Significance of the TPP Participation: Promising key for internationalization and productivity improvement

TODO Yasuyuki
Faculty Fellow, RIETI

Historically, civilization has developed by incorporating new information and technology into creating new knowledge through trade. A good example illustrating this is type printing technology, invented in China and introduced to Europe by merchants and missionaries. Gutenberg then established the technology for metal type printing by combining type printing technology from China and excellent German metallurgy.

By exporting, contemporary Japanese companies not only increase sales but also improve productivity and efficiency. For instance, Miyasaka Brewing Company, known for the sake brand Masumi, learned of wine tourism in California through export and designed the "Kami Suwa Kaido Nomiaruki (Drinking and Walking)" tour to create new domestic demand for sake.

Miyasaka Brewing Company is not a unique example. The graph shows the transition of the average labor productivity (value added per worker) of Japanese firms from 1995-2007, comparing those which started exporting for the first time in 2000 and those which did not export at all during this period. Exporting companies were more productive than non-exporting companies before starting export, and the gap between them widened even further after the former started export. According to a study by Fukunari Kimura, a professor at Keio University who analyzed this issue in a more rigorous manner, exporting increases firms' productivity growth rate by about two percentage points on average.

Figure: Transition of labor productivity resulting from export
(value added per worker)Figure: Transition of labor productivity resulting from export

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A number of empirical studies have found that export, foreign direct investment (FDI), offshoring, and FDI inflows in R&D increase the productivity of Japanese firms. These studies clearly show that firms grow by creating new technology and knowledge through internationalization.

However, the ratio of Japan's export to gross domestic product (GDP) is the second lowest (average from 2004-2008) among member countries of the Organisation for Economic Co-operation and Development (OECD). The ratio of FDI inflows to GDP is also the second lowest, and Japan ranks 25th in FDI outflows. That is, the degree of Japanese internationalization is considerably low.

However, Japan can be internationalized further. Ryuhei Wakasugi, a professor at Kyoto University, and others including myself used comprehensive firm-level data for Japan to show clearly that there are many firms which have the technological potential to be competitive globally yet remain in the domestic market. These firms, which I call "lying dragons," exist in any industry and region, and you can find quite a few of them among small- and medium-sized enterprises.

Kaneko Manufacturing Co., a relatively small firm in Saitama with 96 employees, used to be a lying dragon. Although it possesses sophisticated metal processing technology and produces parts for airplanes and medical equipment, it remained as a subcontractor to domestic firms until two years ago. The firm happened to participate, however, in a seminar for the internationalization of firms, which led to a trade exhibition abroad under the support of the Japan External Trade Organization (JETRO). At the exhibition, Kaneko Manufacturing Co. was highly evaluated by overseas firms, and consequently started exporting its products. It has since been growing rapidly by using the network it constructed abroad.

There must be such lying dragons all over Japan. Their awakening and internationalization not only increase their own domestic production and employment but also lead to the vitalization of the entire Japanese economy as the expertise and technology they have acquired abroad spread to other firms in Japan. Therefore, policies are needed to support internationalization of firms.

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One of the most effective policies for achieving this is through economic partnership agreements (EPAs). As EPAs lower tariffs and other trade barriers, profit from export expands. Subsequently, some lying dragons which have until now been hesitant about exporting in fear of associated risk should take a plunge and do so.

In addition, unlike simple free trade agreements (FTAs), EPAs have a more comprehensive framework which includes elimination of barriers to FDI flows among member countries and reinforced protection of intellectual property rights. Consequently, EPAs not only strengthen linkages through trade but also contribute to the construction of production networks through FDI and intellectual networks through joint research. EPAs thus have a greater growth effect through expanding international networks.

The Trans-Pacific Partnership (TPP), an EPA among nine trans-Pacific countries including the United States, is particularly important for Japan. One of the reasons is that it has a large trade creation effect. The Cabinet Office and the Ministry of Economy, Trade and Industry have estimated that the growth in exports brought about by participation in the TPP will increase GDP by 3-10 trillion yen.

More importantly, however, is the TPP's effect on creating new knowledge and technology. This should be particularly significant since possible members of the TPP include advanced countries such as the United States, Australia, and Singapore.

In fact, a study by Keiko Ito, an associate professor at Senshu University, shows that although firms which have started exporting to advanced countries improve productivity, no such effect is brought about by exporting to Asian countries. A study by Satoshi Shimizutani, a senior research fellow at the Institute for International Policy Studies, and myself shows that only leading-edge R&D investment in advanced foreign countries is effective in increasing the productivity of the parent companies in Japan.

In other words, being connected with advanced countries has a greater growth effect. Japan has thus far concluded EPAs mainly with Asian countries, which include relatively few technologically advanced countries. This is precisely the reason why Japan should participate in the TPP.

On the other hand, there are more than a few concerns about the TPP. For instance, the Ministry of Agriculture, Forestry and Fisheries has estimated that the TPP will decrease GDP by about eight trillion yen. In this estimate, it is assumed that a large part of the production of agricultural products, on which a tariff of 10% or greater is imposed, will be destroyed. It is inconceivable, however, that domestic agricultural production will be destroyed by eliminating tariffs on agricultural products. One of the reasons is that a large percentage of Japanese agricultural products is of higher quality than those of other countries. It is difficult to conceive that importing low-quality rice will result in a sharp decline in the consumption of domestic, high-quality, brand-name rice.

In addition, just as there are lying dragons in the industrial sector, there must be lying-dragon farmers in agriculture. High-quality Japanese rice is being traded at a high price in the international market, and rice export has been increasing in recent years. There surely must be many farmers who produce rice of similarly high quality but have not considered exporting their products. If that is the case, then the TPP should help export Japanese agricultural products.

Some argue that Japan should not participate in the TPP since it may hurt the areas affected by the Great East Japan Earthquake. However, there are many lying dragon firms in the affected areas. According to this year's White Paper on Trade and Commerce, a fairly large number of industrial products manufactured in the Tohoku area are not directly exported but instead are indirectly done so after being integrated into products exporting from other areas of Japan. This shows that there are many firms in the Tohoku area with the technological potential for selling their products in the global market but nonetheless remain as subcontractors to domestic companies. If participation in the TPP helps firms in the affected areas including these lying dragons increase export and improve productivity through internationalization, it should be able to contribute to the reconstruction of the affected areas.

For instance, the aforementioned Kaneko Manufacturing Co. has a factory in the northern part of Iwaki prefecture, a little more than 30 km from the Fukushima Daiichi Nuclear Power Plant. Production at the factory was suspended due to the impact of the nuclear power plant accident, but it was resumed in October. The TPP would effectively support such vigorous firms in the affected areas.

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The TPP alone is not sufficient for further internationalization of firms. EPAs with the European Union (EU), China, and Korea are equally important. In addition, in order to awaken lying dragons, concurrently strengthening networks to provide effectively firms with information about overseas markets and policy support for internationalization is required.

There is no exact estimate for the impact of these policies for internationalization. However, it may not be an ambitious prediction that the internationalization of firms through these policies will raise the economic growth rate by about 0.5%, in light of the fact that the growth rate of real GDP per capita rose by 1.7% as a result of the opening up of Japan at the end of the Edo period, and that engaging in export or FDI increases firms' productivity by 2-3% on average, If this turns out to be the case, the cumulative GDP increase from internationalization compared with the status quo will exceed 100 trillion yen in 10 years. Japanese participation in the TPP, which can be expected to bring about such a large growth effect, is expected by all means.

* Translated by RIETI.

>> Original text in Japanese

October 13, 2011 Nihon Keizai Shimbun

November 21, 2011