Faculty Fellow, Research Institute of Economy, Trade, and Industry (RIETI), Japan
After five and a half years of negotiations, the Trans-Pacific Partnership (TPP) agreement was reached on October 5, 2015. Yet it is too early to celebrate as the agreement must be ratified by the participating countries including those where anti-TPP protestors have significant political influence. The TPP is a free trade agreement (FTA) among 12 Asia-Pacific countries, which together account for approximately 40% of the world's gross domestic product (GDP). Not only is it extremely ambitious in the level of liberalization in trade in goods, investment, and services, but also comprehensive in its coverage, setting rules for such areas as electronic commerce, government procurement, intellectual property, labor, and the environment. The TPP has high potential to promote economic growth and improve people's living standards by facilitating the free cross-border movement of key factors of economic activity, such as goods, people, money, and information. Failure to bring the TPP into force would be a great loss to not only the TPP countries such as Japan and the United States but also the global economy.
TPP and the revitalization of the Japanese economy
Following the collapse of its economic bubble, Japan plunged into a prolonged period of stagnation which now has come to be referred to as the "lost two decades." Thanks to the expansionary monetary and fiscal policies under the leadership of Prime Minister Shinzo Abe and his second Cabinet formed in December 2012, the Japanese economy was boosted in 2013. But the effect was short-lived and the economy has been sluggish since 2014. The stagnation of the Japanese economy can be partly attributable to external factors such as a slowdown in the global economy. However, internal factors—i.e., a shrinking and aging population, massive government debts, and slow responses to structural problems such as the closed nature of the market—are more serious. In revitalizing the Japanese economy, which is currently in such a dire predicament, the TPP will be playing an important role.
Economic growth is a product of interactions between supply side factors such as an increase in labor and capital inputs and an improvement in productivity, and demand side factors such as an increase in consumption, investment, and exports. Under the current and future state of the Japanese economy, we cannot hope for an increase in labor and capital inputs or an expansion in domestic demand such as consumption and investment. This makes it crucially important to boost productivity and expand overseas business such as exports and foreign direct investments in revitalizing the economy. The TPP will pave the way for the revitalization of the Japanese economy by helping expand exports to and investments in Asia-Pacific countries with high growth potential.
As the TPP is to realize far-reaching trade and investment liberalization, Japanese companies will be able to expand exports and direct investments to and in other member countries. Most of Japanese exports are industrial products, and the TPP will likely boost Japan's exports in industrial products as its 11 trade partners, those that are parties to the TPP, will eliminate tariffs on 99.9% of industrial products. The TPP will also remove tariffs on 98.5% of agricultural products and thus result in increased exports in competitive agricultural products.
For Japanese companies, the greatest benefit of the TPP will probably come from the sweeping liberalization of foreign direct investments. The TPP members agreed on the fundamental principles of non-discrimination against foreign firms and a level playing field for both domestic and foreign firms. Specifically, the TPP members will be prohibited from imposing technology transfer and other performance requirements on foreign investors in their territories. Also, they will be required to open their government procurement market to foreign firms and abolish assistance to state-owned enterprises (SOEs) that causes adverse effects on foreign firms. Those rules will facilitate Japanese companies' entries into other TPP member countries and enable them to operate efficiently. Many Japanese companies are already generating significant revenues from their overseas operations, and a portion of the income earned overseas are being repatriated to Japan and invested in the development of new products and technologies to enhance their competitiveness. By creating a better cross-border business environment, the TPP will help Japanese companies to improve their competitiveness and achieve growth.
The TPP will also open some of the protected areas of the Japanese market, leading to an increase in imports and exposing domestic players to greater competitive pressure. This will help improve overall productivity through two channels. First, contractions in output in uncompetitive industries will unleash hoarded human and financial resources, prompting a shift of labor and capital to competitive industries and thereby lifting the productivity of the entire economy. Second, faced with greater competition, Japanese companies will be spurred to develop new technologies and products for the sheer purpose of survival, which in turn will also lead to a rise in productivity. While the Japanese industrial sector has long been open to international competition, the agricultural sector remains highly protected. Under the TPP, Japan will eliminate tariffs on approximately 400 of the 834 agricultural items that have been exempted from tariff elimination under its earlier FTAs. In those areas, including oranges and ham, an increase in productivity can be expected following the market opening. However, Japan will maintain tariffs on its five sacred product categories—i.e., rice, wheat, beef and pork, dairy products, and sugar—which constitute a significant portion of the agricultural sector. As such, we cannot hope for a significant productivity increase, one that is large enough to revitalize the Japanese economy.
