present, Japan, China, and South Korea are engaged in a round of negotiation apart from other RCEP participants. There also are different FTA talks between China and South Korea. In 2010, APEC leaders agreed on the establishment of the FTAAP at the meeting held in Yokohama.

So far, Japan has enacted 13 FTAs (12 bilateral FTAs and an ASEAN FTA) and is currently participating in multiple mega FTA negotiations such as the TPP, RCEP, EU, and Japan-China-South Korea FTA. Japan is characterized by its low FTA coverage ratio of less than 20%, suggesting ample room for ratifying additional FTAs. In other words, Japan is not yet fully active in implementing FTA policies. In terms of the tariff elimination ratio, Japan remains at a level slightly higher than 85%, while the U.S.-Australia FTA and the U.S.-South Korea FTA have high ratios of 99%-100% and 98%-99%, respectively. If the TPP requires almost 100% tariff elimination, it will be difficult for Japan to agree to it with its existing FTA strategies. This is the most critical issue between Japan and the United States. Promoting FTAs is one of the important initiatives under the Growth Strategy, i.e., the "third arrow" of Abenomics. It is estimated that the enactment of the 12-country TPP, RCEP, and FTAAP will increase Japan's GDP by 2.0%, 1.8%, and 4.3%, respectively (Petri, Plummer and Zhai, 2012). As mentioned above, the TPP and other FTAs bring significant benefits to the Japanese economy. Obstacles hampering the progress include objections from sectors with limited competitiveness, such as agriculture, insurance and finance, and medical services. There is also a problem of non-tariff barriers. However, for a brighter future of the Japanese economy, policy implementation should not be hampered by the opposition of some vested interests.

The Japanese economy is facing some structural problems, including the falling population, lack of openness, and budget deficit. In order to return it to the growth path, it is necessary to advance domestic structural reforms while pursuing the open-door policy in the foreign trade relations. In view of the stalling of the WTO’s Doha Round, pursuit of an FTA would be important as the second-best solution. Formation of a mega FTA is the first necessary step to achieve the liberalization under the WTO, a worldwide free trade agreement. The TPP is important also for other mega FTAs. If developed countries such as Japan and the United States do not define rules as soon as possible, Japanese companies must compete in the absence of rules when emerging economies flourish further. To ensure smooth progress in the TPP and FTA negotiations, dissenting opinions within Japan must be resolved by providing safety nets, such as income compensation payments for those who incurred damage and the provision of education and training to strengthen human capacity. Implementing appropriate measures will minimize the damage and maximize the benefits. Now it is the time for Prime Minister Shinzo Abe and U.S. President Barack Obama to recognize the importance of the TPP and take a leadership role in the TPP negotiations by making mutual concessions.