Issues to Tackle Following the TPP Agreement: Leadership to expand the free trade area

Faculty Fellow, RIETI

Just as it seemed that any agreement on the Trans-Pacific Partnership (TPP) would again be put off for another day, the negotiators reached an 11th-hour agreement in principle. For Japan, getting to this point actually took five years since then-Prime Minister Naoto Kan announced the government was considering joining the talks, and more than two years since Japan officially did so.

A major feature of the TPP is not only more access to markets for goods (i.e., eliminating and reducing tariffs) and deregulation of trade in services, but also a comprehensive treaty including non-tariff considerations (investment, competition, intellectual property, government procurement, etc.) and some new areas (environment, labor, etc.) that was negotiated multilaterally.

The negotiations were expected to be difficult, since they covered 31 areas and the 12 nations included developing, semi-developed, and highly developed countries. In fact, on top of having to negotiate a new trade order, old battles such as that between the United States and Japan over opening the markets for agricultural products and automobiles and New Zealand's demand to open dairy product markets weighed the process down.

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Going forward, the focus will shift to domestic proceedings such as approval by the legislative branches of the various countries. Among the conditions for the TPP to take effect, at least six nations representing at least 85% of the gross domestic product (GDP) in the group of countries must approve it. Under that condition, the treaty will not take effect unless it passes in both the United States and Japan. Prime Minister Shinzo Abe, who is very conscious of measures that need to be taken by the agricultural sector, immediately set up a general committee to promote the TPP, in which the entire Cabinet is participating. This shows that his intention for an all-out effort to secure Diet approval.

Likewise in the United States, President Barack Obama is making a strong push for ratification. However, things could be trickier with Hillary Clinton, who quite possibly could become Obama's successor. Though her choice of words has been delicate, she has suggested that she does not support the TPP to the extent of her knowledge of its details. Even so, in the end, it seems likely for the United States to ratify the TPP because of the country's emphasis on the economy and security.

On the other hand, ratification is no sure thing in Vietnam, where the TPP would pressure to reform state-owned enterprises, or in Malaysia, which would likewise need to reform such enterprises and curtail its "Bumiputra" policy, which gives preferential treatment to ethnic Malays.

In Japan, both those who generally support the TPP and those against it are unhappy with the agreement as it currently stands. We could argue the merits or demerits of the agreement's details endlessly, but one thing is certain: the TPP would be a giant step forward in forming an Asia-Pacific trading bloc. The issue before us now is how to further expand the TPP and ultimately create a Free Trade Area of the Asia-Pacific (FTAAP).

Now that the WTO's Doha Round of multilateral trade talks has stalled, the TPP is promoting comprehensive economic partnerships in the Asia-Pacific region. Setting up new common rules for trade and investment would be highly meaningful to the Asia-Pacific region, which is growing fast.

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The establishment of such rules would have a major impact on the formation of other vast trading blocs, so-called mega-FTAs. It would have a particularly direct impact on Regional Comprehensive Economic Partnership (RCEP) negotiations in East Asia because, of the 16 nations involved in the RCEP talks (Association of Southeast Asian Nations (ASEAN) plus Japan, China, South Korea, India, Australia and New Zealand), seven of them including Japan are also taking part in the TPP talks.

It seems quite likely that a number of the other nations in the RCEP talks will seriously consider joining the TPP.

South Korea has actively promoted a regional FTA based on a number of bilateral FTAs. The result is that its share of trade value with countries that are part of an FTA is more than 40%. In Japan, the figure is only about 20%. South Korea is part of an FTA with both the European Union (EU) and the United States. These arrangements have impacted the competitiveness of Japanese products in the automotive and other fields. If the TPP goes into effect, it could cause South Korea to lose its superior position, but South Korea has already begun bilateral talks with nations taking part in the TPP negotiations with the idea of joining the pact.

Of the 10 members of ASEAN, Singapore, Malaysia, Vietnam, and Brunei are part of the TPP negotiations. There is a strong chance going forward that trade with the ASEAN region and the flow of investment there will change drastically, which would increase the momentum of countries like Thailand and the Philippines to join. The likelihood of a domino effect is very high as non-member nations compete to join and not fall behind during the expansion of FTA networks.

Additionally, if many of the ASEAN member nations join the TPP, China will also be under pressure to do so. Of course, it is hard to imagine that China would be in a hurry to join the TPP, since the pact would require them to reform their state-owned enterprises and set a high level of intellectual property protection. China is likely to speed up the RCEP talks to counter the TPP, allowing us to predict that the TPP and RCEP will coexist.

Besides the TPP and RCEP, Japan is involved in talks to form two other mega-FTAs: the China-Japan-South Korea Free Trade Agreement and the Japan-EU Economic Partnership Agreement. The only proposed mega-FTA in which Japan is not taking part is the Transatlantic Trade and Investment Partnership (TTIP) between the United States and the EU. Together, all of the mega-FTAs for which Japan is negotiating account for about 80% of the world's GDP. If those mega-FTAs are realized and existing FTAs are included, trade with FTA member countries would make up more than 70% of Japan's trade value by country.

In the process of negotiating a China-Japan-South Korea FTA, China has proceeded with a China-South Korea FTA first, but there is a strong possibility that it will try to advance not only the RCEP but also the China-Japan-South Korea FTA talks, thereby permitting it to take the initiative in mega-FTA talks other than the TPP. A TPP agreement would also likely jumpstart the currently stagnant talks for a Japan-EU Economic Partnership Agreement.

Simply stated, the TPP agreement has raised Japan's profile in other mega-FTA negotiations, and put Japan in a position to exert significant influence in forming common trade rules in multiple vast trade zones. In these negotiations, it is vital that Japan take the initiative to set desirable common rules.

It is also important to increase the number of countries taking part in mega-FTAs in which Japan is involved. An increase in the number of participating nations would further energize and smooth the way for trans-border economic activity.

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Canadian economist Jacob Viner pointed out that regional trade agreements result in both positives (trade creation) and negatives (trade diversion). Trade creation effect takes place when new trade occurs between agreement members, lowering the price of goods in importing countries and increasing imports there. Trade diversion effect means that countries shift their imports from countries with efficient production to those where production is inefficient, with the result that the importing country pays higher prices to exporting countries. It is highly possible that a greater number of participating countries will prevent or eliminate the trade diversion effect.

During the TPP negotiations, moreover, Japan squared off against Canada and Mexico over the issue of rules of origin for automobiles. For automobiles whose manufacturing (including components) takes place both partly within and outside the TPP trade area, as long as a certain percentage of the production takes place within the TPP trade area, those products would be recognized as being manufactured within the trade area and be exempted from tariffs.

Consequently, though it seems likely that the minimum percentage will be set low enough such that it is not a disadvantage to Japan, the greater the number of member countries there is, the easier it will be to meet the rules of origin and build efficient supply chains. Japan has built solid supply chains in Southeast Asia, and if those nations join the TPP, it would be highly advantageous for Japan.

Japan should seize this opportunity to take the lead in deregulating trade and investment in the Asia-Pacific region and setting common rules with a strategic and multi-layered approach. It should also show leadership in merging the TPP and RCEP, which will be essential to achieving an FTAAP in future.

>> Original text in Japanese

* Translated by RIETI.

October 26, 2015 Nihon Keizai Shimbun

December 17, 2015