How to Handle the Tariff Man? Japan’s Strategy

TRUMP’S OBJECTIVES

Trump’s tariff policy appears to have three main objectives: 1) Reducing the trade deficit; 2) Revitalizing the US manufacturing sector; and, 3) Achieving non-economic goals, such as curbing illegal immigration and drug trafficking.

The third objective — particularly addressing illegal immigration and narcotics trafficking — may see some success by applying pressure on targeted countries. However, the first two objectives are unlikely to be achieved through tariffs. The trade deficit is primarily driven by macroeconomic factors, such as national savings, consumption and investment levels. Addressing it with microeconomic tools such as tariffs is largely ineffective. A more appropriate solution would involve reducing the fiscal deficit through more disciplined government spending.

As for revitalizing US manufacturing, protectionist policies tend to be counterproductive over the long term. Tariffs reduce competition, which is vital for fostering innovation and enhancing industrial excellence. A more effective strategy would focus on industrial restructuring and investment in research and development (R&D).

The likely impact of Trump’s tariff policy on the US economy is negative: It raises prices, dampens consumption and slows economic growth, leading to a global economic slowdown. Indeed, stock markets dropped sharply following the announcement of reciprocal tariffs, signaling investor concern. Many observers hope this market reaction will prompt a reversal of the measures.

JAPAN’S RESPONSE

Japan has been significantly affected by the tariffs. A 25 percent tariff has been imposed on Japanese steel, aluminum, automobiles and auto parts. In addition, a 10 percent universal tariff now applies to almost all other Japanese imports as part of the reciprocal tariff framework. This rate may rise to 26 percent on July 9 if negotiations fail. The level of reciprocal tariff imposed on each country is reportedly tied to the size of its trade surplus with the US — essentially a measure of US dissatisfaction. In 2023, Japan accounted for about 9 percent of the US trade deficit, a significant drop from roughly 50 percent in 1990, during the peak of US-Japan trade tensions. Japan now ranks seventh in terms of trade deficits with the US, behind China, Mexico, Vietnam and others.

Negotiations have begun, but the content remains undecided. Japan seeks a comprehensive discussion covering all affected sectors, particularly automobiles and auto parts. In contrast, the US appears focused solely on items covered under the reciprocal tariff framework.

Japan is particularly concerned about the 25 percent additional tariff on automobiles and auto parts, because the automotive sector is vital to its economy. The industry represents about 4 percent of Japan’s gross domestic product (GDP), 20 percent of its manufacturing output and 20 percent of exports. It includes major automakers and a broad network of small- and medium-sized suppliers, and it is also closely linked to service sectors such as transportation. Approximately 5 million workers — roughly 10 percent of Japan’s labor force — are connected to the automotive industry.

To avoid further tariffs, especially those targeting automobiles and auto parts, the Japanese government is pursuing two main strategies: 1) Co-operating with the US to revitalize American manufacturing, and 2) Expanding imports from the US.

First, Japan aims to support US manufacturing by increasing investment and sharing advanced technologies. Japan is already the largest foreign investor in the US, with Japanese companies employing over 1 million American workers in sectors including automotive, chemicals, finance and insurance. The Japanese government is prepared to support these firms and is considering technical assistance to help rebuild the struggling US shipbuilding industry.

Second, Japan is exploring increased imports from the US in sectors such as agriculture and energy. Potential imports include agricultural products such as rice, soybeans and corn, as well as liquefied natural gas (LNG). In response to Trump’s criticism of Japan’s strict automobile safety standards — which he claims limit American car exports — Japan may temporarily allow US vehicles that meet American, rather than Japanese, safety standards. However, many observers remain skeptical, noting that differences in consumer preferences and driving environments are more significant barriers.

On agriculture, Japan is considering increasing its allocation of rice imports from the US, possibly reducing imports from other exporters. This could be timely, as domestic rice prices have surged due to supply shortages. Critics argue this may be an opportunity to reform Japan’s rice policy to make it more competitive. In addition, Japan may import more US corn and soybeans, which have suffered declining exports to China due to retaliatory tariffs. Japan hopes to fill this gap and support American farmers. LNG imports from Alaska are also under discussion, although these would be part of a long-term project with no immediate impact.

In parallel with these measures, the Japanese government is preparing financial and fiscal support for businesses and workers affected by reduced exports to the US and the broader economic slowdown resulting from US tariff policies. In addition, the Japanese government is encouraging domestic companies to diversify their export destinations in order to reduce dependence on any single country.

