# Prospects of a Transatlantic FTA : Implications for Japan and the Global Trading System?

Date June 8, 2012 Hosuk Lee-MAKIYAMA(Director, European Centre for International Political Economy (ECIPE)) NAKATOMI Michitaka(Senior Fellow, RIETI)

## Summary

Hosuk Lee-MAKIYAMA

The European Centre for International Political Economy (ECIPE) is a think tank based in Brussels, which focuses entirely on international economy and trade. It is the only think tank in Brussels focusing on such issues. When ECIPE was created, one of the main goals was to bring the perspective of the world to Brussels, rather than focus exclusively on the European Union (EU). A key focus in our work so far has been on an EU-Japan free trade agreement (FTA). This is also known as an economic integration agreement (EIA) and is perhaps the most important FTA for Europe to pursue at present.

The EU-U.S. economic relationship is the largest in the world. In 2011, bilateral trade and market space between the two showed that the transatlantic economy represents 54% of world GDP. In comparison, combining the EU and Japanese economies together would account for approximately 32% of world GDP. The EU-U.S. market is worth $5 trillion in total commercial sales and is already relatively well integrated. Transatlantic trade employs around 15 million people, not including those working for transatlantic multinational corporations (MNCs). The EU and the United States together account for 25% of global exports and 32% of global imports. Much of the economic activity between them is actually taking place through subsidiaries. Mutual investment stocks are worth over 2.1 trillion, which account for 58% of global inward foreign direct investment (FDI) stocks and 72% of global outward FDI stocks. There is also a high degree of intrafirm trade present between the two parties. Intrafirm trade refers to a company trading with its own subsidiaries. 61% of U.S. imports are from the EU, and 31% of U.S. exports are to the EU. A large transatlantic economic link already exists, and if this link were to decline in some way, it would have a large impact on the global economy. There have been several previous transatlantic initiatives designed to promote integration between the EU and the United States. In terms of recent economic developments, in 1995, the New Transatlantic Agenda was signed, and the Transatlantic Business Dialogue (TABD) was established for the purpose of creating a framework for cooperation between the transatlantic business community and the governments of the EU and the United States. The first real trade integration initiative was proposed by Sir Leon Brittan in 1998 after the completion of the Single Market and the World Trade Organization (WTO). This initiative involved tariff elimination, an FTA for services, and the extensions of mutual recognition agreements (MRAs). An MRA is an international agreement by which two or more countries agree to recognize one another's conformity assessments for goods. The EU economy has developed not by innovation and technological upgrades, but by market enlargement through incorporating markets with lower labor costs, integration, and improved efficiency. The Transatlantic Economic Council (TEC) was a body set up between the United States and the EU in order to reduce barriers to transatlantic trade and investment and enhance economic growth and integration. Unfortunately, regulatory cooperation has proven to be a complex issue between them. Furthermore, previous transatlantic initiatives have had disappointing results. Prior to 2011, the only achievements made were the "open skies" agreement between the United Nations (UN) and the United States and weak cooperation agreements on intellectual property (IP) innovation and energy. One of the main reasons why a EU-U.S. FTA has never materialized is because of European skepticism. Europeans appear to remain very committed to the multilateral system, which they think would be undermined by a bilateral EU-U.S. FTA. The EU imposed a moratorium on itself, forbidding FTAs. There is also a strong commitment to the WTO system within the EU trade leadership. On top of this, it seems that an ideological divide between the EU and the United States developed after 9/11. The crisis led to a larger sensitivity towards imports, and liberal and free trade order which existed in the 1990s were in effect replaced by mercantilism. Furthermore, trade policy in Europe is generally considered of less importance than foreign policy. The German and French opposition to the Iraq War also highlighted the ideological divide. With regard to transatlantic cooperation, trade and investments were already considered to be liberalized. On top of this, relatively small gains were considered to be unworthy of the effort or difficulties involved in making concessions. Although there are significant potential gains to be made, non-tariff barriers (NTBs), which are regulatory divergences, are extremely difficult to negotiate. Mutual recognition and regulatory harmonization are crucial to EU-U.S. cooperation. A EU-U.S. FTA would be impossible while excluding sensitive sectors, of which both parties have. Several changes have come about in recent years. The Doha impasse has occurred, and the EU has developed and is currently developing politically important FTAs. However, the economic value is very small, at less than 0.1% of the GDP. It is evidently important for the EU to create FTAs with big trading partners such as the United States, China, and Japan in order to have a significant economic impact. New trade issues and barriers have come about, ranging from manufacturing tariffs to services and NTBs. However, potential common positions have also come to light. The emergence of competitors also means that it has become necessary