The Political Economy of the Japan-Mexico EPA: How Does a Cross-Regional Initiative Affect the Future of Japan's Regional Integration Efforts?

Date July 4, 2005
Speaker Mireya SOLIS(Assistant Professor, American University)
Commentator URATA Shujiro(Faculty Fellow, RIETI / Professor of Graduate School of Asia-Pacific Studies, Waseda University)
Moderator TANABE Yasuo(Vice-President, RIETI)


The Japan-Mexico Economic Partnership Agreement (EPA) which just came into force in April is of wider interest because of the effect this cross-regional initiative has on future Japanese EPA policy. In fact, this EPA with Mexico is important to understand the future evolution of Japanese EPAs not only because is it the second such major initiative, but also because Mexico is very different from Singapore in that it is a developing country and an agricultural exporter. This presented a challenge to Japanese officials to be able to deliver some concessions in wrapping up the agreement.

In the broader background, there is a lot of exciting activism going on in Japanese trade policy today, with many new initiatives taking place, making it a precious moment to try to understand the process of trade policy formulation in Japan, as well as assessing where Japan is headed with its new policies. The basic questions have to do with the motivation and timing for this new shift in Japanese trade policy. Until recently, Japan was not keen about negotiating bilateral free trade agreements (FTAs) as they could hinder the multilateral liberalization process. Another important question has to do with the content and types of FTAs that Japan is pursuing. The question of whether Japan is prepared to engage in some form of deeper liberalization with developing countries on a broader number of issues has to be considered. The final question has to do with the implications of this shift in policy. After all, when the world's second-largest economy decides to trade preferences selectively with a few partners, there are implications for East Asia and the multilateral system at large.

Not surprisingly, there are many studies analyzing the basic goals and motivations for Japan to be embarking on these trade initiatives. The most dominant explanation that appears in these discussions can be characterized as a "regional crisis, leadership response," which looks at the impact of the Asian financial crisis as convincing people that the market-led process of integration was insufficient and that there was a need for regional institutions to guarantee growth. This helped Japan become more assertive and helped other Asian countries become more accepting of Japan adopting a leadership role in the region.

The second common explanation also looks at regional events, in particular Japan's disenchantment with the Asia-Pacific Economic Cooperation (APEC) process, especially after the high-profile 1998 case in the Early Voluntary Sectoral Liberalization (EVSL) initiative. There was a fundamental clash between Japan and the U.S. on the guiding approach of APEC, with the U.S. pushing for binding liberalization and Japan, as well as many other Asian countries, supporting consensus-based discussion and volunteerism. As a result, Japan detached itself somewhat from APEC and began to pursue other regional options in the form of FTAs.

The last conventional explanation focuses on the idea that Japan is embarking on this FTA/EPA trade diplomacy in order to foster its goals at the multilateral level. By creating a network of FTAs, Japan is able to be more proactive in the World Trade Organisation (WTO) because it can enlist the support of its FTA partners to endorse its initiatives.

While these explanations offer some important insights, they fall short of fully addressing the complexity of the new EPA/FTA initiatives. Regarding the first argument, which focuses on the Asian financial crisis, even though it is very persuasive in making the case that the regional context was changed, it is limited in that while there is a clear link between the regional financial crisis and regional financial integration initiatives, it is harder to establish the link between the financial crisis and bilateral trade liberalization. The second limitation is that it is completely irrelevant in the case of the Japan-Mexico EPA.

The second line of argumentation looking at APEC suffers from a logical shortcoming. That is, if you make the case that Japan withdrew from APEC, then it is hard to understand why it immediately jumped into bilateral FTAs, which precisely endorse binding liberalization commitments. In the EVSL case, a lot of the problems had to do with the list of sectors that were presented to Japan and the fact that the preferences of Japan with regard to trade liberalization were not accommodated.

The last explanation, about becoming more active at the WTO level, is problematic in that Japan is not seeking to negotiate a customs union involving common external tariffs. Therefore, Japan and its FTA partners manage their tariff policy independently in the WTO. Moreover, looking at the coalitions of countries which have been most active in the WTO (the Cairns Group, the Group of 20), it is clear that these coalitions cut across FTA memberships. The idea that FTA partners can pursue common causes in the WTO remains somewhat of an unproven proposition.

