Japan and U.S. Starting Trade Negotiations: Japan in a difficult position regarding cars and foreign exchange

Faculty Fellow, RIETI

At a summit meeting on September 26, 2018, Prime Minister Shinzo Abe and President Donald Trump agreed to start negotiations toward concluding a Japan-U.S. Trade Agreement on Goods (TAG). The negotiations are scheduled to start in earnest in January 2019. As President Trump is scheduled to visit Japan to attend the summit meeting of the Group of 20 (G20) major economies to be held in Osaka in June. Working-level negotiations are expected to come to a head by then. In this article, I will explain the background to and the prospects for the negotiations.

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At the heart of President Trump's trade policy are his beliefs that "a trade deficit is bad and a trade surplus is good" and that "bilateral negotiations are more likely than multilateral negotiations to lead to a favorable deal." Based on these beliefs, he started a series of bilateral trade negotiations with the major trading partner countries with which the United States is recording a large trade deficit (See the figure below).

Figure:Top 15 Countries/regions in terms of Trade Deficit for the United States in 2017
Figure:Top 15 Countries/regions in terms of Trade Deficit for the United States in 2017
Note: The above is a list of the top 15 countries/regions in terms of the value of trade surplus with the United States (trade deficit for the United States) in 2017. "China" includes Hong Kong.
Source: U.S. census survey data

President Trump believes that the U.S. trade deficit with Japan, which is worth around 70 billion dollars (7.6 trillion yen) annually, is attributable to unfair trade practices and is destroying wealth and jobs in the United States. Immediately after taking office as president, he pulled the United States out of the Trans-Pacific Partnership (TPP). This move was intended to shift emphasis in trade negotiations to a bilateral format in addition to undermining the legacy of former President Barack Obama, his predecessor.

On March 23, 2018, President Trump imposed additional tariffs of 25% and 10% on imports of steel and aluminum products, respectively, from many countries/regions, including Japan, based on Section 232 of the U.S. Trade Expansion Act, which authorizes sanctions against trading partner countries/regions when a national security threat is recognized. This action reflected his intention to deal with the problem of excess supply of steel and aluminum that was caused by China's state-owned enterprises financed by huge amounts of hidden subsidies, to increase support for himself in the rust-belt regions, and to pave the way for bilateral negotiations with countries with which the United States has a trade deficit.

As part of efforts to pave the way for negotiations, the United States agreed with Japan to establish a new framework of trade talks for free, fair and reciprocal (FFR) trade deals at a summit meeting in April. However, as bilateral trade negotiations with countries other than South Korea, Argentina and Brazil did not go well, President Trump instructed the Department of Commerce on May 23 to start investigations concerning automobiles and auto parts as well based on Section 232 and suggested the possibility of introducing additional tariffs of up to 25%.

If the United States imposes additional tariffs on imports of automobiles and auto parts, it would have an immeasurable impact on Japan. According to data for 2017 (as reported by Nikkei on September 16, 2018), Japan exported 1.74 million vehicles (worth 4.4 trillion yen) to the United States in that year. In addition, Japanese automakers exported 770,000 vehicles from Canada and 690,000 vehicles from Mexico to the United States. Regarding auto parts, Japan exported 940 billion yen's worth to the United States. The total value of annual exports of automobiles and auto parts from Japan to the United States was around 50 billion dollars, accounting for slightly less than 40% of the total value of Japanese exports to the United States.

At the first FFR meeting held on August 9-10, Japan called on the United States to return to the TPP, while the United States showed its preference for a bilateral free trade agreement (FTA). In the end, the Japanese government agreed to start TAG negotiations due to concerns over the possibility of the United States unilaterally increasing tariffs on automobiles and auto parts, and as a result, the imposition of additional tariffs was put off for the moment. A Japan-U.S. joint statement made it clear that Japan will not open the market for agricultural, forestry and fishery products further than under its previous economic partnership agreements (EPAs) and that with regard to market access for automobiles, the outcome of the negotiations will be designed to increase production and jobs in the auto industry in the U.S.

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On December 21, the Office of the United States Trade Representative (USTR) announced 22 negotiating objectives for trade negotiations with Japan. The Office of the USTR simply calls the planned agreement a "United States-Japan Trade Agreement" (USJTA), without using the term "goods," which the Japanese government is emphasizing. The 22 objectives cover most of the 21 fields of negotiation under the TPP. In other words, the Trump administration regards negotiations with Japan as standard FTA negotiations and intends to conclude a deal more favorable for the United States than under the TPP agreement.