to coordinate against the rising economies of Brazil, Russia, India, and China (BRIC). The 2008 subprime and euro crisis have resulted in sensitivities in manufacturing and soft mercantilism. Domestic lobbying, especially in manufacturing, has concluded that growth is needed to sustain current levels of employment and re-balance trade. However, it is very difficult to conclude FTAs with export-driven countries as they tend to focus on a few key sectors, which happen to be the EU's sensitive sectors. Against this background, the ECIPE and the German Marshall Fund of the United States (GMF) set up the Transatlantic Task Force on Trade with the serving minister of trade of Sweden, a former U.S. congressman who has been very active in trade issues, and a host of well-known policy makers such as the former EU ambassador to the United States, the former minister of Foreign Affairs of Spain, and a former U.S. trade representative. The main conclusion of their findings was that the EU and the United States should move to a barrier-free transatlantic marketplace for trade and investment. They also concluded that deeper transatlantic economic integration will create momentum for multilateral trade liberalization and help to redevelop the mutual economies of the EU, United States, and the Doha Development Round. Also, as EU-U.S. sector interests are mutual, a decentralized and sector-driven approach would be the most beneficial. Each sector must negotiate regulatory cooperation. Another controversial conclusion is that initiatives should be based on preferential market access. In other words, agreements between the two parties would be exclusive. This would help to promote the development of other more exclusive FTAs. Active involvement of private sector stakeholders in the negotiating process should also be encouraged. Finally, the EU should take ideological leadership on trade as this currently doesn't exist. The ECIPE taskforce has made several recommendations. In the context of EU-U.S. bilateral relations, we must aim for a Transatlantic Zero Agreement. In other words, tariffs should be eliminated. We must also have regulatory cooperation in order to eliminate NTBs. We need to liberalize substantially the trade in services and intensify cooperation with third countries, though not necessarily in FTAs. Finally, we should launch negotiations on a bilateral investment treaty (BIT) and bilateral public procurement agreement. With regard to joint-multilateral initiatives, we should promote plurilateral and sectoral agreements, plus include full coverage of all elements related to the digital economy in creating an International Digital Economy Agreement (IDEA). It has also been suggested that we should make preferential agreements on the principle of "coalitions of the willing," while remaining open to allowing other non-most favored nations (non-MFNs) to join. Other recommendations include having a plurilateral framework agreement in services, closer EU-U.S. cooperation to promote the enforcement of disciplines on subsidies and state-owned enterprises, strengthening of the WTO Trade Policy Review Mechanism (TPRM), and the further expansion of the Agreement on Government Procurement (GPA). The ECIPE recommendations have enjoyed broad political support. A number of senators have signed a letter endorsing their support, which they sent to the president of the United States. Important politicians such as John Kerry of the Democratic Party and Robert Portman of the Republican Party have also signed this letter, showing the level of support and commitment to ECIPE's recommendations. In recent developments, high-level working groups on jobs and growth have been set up between the EU and the United States. Issues such as tariffs, services and investment, compatibility of regulations and standards, NTBs, rules and principles on global issues of common concern, and shared economic goals relating to third countries have been decided upon. An interim report was issued in June 2012, and a final report is to be expected at the end of 2012. ECIPE recommendations have also resulted in the development of the EU-U.S. Trade Principles for Information and Communication Technology Services, and the United States has reached its own agreement with Japan. A Statement of the EU and the United States on Shared Principles for International Investment has also been created. Furthermore, a Mutual Recognition Agreement for Authorized Economic Operators has recently been published. Although there is strong political interest in creating an FTA between the EU and the United States, the difficulties involved in such a process are perhaps being underestimated. There is a preference to use a chapter-by-chapter approach by EU and U.S. businesses over single undertakings. Also, simply by completing a transatlantic zero-tariff agreement, the GDP increase will amount to 0.32% to 0.47% ($46 billion to $69 billion) for the EU and 0.99% to 1.33% ($135 billion to \$181 billion) for the United States. The United States wants to push for separate services and investment FTAs. However, there are many sensitive sectors related to EU-U.S. FTAs, such as audiovisuals, air transport, electricity, telecommunications, transport, maritime, and postal services. In the EU, there are also state-level commitments; services such as banking are regulated on a state level, which don't exist in the United States. This is another barrier which needs to be overcome. Investment is another sensitive issue as it is a new EU Commission competence. Technically, past BITs are invalid, and there isn't a coherent EU policy on BIT agreements. Finally, with regard to public procurement, there is a perception in the EU that it is more open than the United States. In fact, 13 U.S. states do not participate in the GPA.