In order gain a more sophisticated and richer understanding of Japanese FTA policy, some of the main insights of political economy will be used as the foundation of my study. One such model is trade concentration (or functionalism) as a bottom-up approach to regionalism. As economic exchange and interdependence expands, the business sector is going to demand some new regional governance structure. Another common model of regionalism is Baldwin's domino effect, which sees regionalism spreading as disadvantaged outside producers attempt to eliminate trade diversion by lobbying for inclusion in the bloc or formation of alternative blocs. The third main explanation of regionalism also focuses on domestic politics, more precisely on lobbying as a rent-seeking activity. For example, politicians can expect trade-diverting FTAs to generate a winning domestic coalition. The last model in the regionalism literature is that of liberal intergovernmentalism, which focuses less on the needs of the private sector and more on what the government is offering. This has been used extensively by Moravcsik at Harvard to analyze the process of European integration. According to this model, regionalism is seen as summit diplomacy and a series of discrete, celebrated bargains among state leaders who resist supranationality.

In the context of the complex negotiation of the Japan-Mexico EPA, three stages can be identified. The first stage is when the idea to negotiate an FTA between Japan and Mexico was first floated. The interest from Japan had to do with concern about the effects of the North American Free Trade Agreement (NAFTA), which was perceived as putting Japanese multinationals in a disadvantageous position vis-a-vis Canadian and U.S. producers, especially in the automobile and electronics sectors. Furthermore, very stringent rules of origin were passed for automobiles, and in the case of electronics, Mexico's export promotion program (the maquiladora industry near the U.S.-Mexico border) was scheduled to be phased out. Japanese companies had, up until then, greatly benefited from this special tariff treatment on the import of machinery and components for production exported to the U.S. Discontent among Japanese business led to the need to negotiate with Mexico being voiced openly. However, this initiative to open negotiations came to a sudden end due to Japan's reluctance to negotiate on agriculture, and Mexico's refusal to negotiate an FTA that completely excluded that sector.

Then negotiations were restarted. The triggers allowing this initiative to come back to life are very telling about what is going on now. One of these triggers was the failure to negotiate a more modest form of cooperation. After agriculture became the deal breaker, both sides agreed to discuss a more modest bilateral investment treaty (BIT). The negotiations again ended quickly due to Mexico's unwillingness to grant most favored nation and national treatment status in this BIT, as such preferences were only awarded to countries that negotiate a full FTA. The second important trigger was the FTA negotiation between Mexico and the European Union (EU) in 2000, in which Mexico demonstrated considerable flexibility, and substantial exclusions were negotiated on agriculture. This sent a message to Japan that it was possible to negotiate an FTA with Mexico that excluded the most politically charged agricultural items, while claiming WTO consistency. This allowed the negotiations to go forward.

At the beginning of this third stage of negotiations, the positions of both countries were clear. For Mexico, it was about trade diversification, extending the FTA network for the first time into Asia, and preventing disinvestment. For Japan, it was mostly about leveling the playing field with American and European companies. Contrary to popular belief, this became a lengthy and hard-fought negotiation that stumbled several times.

There were several main obstacles in the negotiation. These included the issue of government procurement, when the Mexican government abruptly announced in the spring of 2003 that only firms in FTA partner countries would be allowed to bid. These marginalized completely Japanese companies. Another important politicized issue involved steel and Mexico's controversial proposal for strict rules of origin. This was seen as a negotiating ploy to postpone the opening of the steel industry and to get concessions. Furthermore, there were important differences of opinion in automobiles. While Japan desired immediate liberalization, Mexico negotiated a duty-free quota equivalent to 5% of the domestic market, above which the tariff was 25%. The critical issue, however, lay with heavy vehicles, which made up about 30% of the Mexican automobile market, and the fact that Mexico refused to open heavy vehicles to Japan.

Last but not least, agriculture was the most difficult issue in this negotiation. In the media, there has been discussion about the "five fingers" (pork, beef, chicken, oranges and orange juice) that almost derailed the talks between Japan and Mexico. Besides these five products, there was also a tremendous gap between Mexican demands for liberalization and what the Japanese were able or prepared to give on many more issues. For instance, it was expected that a basic preliminary agreement would be signed on the occasion of the meeting between Mexican President Fox and Japanese Prime Minister Koizumi in October 2000, but there was a collapse of the talks because of agriculture. According to Mexico's trade negotiators, the Japanese offer was incredibly limited, to the point that Mexico preferred to withdraw. It took six months to make amends and eventually the number of concession items on the Japanese side grew substantially to 796, and agreement on the "five fingers" was negotiated.

Reviewing the applicability of international political economy (IPE) models with regard to the Japan-Mexico negotiation, the trade concentration hypothesis does not seem to be very useful, as the aggregate volume of trade between the two countries is very modest. Despite this modest volume, the JMEPA became an important initiative in establishing precedents. Thus, those IPE models that provide sectoral explanations of what drives these trade negotiations are the most valuable in the Japan-Mexico case. Clearly trade diversion, including the NAFTA and maquiladoras issues, is most persuasive as a reason for the JMEPA negotiations. Parts of the domestic lobbying argument are applicable to this case, especially since it was clear from the beginning that some accommodation of agricultural interests was essential. As for summit diplomacy, rather than being of importance, it was exposed in the failed Fox-Koizumi meeting that it was not possible for the top leaders to move things forward.