Attention should be paid to the inclusion of currency (foreign exchange) among the objectives. President Trump has accused Japan of promoting exports by inducing depreciation of the yen. With the United States-Mexico-Canada Agreement (USMCA) in mind, he is also expected to call on Japan to agree to a currency clause that prohibits foreign exchange manipulation to induce currency depreciation. In addition to negotiations over goods trade, negotiations over other items will also be conducted.

With respect to negotiations concerning the automobile sector, the U.S. negotiations with other countries may serve as a reference. In the renegotiations over the U.S.-South Korea FTA, agreements were reached on the following points, among others: (1) the timing of the abolition of the 25% tariff on South Korean-made pickup trucks will be pushed back 20 years to January 1, 2041; (2) South Korea should increase the annual quota of vehicles that may be imported by each U.S. automaker without meeting the South Korean safety standards, as long as the U.S. safety standards are met, to 50,000 vehicles (up from 25,000 vehicles before the renegotiation); (3) imported auto parts should also be regarded as meeting the South Korean safety standards as long as they meet the U.S. standards; and (4) when South Korea establishes automotive environmental standards, it should take the U.S. standards into consideration as well.

Under the USMCA, when additional tariffs are imposed on automobiles and auto parts based on Section 232, imports of all light trucks and up to 2.6 million passenger cars from each of Mexico and Canada per year should remain tariff-free, while imports of auto parts should remain tariff-free for up to 108 billion dollars' worth per year in the case of Mexican products and for up to 32.4 billion dollars' worth per year in the case of Canadian products. At the moment, the volume of exports from both countries is within the tariff-free quotas, but the volume is expected to surpass the quotas in the near future.

In light of the above, the possibility cannot be ruled out that in the Japan-U.S. negotiations, Japan's safety and environmental standards will be virtually disregarded, or Japan will be forced to accept in effect some form of quantitative restriction on exports. If an export quota is introduced, the allocation of export permits to manufacturers will then emerge as a problem.

However, if Japan decides to voluntarily restrict its exports, Japanese automakers may be able to earn additional profits by taking advantage of upward price pressure generated by the reduced supply of Japanese vehicles, or by shifting exports to passenger cars with larger profit margins. Meanwhile, even if Japan accepts the U.S. safety standards as import criteria, the volume of imports of U.S. vehicles is unlikely to increase substantially. The United States may demand that Japan take additional measures to increase imports or expand direct investments in the United States.

The Japan-U.S. trade negotiations are expected to be affected by other ongoing trade negotiations. On July 25, 2018, President Trump and European Commission President Juncker, who represents the European Union, agreed to start trade agreement negotiations, and the negotiations are expected to start in earnest in due course. The future course of the Japan-U.S. negotiations will be affected by how the U.S.-EU negotiations play out. Meanwhile, the Japan-EU EPA will be put into force on February 1, 2019. Japan should work with the EU in pushing back against unreasonable demands that contravene the rules of the World Trade Organization (WTO).

Moreover, the Trump administration is holding negotiations with the Chinese government in order to make China resolve trade problems, including its forcible technology transfers and infringement of intellectual property rights, and to implement structural reforms in exchange for giving it a reprieve from the imposition of additional retaliatory tariffs on 200 billion dollars' worth of Chinese products. The U.S.-China negotiations, for which the agreement deadline has been set for March 1, may also affect the Japan-U.S. negotiations. If the U.S.-China negotiations falter, the Japan-U.S. negotiations may be postponed. Conversely, if the U.S.-China negotiations are concluded smoothly, the pressure on Japan may grow.

President Trump's favorite tactic in bilateral negotiations is using the implementation or the threat of implementation of protectionist policy measures as a way to steer negotiations in a favorable direction and win concessions from the other side. Regrettably, this tactic has worked just as the president intends it to. Because of the United States' overwhelmingly strong political and economic influence, negotiating partner countries are forced into a situation in which they cannot but give concessions. Even China, which was sounding tough in dealing with the Trump administration, has started to give ground on some matters. Although the Japan-U.S. negotiations are expected to be tough, I hope that an agreement consistent with the WTO rules will be reached.

>> Original text in Japanese

* Translated by RIETI.

January 14, 2019 Nihon Keizai Shimbun

February 27, 2019