Japan’s Pursuit of FTAs in the Region

by Jacques deLisle

November 10, 2006

Edward J. Lincoln is director of the Japan-U.S. Business Center and professor of economics at the Stern School of Business, New York University. He is the author of The World Transformed (forthcoming, 2007) on the underappreciated importance of economic issues in international relations and American foreign policy, and, most recently, East Asian Economic Regionalism (CFR and Brookings Institution, 2004). This essay is based on his presentation at the Roundtable Discussion on Free Trade and East Asia held in Philadelphia on October 4, sponsored by FPRI and co-sponsored by the World Trade Center of Greater Philadelphia.

In the past six years the Japanese government has undertaken a dramatic shift in trade policy, embracing the global trend toward bilateral and regional free-trade negotiations. This sharp shift in policy came after a decade of eschewing free trade agreements (FTAs) in favor of reliance on the World Trade Organization. While the change is hardly remarkable given the behavior of other governments in this area, the new Japanese policy raises a number of important issues.

Causes

Until 2000, the Japanese government had publicly declared that its interests were best served by the global framework of the WTO, and it was aggressive in its use of the WTO to settle disputes.[1] After all, Japanese firms had global business interests best served by opening markets broadly around the world. Suddenly, however, the government became a whole-hearted supporter of bilateral and regional FTAs, while expressing disappointment with the WTO. To date, this new policy has yielded only a modest number of agreements, mainly with other Asian nations, but it is clearly set to continue. What caused the shift?

First, one should not discount the bandwagon effect. FTAs proliferated beginning in the 1990s, from fewer than 90 in 1990 to over 250 today.[2] By the end of the 1990s, Tokyo noted that Japan was one of the few countries in the world that was not a member of any preferential agreements. Aside from the economic disadvantage this might cause for Japanese firms (considered below), the rapid global growth in FTAs, and particularly the American embrace of this format, led Tokyo to view such agreements as the new global mainstream approach. Analysts of Japan have long argued that its foreign policy tends to be reactive, and the shift to embrace FTAs appears to be a classic reactive policy shift.

Second, not being a part of FTAs was beginning to create problems for Japanese firms, at least in the case of one specific agreement—NAFTA. Mexico had created a preferential tariff system in the 1960s that permitted foreign manufacturing firms to bring in parts duty-free so long as the output was exported. This preference led Japanese firms (along with many American and European firms) to invest in manufacturing assembly plants in Mexico (the maquilladora factories). When Mexico joined NAFTA, however, the agreement stipulated that this system was to be ended by 2002. The European Union responded quickly by negotiating an FTA with Mexico (as have some 32 other countries; Mexico has been very active in reaching agreements with other governments), so that their exports of parts to Mexico would continue to enter duty-free. Japanese firms felt disadvantaged by this outcome, and began to lobby their government to negotiate its own FTA with Mexico (which it has now done). The Mexico story, however, should not be over-generalized. Tokyo is fond of using it as part of its own explanation for why a new policy of FTAs is necessary, but it is unclear how many other examples of such specific disadvantage exist.

Third, the government became worried that China would dominate the region economically, including through preferential trade deals. This explanation is as much about politics and image as it is about economic consequences. The Chinese government announced its intention to negotiate a regional FTA with the members of ASEAN in 2000, before the Japanese government had begun negotiating any FTAs. This policy activism put Tokyo in a defensive position, but despite the angst among government officials, it took almost three years (until late 2003) to make a similar offer to the ASEAN governments. Nevertheless, the sense of competition with China for regional leadership appears to provide a strong rationale for the Japanese government to negotiate with others in the region.

Fourth, like many governments, the Japanese government argues that the lack of investment rules in the WTO has made negotiation of FTAs increasingly important as Japanese firms have become substantial investors around the world. Prior to the mid-1980s, Japanese firms (and especially manufacturing firms) remained at home and dealt with the world through exports. That situation has changed dramatically in the past two decades, and in some industries such as automobiles, over half of production is now overseas. As investment expanded, Japanese firms became concerned about the local rules governing investment. Although the WTO has begun to address these issues through the Trade Related Investment Measures (TRIMS) agreement, the government felt that it could negotiate more robust rules that would favor the interests of Japanese firms through FTAs.

Fifth, the government realized that FTAs provide an opportunity to engage in asymmetrical power relationships with trading partners. As has been the case for the United States, most of the countries with which Tokyo has negotiated have been small. While the ideal for bilateral FTAs is total removal of trade and investment barriers on both sides, few agreements adhere to this ideal. Therefore, bilateral deals enabled Tokyo to protect its favorite domestic interests, especially agriculture, more successfully than in the context of broad global negotiations. Japan’s FTAs have so far virtually excluded concessions on agriculture. This is important, because the rhetoric has been exactly the opposite in elements of the Japanese government. For example, officials at the Ministry for Economy, Trade and Industry (METI) claimed that they wanted to use FTAs as a tool to force concessions from the Ministry of Agriculture, concessions that would then provide a wedge leading to broader agricultural concessions in the context of the Doha Round of the WTO. If that was their intention, it has failed.