To conclude, there are three important implications of this FTA for the future of Japanese regionalism. The first is that a cross-regional bridge such as the JMEPA actually helps Japanese trade diplomacy in that it placates those critical of the proliferation of FTAs as a disruptive trend leading to the formation of three insulated blocs (Europe, North America and East Asia).With important cross-regional initiatives present, there will be less resistance to the negotiation of, for example, East Asian economic groupings. In addition to Japan, many East Asian countries are embarking on cross-regional initiatives, sometimes outside their immediate neighborhood.

Another implication to highlight is that Japan is negotiating FTAs with many developing countries. The precedent set with Mexico is that Japan is prepared to endorse a moderate developmental focus in its FTAs. Despite the presence of an economic cooperation chapter in the EPA, there are no binding obligations or commitments of assistance. Some developing-country partners could potentially become disenchanted with an EPA if some of their expectations for larger economic assistance are not met.

The negotiation with Mexico was the first time that Japan sat down to negotiate with a large agricultural exporter. It was said in the Japanese media that the Mexico negotiation was the litmus test of whether Japan could indeed flesh out a broad FTA policy and talk about liberalization with countries that have a large agricultural sector. Therefore, the greatest precedent set was that Japan was prepared to make only modest concessions, and that it is going to follow a very guarded approach to agricultural liberalization by using a variety of mechanisms, including outright exclusions, renegotiations, and tariff rate quotas.

In comparing the FTAs Mexico has with Europe and with Japan, the volume of trade covered is higher for the JMEPA (99.6%) than the Mexico-EU FTA (95%), though concessions only covered 43% of the tariff lines. Also, in all categories, the process of liberalization is expected to take longer with Europe. A very interesting development visible in both is the existence of quota items, and it is worth noting that in Mexico's FTA with Europe, Mexico even requested some products to be excluded as a result of the agricultural liberalization lessons in NAFTA.

However, the renegotiation category poses a slightly dangerous precedent in the sense that it is unlikely that we will see substantial concessions on any of the products for renegotiation, as the impetus for reaching agreement is eliminated once the FTA is in place. Finally, it is important to keep in mind that Japan is not an outlier in trying to carve out some protection for its agricultural sector. It seems that escape mechanisms and protection tactics have become well ingrained in FTAs and could become a worrisome trend as the number of FTAs increases, accompanied only by meager agricultural liberalization.

Commentator: URATA Shujiro, Faculty Fellow, RIETI/Professor of Graduate School of Asia-Pacific Studies, Waseda University

Additional explanations for Japan's motivation for the FTA could be: 1) the promotion of domestic deregulation in Japan that has been of interest for the current and previous governments; and 2) the emergence of China. It is important to think about the role of FTAs in political reform. Also, what is the response from the political economy perspective on the role of China in stimulating competitive FTAs in the Association of Southeast Asian Nations (ASEAN) region?

Further considerations of note are the reasons that Mexico decided to phase out the maquiladoras program, and more specifically, whether U.S. pressure to do so was involved. In addition, it would be very interesting to examine the series of events in the six months subsequent to the Koizumi-Fox meeting in 2003 that led Japan to substantially increase its tariff line offers. One guess might be that the Ministry of Agriculture, Forestry and Fisheries in Japan responded with a greater number of offers to counter criticism leveled at it for not coming forward in the negotiation and for being a stumbling block. From the Japanese side, it would be interesting to follow what happened in Mexico during those six months for the Mexican government to agree to the limited offers coming from Japan.

Finally, it is important to study the impact that FTAs, such as the ones mentioned with exceptions in agriculture, have on WTO negotiations, especially in the agriculture negotiations.

Dr. Solis: I agree that many people believe FTAs to be a tool for reform in this country and a vehicle for deregulation, and perhaps even to weaken the clout of the agricultural lobby over Japanese trade policy. So far, however, it remains a promise unfulfilled. Looking at the selection of trade partners in the early stages of Japanese FTA policy and what has been done in the agriculture negotiation to make these agreements politically feasible in Japan, the question arises as to the overall impact of FTA policy on the Japanese economy. Japan has so far been extremely cautious in its FTA policy and has approached small trading partners so that the effect of domestic adjustment costs associated with liberalization of Japanese markets is minimized. In those sectors, in which significant adjustment costs (e.g., agricultural goods) can be expected, there are very important exclusions and quotas, thus mitigating the impact -- but at the same time reducing the potential benefits of the FTA.