TPP as a vehicle for rebuilding the world trade regime
Due to differences in opinions among member economies, the Doha Round of multilateral trade liberalization negotiations under the World Trade Organization (WTO) has been stagnant for years. Against this backdrop, countries wishing to expand exports as a means to achieve economic growth are tying up with likeminded countries to liberalize trade among them, resulting in a rapid increase in the number of FTAs. Another factor behind the proliferation of FTAs is their role as a mechanism complementary to the WTO, which basically concerns trade in goods. In the face of the growing cross-border mobility of people, money, and information, countries are increasingly turning to FTAs to make rules of those areas that are not covered by the WTO. Furthermore, a chain reaction or domino effect of FTAs is providing an additional spur. Since FTAs are discriminatory trade initiatives that favor member countries, non-member countries are forced to suffer a decrease in their exports to member countries. Some countries left outside one FTA would find themselves put at a disadvantage and feel compelled to form a separate FTA to change the situation, which in turn would prompt those excluded from that FTA to form another.
Most of the FTAs concluded to date are bilateral or involve only a few members, and each FTA has its own set of rules. Because of this, the presence of a growing number of FTAs has been causing the fragmentation and complication of the world trade environment, hampering the expansion of trade. A particularly serious problem is that crisscrossing FTAs are posing an obstacle to the creation and smooth operation of supply chains, which have been serving as an engine for economic growth. It is the very need to address these problems that has prompted countries around the world to pursue mega FTAs—those that would allow a large number of countries to trade with one another under a common set of rules. Apart from the TPP that has just reached a framework agreement, mega FTAs currently under negotiations include: the Regional Comprehensive Economic Partnership (RCEP), a 16-country FTA that would bring together the 10 member states of the Association of Southeast Asian Nations (ASEAN), Japan, China, South Korea, India, Australia, and New Zealand; an FTA between Japan and the European Union (EU) encompassing the 28 EU member states and Japan; and the Transatlantic Trade and Investment Partnership (TTIP) between the United States and the EU.
Creating a single, unified set of global rules would be an effective way to expand trade and investment and thereby promote world economic growth. However, rulemaking in the WTO has been a very difficult task. Given that reality, establishing mega FTAs that would achieve highly ambitious liberalization and provide a comprehensive set of fair and transparent rules, and then expanding and integrating those mega FTAs to eventually cover the entire world would be one of the very few effective ways to create a global set of rules. As the most ambitious mega FTA, the TPP is not only setting a model but also leading the way for other mega FTAs to follow. Negotiations for the TPP, which were launched in 2010 ahead of those for other mega FTAs, moved into full gear and got accelerated in 2013 with Japan's announcement of its participation. This development prompted the launch of negotiations for other mega FTAs as countries concerned were afraid to be left behind. If we understand this point, we can see the crucial importance of bringing the TPP into force to the promotion and successful conclusion of the negotiations for other mega FTAs.
Japan's FTA strategy beyond the TPP
The TPP will promote the revitalization of the Japanese economy by helping Japanese companies to expand exports and direct investments. The full liberalization of the agricultural sector—though not realized this time around—would pave the way for the full-fledged revitalization of the Japanese economy. In order to further open up the agricultural market and enhance the competitiveness of this segment of the economy, we must implement all necessary structural reforms in the sector properly and without fail.
Apart from the TPP, a series of mega FTAs including the RCEP, Japan-EU FTA, and the TTIP are being negotiated at the moment. We should seek to bring those negotiations to a successful end as quickly as possible. And then, by expanding and integrating those agreements, we should rebuild the world trade regime so as to pave the way for achieving economic growth for the entire world. Being a party to the TPP, the RCEP, and the Japan-EU FTA, Japan is in a unique position to be able to negotiate with due regard for consistency among those mega FTAs. The Japanese government contributed to bringing the TPP negotiations to a successful conclusion by devoting a great deal of manpower and acting energetically and effectively. It is hoped that the government will take the same rigorous approach and make active contribution toward the conclusion of other mega FTAs.
[Published with permission from RIETI; original posting dated October 27th 2015 is found here]