In terms of the implications for Japan and the trade system, unfortunately, there is now, indirectly, a new priority in the EU trade policy. The EU made an FTA with Mexico in 1997 in order to mitigate the North American Free Trade Agreement (NAFTA). Trade and economic integration in the Asia-Pacific region is developing rapidly, therefore the EU attempted to develop NAFTA. Industries in the EU also maintain a very protectionist stance, supporting a EU-U.S. FTA as a priority.

This will inevitably have an effect on other EU FTA negotiations, including those with Japan. The United States will set a new level of demands on EU-sensitive sectors, which must be fulfilled. Negotiations on regulatory cooperation and NTBs have been successful between the EU and Korea, but will likely be problematic with the United States and Japan. Furthermore, Japan could possibly demand chapter-by-chapter negotiations with the EU based on the size of its economy, which would be difficult to resolve. There is a belief in the EU that single undertakings are necessary against Asian trading partners as many Asian economies are strong only in a few select sectors.

The EU has engaged in a scoping exercise with Japan in order to see what benefits a EU-Japan FTA would bring about. This may result in the United States demanding a scoping exercise with the EU. It may be difficult for the EU to make an FTA with the United States by giving the strict concessions which the latter demands. The EU-Japan scoping exercise seems to have served as a negative force in negotiations with Japan.

Another issue involves the overlaps and conflicts with multilateral and plurilateral agreements. The EU supports MFN, and even if an FTA is reached with the United States, other countries should be able to join. The United States does not endorse MFN and would like to establish a preference barrier. With regard to International Service Agreements (ISAs), it would seem that a non-MFN would not be possible for the EU. Finally, the role of the WTO and Doha should be seen as a building block to multilateral cooperation rather than as a stumbling block. Its role is to set the level of precedent for the next agreement.

It seems that a new transatlantic leadership is emerging. An FTA with cross-ownership, MNCs, and heavy mutual investment has created a shared business and policy culture. The EU and the U.S. regulations are similar and operate on the same principles of necessity and conformity. This may lead to a new trade policy coordination and standard-setting mechanism that will affect Japan. Japan and its businesses will have to respond if the EU and the United States manage to complete a full-scale regulatory cooperation. Whatever they achieve will surely have a large impact on Japan.

Q1: There are concerns as to whether the EU and the United States can truly cooperate on the various issues associated with such a large-scale scheme without the use of mediators. Are there any differences in the likelihood of potentially effective cooperation in relation to each of those issues?

Hosuk Lee-MAKIYAMA
It is for certain that the WTO will not move forward without the top five players cooperating closely with each other. However, the concept of a liberal trade order originally comes from the United States and not from Europe. It's a matter of investment hegemony rather than trade hegemony, and what is important here is from where the investment comes. For instance, geographical indication (GI) is a concept which is implemented in Europe in order to protect agriculture without giving direct grants. It would be difficult for the GI system to take root in multinational frameworks since it has low priority in terms of trade policy. Using a bilateral framework may make it easier to solve these issues, as opposed to using a multilateral framework.

Q2: Using a bilateral framework would result in a tendency to shift to a non-MFN (most-favored-nation treatment) system. However, in reality, the current service commitment, for instance, is MFN-based. It may prove difficult for the currently successful MFN system to be replaced effectively by that of a non-MFN system. What is your opinion on this matter?

Hosuk Lee-MAKIYAMA
While the United States can specifically categorize each country, Europe has a non-discrimination principle, therefore all services are MFN-based in the first place. What could be realized on a non-MFN basis should be limited, such as the temporary movement of workers as is the case of qualified professionals with expertise including lawyers and financial planners.

Q2-2: I have two more questions. The first one is about the FTA between the United States and Europe, which it was said should be based on the General Agreement between Tariffs and Trade (GATT) framework. However, it seems rather difficult to realize such an FTA on a sector-based system. What are your thoughts on this? My second question is about the General Agreement on Trade in Services (GATS) system, which only has a history of 17 years. Because GATS itself is still relatively immature, I think the movement toward an FTA in this area, especially that of the United States and Europe, may largely change the framework of GATS itself. What do you think about this?