The distinction between rhetoric and reality is important, because there are two other common explanations by the government that are unconvincing.[3] One is that the government was frustrated with the slowness of progress in both the WTO and the broad regional Asia-Pacific Economic Cooperation forum (APEC). The Uruguay Round Agreement was signed in 1994, and the Doha Round is currently at a stalemate. This argument is unconvincing because Tokyo has generally been an obstructionist force in global trade negotiations. For powerful domestic political reasons, the government waited until the last possible moment in both the Tokyo Round Agreement (1979) and the Uruguay Round Agreement to make its concessions on difficult issues such as agriculture or government procurement, much to the frustration of American trade negotiators. The same has been true in the Doha Round, although the Europeans have reaped more of the public blame. At APEC, Tokyo was largely responsible for the failure of the Early Voluntary Sectoral Liberalization initiative in 1997, a failure that effectively ended the effort by Washington and some other participating governments to use APEC as a mechanism for achieving regional progress on trade liberalization.

The second false issue is the 1997 Asian financial crisis, which many in Asia raise as an explanation for regional actions excluding the United States. While some Japanese government actions (such as pushing the Chiang Mai Initiative, which enabled enlarged foreign exchange swaps among central banks in the region) were likely motivated by a desire for regional initiatives without U.S. participation, the 1997 crisis is not a convincing argument for Japan’s embrace of FTAs. Indeed, Japan and other Asian nations recognized the need for U.S. engagement when rapid growth of exports to the U.S. market played a key role in pulling the region out of the 1997 crisis. Furthermore, the new Japanese trade strategy did not emerge until 2000, several years after the 1997 crisis, and the chosen partners are not entirely in Asia.

Issues

Since it began negotiations with Singapore in 2001, Japan has completed four agreements and is in the process of negotiating seven others. Table 1 provides a summary of the current status of agreements and negotiations. In comparison to some other countries (Mexico or Singapore, for example) the number of agreements is small, although it is certainly growing. The agreements concluded or under negotiation raise two important issues:

1. Diminished WTO Commitment. The flurry of FTA negotiations has clearly sapped strength from the government’s commitment to WTO negotiations. Officials have been reassigned from global to bilateral negotiations, and even those within the office of WTO negotiations have frequently had their work diverted to ongoing bilateral talks. This problem is not confined to Japan; Washington has also diverted human resources from global to bilateral trade negotiations. Nevertheless, it is distressing that the Japanese government has redirected its resources away from the Doha Round of WTO negotiations. Since Japanese firms have truly global interests, they and the nation stand to benefit far more from a successful WTO round than from a series of FTAs with small trading partners.

2. Low quality. The quality of Japan’s bilateral FTAs has been particularly low. The rules of the WTO permit these agreements so long as they remove substantially all barriers. All bilateral and regional agreements fall short of this ideal, but those negotiated by the Japanese government have been particularly egregious. Although many tariff lines are reduced to zero, this has not been true in agriculture, where concessions have been minimal. Mexico got very little on chickens, and Thailand got nothing on rice--products that had been important to them when they entered the negotiations. In the end, these nations were willing to go forward with agreements mainly because the industrial product tariff elimination increased the probability that Japanese manufacturing firms might increase direct investments in their countries. On trade in services, the quality of these bilateral agreements has also been low. Tokyo’s tendency has been to write into the agreements establishment of bilateral committees for specific service-sector industries or service-related issues (such as credentialing or licensing of service providers) with little mandate to pursue specific outcomes. Whether these committees will produce follow-on agreements that really reduce barriers for each others firms and individuals in the service sector, therefore, remains largely unknown.

East Asian Regionalism?

The big question is whether Japan’s FTA activity leads in the direction of a unified East Asian regional agreement. The agreements negotiated to date have all been bilateral, although the Japanese government is negotiating an agreement with ASEAN as a whole, which is expected to reach completion in 2007. But there are at least three reasons to suspect that movement in this direction will be slow or not materialize in the near future.

First, not all of Japan’s FTA activity is within East Asia. Mexico and the proposed negotiations with the Gulf Cooperation Council (GCC), for example, are outside the region, and Japanese interest in an FTA with the United States has been rising recently (see below). This tendency to include negotiations with partners outside of East Asia is also characteristic of other governments in the region, including South Korea (U.S., Chile), Singapore (U.S., Australia, Canada, Mexico, New Zealand), and Thailand (U.S., