RIETI Policy Debate

Round 9: FTAs Take Off in East Asia—The Absence of a Japan-China FTA is a Loss

Senior Fellow, RIETI

Free trade agreements (FTA) are on fire in East Asia, something that could not even be imagined just a few years ago. FTAs indicate a policy that integrates markets by eliminating trade barriers such as tariffs between countries. This abolishment of barriers between the countries activates competition between the two parties. This leads to natural selection that results in increasing economic efficiencies and also promoting growth. Consequently, victors and losers emerge from its inception. Since it is a quite severe policy, it had trouble moving forward in East Asia, an area not know for being adept at liberalization.

However, Japan created the turning point. The whole trend was ignited when Japan and South Korea began a joint study into an FTA in 1999. When Singapore got wind of this, there was an immediate reaction, leading to Japan and Singapore promptly proceeding with FTA negotiations (concluding an agreement in January 2002). When China saw what was happening, it claimed that it was being left out and soon was on a charge of its own. It first approached the Association of Southeast Asian Nations (ASEAN) about an FTA and, with remarkable concessions as its weapon, successfully signed a basic treaty with ASEAN in November 2002.

ASEAN, which has always maintained a balance between the two Asian powers, concluded an FTA with China but has left Japan out. Now Japan, feeling a sense of crisis, has followed China's lead and commenced negotiations with ASEAN.

What will happen if Japan is left out of the flow of tariffs that is being abolished between China and ASEAN? This reminds me of the fortunes of Japanese companies that had set up operations in Mexico. As a result of Mexico signing the North American Free Trade Agreement (NAFTA) with the U.S.A. and an FTA with the European Union (EU), Western foreign companies were able to import components and materials from their home countries duty free. Japanese companies bore the handicap of paying tariffs and many were forced to withdraw from the country.

Fortunately, Japanese companies have already established production bases throughout Asia. If Japan were left behind, the companies would most likely simply move their parts production and assembly operations to a plant in a region where it is able to trade duty free. However, this only means further hollowing out and it is only natural that the sense of crisis has increased within Japan.

ASEAN has also been stimulated by Singapore, which took the lead in forming an FTA with Japan. Malaysia, the Philippines and Thailand have begun bilateral negotiations for FTAs with Japan to seek a balance with the FTA gained with China.

Although this is an unbelievable situation, there are three major problems remaining for Japan.

The first is the lack of openness in the agricultural products market of Japan, an issue that needs no further mention. It is said that FTAs permit exceptions of up to 10 percent of the trade volume. However, taking into consideration their strengths in agricultural products, is an FTA within this framework truly possible with Thailand and other ASEAN countries? Japan's counterparties in the negotiations will probably bring to the table the amazing concessions China showed to try to shake Japan. The task Japan is weak at remains: coordinating national and special interests.

The second problem is what to do about Japan and China even if Japan and ASEAN did successfully conclude an FTA. The best possible answer for ASEAN is being able to conclude FTAs with both Japan and China. However, the remaining side of the triangle relationship -- the FTA between Japan and China -- would prove disadvantageous for both Japan and China if it did not exist.

As for the Japan-China FTA, abolishing mutual trade barriers between the countries would logically benefit Japan, which already has low industrial protection barriers, but the pain of restructuring for weak industries would also be great. Moreover, as the "Theory of the Chinese Economic Threat" indicates, the Japanese see no merit in unifying economies with China. To a certain extent, they can understand an FTA with ASEAN but most Japanese are hesitant to create an FTA with China. In addition, the mutual lack of trust in each other's political systems is still deeply rooted. The day that an FTA is concluded between Japan and China will not arrive that soon.

The third and largest problem is the fact that actual economic integration with China is irresistibly moving forward with or without an FTA. Thanks to the dramatic reduction in traditional costs of people, objects and money, there are already integration merits in place that are equivalent to abolishing the tariffs between Japan and China. Although Japanese companies that have encountered Severe Acute Respiratory Syndrome (SARS) in China may contemplate diffusing their risk within Japan and Southeast Asia, their attitude regarding investment in China will probably not change in the long term.