Hosuk Lee-MAKIYAMA
In the case of the GATT approach, an FTA may not be enforced until the various conditions presented are fulfilled 100%. However, if the EU and the United States really wish to move the negotiation forward promptly, other WTO members cannot stop this from happening, regardless. Another option is to implement a transatlantic zero-tariff agreement (TAZA), which starts from zero tariff and has no sensitive sector. It is still undecided which approach will be taken. Regarding GATS, there is no genuine service-only FTA under the GATS framework yet. If this is to be established as a new standard, technical issues on how it can be operated through an FTA or WTO framework, for instance, whether it should be operated on a positive list basis or negative list basis, shall become an important concern.

Q3: The situation related to the WTO system is currently in the process of great change, especially in the United States and the EU. If the development of FTAs or the TPP accelerates in the future, how will the WTO system change in accordance with this? Will it focus solely on the function of dispute settlement or on the establishment of FTAs in different parts of the world, which may result in the revival of something similar to the round talks?

Hosuk Lee-MAKIYAMA
Because the WTO deals with a wide range of issues, it will remain as a multilateral system even if the Doha round is discontinued. Previously, talks under the WTO took place with many different political institutions, though it has not yet been possible to reach a final agreement. The WTO system is peculiar in that it does not only offer concessions such as bilateral FTAs to certain countries, but also to the entire world. We believe that the current level of the talks will be changed fundamentally, and there will be some kind of competition over deciding the level of negotiations—for example, whether systems will be plurilateral, sectoral, or whether or not to generate a new, big trade round.

Q4: I believe there was an intention for extending not only the market, but also the supply chain behind the expansion of the EU eastward. However, in the case of FTAs by the United States and Japan, the impact on the market appears to be more of a point of focus than that of the issue of the supply chain. The position of Japan as a technologically advanced country may also provide different implications to those associated with the expansion of the EU. What is your opinion on this? Also, I would like to ask briefly about your thoughts on the prospect of Russia's accession to the WTO.

Hosuk Lee-MAKIYAMA
In the case of EU-U.S. integration, service and investment are more important than the trade of goods because large economies specialize in all sectors. What they can provide one another with are added values through investment, rather than products. That is why service fragmentation becomes more important than product integration. In addition, the importance of service sectors within the entire economy is quite significant in the EU and the United States. Regarding Russia, I personally have doubts as to whether or not the country is really ready to join the WTO. China had carefully prepared for nearly 10 years before its accession to the WTO, but it still has some problems even now. On the other hand, the preparation period for Russia was only about a year, and everything seems to have been decided very suddenly. I know that Russia hasn't made the same level of preparations that China did, and some problems such as the Georgia issue seem to have been solved rather forcibly behind the scenes.

Q5: What is Brussels' view on the future relations between the EU and China in terms of trade and the movement toward establishing a framework in Asia, for instance China, Japan, South Korea, or ASEAN?

Hosuk Lee-MAKIYAMA
This should be the same for both Brussels and Washington D.C., but the idea is not "EU-U.S. against the rest of the world." We find support wherever we can and cooperate with any countries whenever our priorities are the same. Also, when we start negotiation on the same type of FTAs as the United States, the countries and issues of negotiation will be identical because it started the process earlier. Also, FTAs where no negotiations have ever taken place involve more difficulties in terms of reaching a conclusion.

Q5-2: The situation just mentioned appears to be being reflected in that Japan is now following the lead of South Korea. It seems that Japan is now losing its connection with the United States, compared to the political, economic and industrial ties between the EU and the United States. It seems that the EU and the United States share a large number of issues, for instance, in terms of investment and intellectual property. However, I personally believe that Japan must join such a movement between the EU and the United States at an early stage rather than follow from behind. What is your opinion on this?

Hosuk Lee-MAKIYAMA
Japan has not become less active, but rather is currently becoming more inward-looking, and so it lacks the advantage of being in the position required for others to take notice. However, since the European regional integration, people are seeking new, idea-based leadership in order to advance the economic system. It may be important for Japan to consider its "soft power," in terms of its influence on thinking and economic ideas, to increase its presence. One example of such an idea originating in Japan is the anti-counterfeiting trade agreement (ACTA). With more initiatives like this, the world will further realize the importance of working with Japan.

*This summary was compiled by RIETI Editorial staff.