Regarding the emergence of China, everybody understands that there is a competitive dynamic involved between Japan and China as the likely suppliers of governance structures for the region, but it is hard to find detailed evidence of how this dynamic works, other than that they monitor and match each other's movements closely. What would be alarming is if the competition between the two countries acts as a bandwagon and becomes the main driver for many of the regional initiatives since it would raise doubts as to the soundness of these regional FTA negotiations.

On the phasing out of the maquiladoras, it is important to note the historical controversy of the program in the United States from the 1980s onward. There was a boom in Japanese investment in the maquiladoras in the early 1980s, with a fairly immediate backlash in the United States among those who felt that Japanese (and Korean) companies were using it as a back door to the U.S. market. This was seen as an unfair way to gain access into the U.S. market as the maquiladoras were supposed to be a bilateral cooperation program, but there were no restrictions and third countries could use them. It was in fact part of the NAFTA negotiation to phase out performance requirements, and so the maquiladoras were targeted because they operated with the condition that all production had to be exported. However, it was not missed on anyone that this would also negate the benefits to third-country firms.

In the background to the failed October 2003 meeting, there was a power struggle in Mexico between the Economic Ministry and the Foreign Affairs Ministry about who should be in charge of FTA negotiations. The economic minister had moved to the Foreign Affairs Ministry with the tacit understanding that he would continue to carry out trade negotiations. But the Economic Ministry was not willing to give up its activities in international trade negotiations, while the Foreign Affairs Ministry was prepared to sign an agreement in October 2003 even though the Japanese offer was not very substantial; others in Mexico argued that it was not an agreement that had domestic political support.

In this sense, the failed meeting was a shock for both countries. In Japan, agriculture was identified as the culprit for the failure of negotiations, with wider implications for the whole future of Japanese FTAs. In Mexico, there was a lack of coordination in the bureaucracy and mixed signals were being sent. The negotiation was revived when finally major concessions were made, for example, in bananas.

On the impact of all these FTA negotiations on WTO, my biggest concern is that successfully excluding certain agricultural issues in FTAs could take away the pressure to hammer out those issues at the WTO. However, when it comes to subsidies, countries will only deal with them at the WTO level.

Comments, Questions and Answers

Q: Despite the knowledge that agricultural issues within FTAs can be dealt through exclusion mechanisms, being from the Agriculture Ministry, I would say that discussing agriculture at WTO is still crucially important.

A: I agree that the stakes are obviously very high since rules set at the WTO apply across the entire membership, and that is why key issues such as subsidies are discussed at the WTO forum.

To follow up your question, it is important to examine what provisions of the FTA the Ministry is still not comfortable with if it has indeed realized the benefits and flexibility of FTAs in terms of excluding sensitive sectors and approaching likeminded countries.

C: In theory, you have to make some change in your policy after some FTA is negotiated. For this, approval has to be gained from members of parliament who are not so familiar with the changes in negotiating liberalization of agriculture. This may be one limitation to the possible changes that could be made.

Q: Given the high number of FTAs that Mexico has, what is it about Mexico, or even Chile, that makes it such an attractive or important potential partner?

A: Geography clearly matters. In the case of Mexico, sharing the border with the United States and being in the NAFTA network makes it stand out. Furthermore, the low cost of labor has attracted a lot of investment. Mexico, as well as Chile, is one of the largest middle-income countries in Latin America and it also has some potential in offering an attractive domestic market.

There is also a "snowball effect" in play in the sense that Mexico and Chile made very strategic shifts from an inward-looking import substitution orientation to reinvent themselves as the new leaders in this new FTA game and to portray themselves as trade hubs. Then, being ahead of the game and having a lot of expertise, it becomes easier to go for the next FTA.

Q: With a lot of foreign direct investment being diverted from other countries into China, it makes bilateral free trade agreements somewhat of a futile exercise. How do you see the China factor playing out in Mexico's future?

A: China is a very important concern in Mexico and much attention has been devoted to the topic of investment diversion and Mexico being not as attractive to American, Japanese or other companies because of the China boom.

FTAs are only one of the instruments available and they are not magical fixes. Having an FTA is not going to guarantee that investment will materialize. There is concern in Mexico that it cannot do anything about the advantageous agglomeration effects in China, the cost of labor, and transportation costs to the Asian market from China. What Mexico can do with an FTA is to give some investment protection to make itself more attractive. Mexico in the past had a very restrictive policy vis-a-vis foreign investment, with many of its export promotion programs being unilateral systems that could be taken away or tinkered with.

One question to consider is whether, given the recent anti-Japanese demonstrations in China, some businesspeople will begin to think about Mexico again, as historical issues are not of relevance with Mexico and there is no anti-Japanese sentiment there.

*This summary was compiled by RIETI Editorial staff.