But is there really no merit in what is, in effect, the integration of the Japanese and Chinese economies? This is not the case. The balance of merits and demerits arising from the three "nots" is this huge deficit. The nots are: (1) Japan will NOT notice even if there are merits, (2) Japan has NOT gone to take advantage of the merits even though they exist, and (3) Japan wants to take advantage of the merits but it can NOT because of reasons on the Japanese side.

As long as this integration in essence cannot be stopped, this huge deficit of accounts will not be able to be eliminated unless greater efforts are made by Japan to grasp these merits. The following are three examples of such efforts.

The first is the absorption of foreign direct investment. After having seen the success of Nissan's reformation instituted by President Carlos Ghosn, I am convinced that more Japanese believe that "foreign investment is a good thing" but many still believe "foreign capital to be Western." However, a glance at Asia reveals that Taiwanese firms have either acquired or participated in the management of Japanese companies, as seen with the semiconductor business of Nippon Steel Corporation and the TFT LCD business of IBM Japan and Fujitsu. Another Taiwanese firm is even planning to invest capital in the Wakayama Steel Works of Sumitomo Metal Industries, Ltd.

The flow of investment into Japan via corporate acquisitions will now expand to include Chinese corporations. There has already been a case of a Tokyo-based medium-sized printing equipment manufacturer that was bought by a nationally-owned company headquartered in Shanghai and then forced into corporate restructuring.

To an Asian company, a business division slated for termination or other Japanese companies in financial and other trouble are also often entities with valuable technologies, sales channels and the like. We are now in an era where we should borrow on the business resources and vitality of Asia to renew our companies.

Japanese suddenly working under a Chinese president dispatched through the firm's acquisition may find it hard to quickly rectify their feelings with the situation. However, when Toyota and Honda began building plants in America around 20 years ago, the individuals involved most likely had the same feelings. However, they rectified their feelings and decided that "employment is important." Is this not an era where the Japanese people again need to rectify their feelings?

The second example is foreign tourists. The Japanese government has set up a roundtable group to discuss establishing Japan as a tourist destination. A proposal was made to increase the present 5 million foreign tourists to 10 million, but the "foreign tourists" they have in mind are not Westerners.

There is a term called "Ego Investment." This refers to an investment that satisfies the investor's "ego" (including its promotional effects and such) though it makes no sense with regard to profitability. An example of this would be the acquisition of a famous French winery. In this vein, when a wealthy Taiwanese likes to stay at high-class Japanese inns for 50,000 yen a night, it is "consumption that satisfies the ego." These wealthy say that it feels great to squander money in Japan. China is also home to many wealthy, but the key to attracting them depends on whether or not the immigration policies of Japan can be revised.

The third example is the utilization of human resources. The vitality and capabilities of the youth in China shine brightly in the eyes of Japan today. If that is the case these human resources should be "imported."

One often hears about "research and development being conducted for the survival of the manufacturing industry." However, not only America but also Europe are using visa arrangements and the awarding of scholarships to recruit student talent from India and China before they graduate. There is no way that the strength of Japan alone can victoriously battle this confederation of people and maintain its advantage in research and development.

All of these three points represent blind spots for Japan, which has stubbornly looked down on Asia. When it is spelled out in this manner, it is vividly apparent that we need to swallow the bitter pill of coming down from our roost. If the Japanese economy is to be rehabilitated, thought must be given to that which has not been done and what has been overlooked to this point. If time is needed before an FTA can be concluded between Japan and China, Japan needs to first start by revising its perception of China (Asia), as this is essential for absorbing the merits that China (Asia) possess.

Reprinted from SENTAKU (June, 2003)

June 30, 2003
Discussion Table

June 30, 2003