Some have suggested that Japan could use its holdings of US Treasury bonds as leverage in negotiations. However, this is unlikely, because the Japanese government is committed to preserving its strategic relationship with the US. Indeed, Japan is keen to signal that it will not use this bargaining chip in order to gain favorable treatment.

THE GLOBAL TRADE SYSTEM AND WTO CHALLENGES

The global trade environment has become freer and more reliable due to a series of successful multilateral trade negotiations under the GATT, which addressed market access and other contentious issues. The creation of the WTO — a more robust institution that succeeded the GATT — marked a new stage in global trade governance. However, the WTO has failed to effectively perform two core functions: 1) Rulemaking (including liberalizing trade and opening markets), and 2) Dispute settlement (including monitoring and enforcing trade rules).

The WTO launched its first multilateral negotiations — the Doha Development Agenda (DDA) — in 2001, covering issues such as agriculture, market access, services, subsidies, trade facilitation, development, intellectual property (TRIPS) and the environment. Yet, persistent disagreements among members have stalled progress.

The dispute settlement mechanism has also ceased to function properly. The Appellate Body, a tribunal within the dispute settlement system, became non-operational in December 2019 due to the US blocking new appointments, citing dissatisfaction with its rulings.

A key reason for the WTO’s dysfunction is its consensus-based decision-making. With 166 members, reaching consensus on contentious issues is highly challenging. In addition, tension between developed and developing members persists, particularly over whether economically advanced developing countries should continue receiving preferential treatment.

As the WTO struggles with liberalization and rulemaking, many members have pursued alternative approaches, such as regional trade agreements (RTAs) and plurilateral agreements (PAs) with like-minded members. To fill the dispute resolution gap, a group of WTO members established the Multi-Party Interim Appeal Arbitration Arrangement (MPIA).

RTAs — including free-trade agreements (FTAs) and customs unions (CUs) — eliminate tariffs among members while maintaining them on non-members. FTAs allow each member to retain its own external tariffs, while CUs adopt a common external tariff. Though RTAs emerged in the 1950s, they grew rapidly in the late 1980s due to the slow progress of the Uruguay Round of the GATT. This trend continued as the Doha Round stalled.

Two significant FTAs advancing a rules-based trade order are the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP). CPTPP, initially signed by 11 Asia-Pacific countries (Japan, Australia, Brunei, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam) entered into force in December 2018. The United Kingdom joined in December 2024, bringing the total to 12 members. The CPTPP is a high-standard agreement covering a wide range of issues, including trade in goods and services, investment, intellectual property, e-commerce, labor, environment and state-owned enterprises. Members have committed to eliminating nearly all tariffs after a grace period, demonstrating a high level of openness.

RCEP, which entered into force in January 2022, includes 15 countries from East Asia (Japan, China, South Korea, Australia, New Zealand and all 10 ASEAN members.) It involves a lower level of liberalization than the CPTPP and omits chapters on labor, the environment, state-owned enterprises and other areas. However, it is the largest trade agreement globally by GDP, trade volume and population.

In contrast to RTAs, plurilateral agreements focus on specific issues and engage a broader set of participants. In 2017, like-minded WTO members began launching Joint Statement Initiatives, which are open to all members. Ongoing initiatives include: 1) E-commerce (approx. 90 members), 2) Investment facilitation for development (more than 120 members), 3) Services domestic regulation (72 members), 4) Micro-, small- and medium-sized enterprises (approx. 90 members).

To address the suspension of the Appellate Body, the EU, Canada, Australia and others launched the MPIA in April 2020. Under this arrangement, members agree to resolve disputes through arbitration. Any WTO member can join by notifying the Dispute Settlement Body. At present 56 WTO members including Japan and China have joined, but the US and South Korea have not.

LEADERSHIP ROLE FOR A RULES-BASED TRADE SYSTEM

In the face of the Trump administration’s erratic and unreasonable tariff policies, Japan has understandably focused on securing exemptions to mitigate negative economic impacts. However, Japan should broaden its approach and assume a leadership role in restoring the WTO system, which stands at a critical juncture.

To that end, Japan should collaborate with like-minded middle powers such as Australia, the European Union, Singapore, South Korea and countries from the Global South. Specifically, it should lead efforts to expand and strengthen both the CPTPP and RCEP, actively advance plurilateral agreements, and promote broader participation in the MPIA. By doing so, Japan can help preserve and reinforce a rules-based global trade order, contributing to global economic growth through the expansion of trade.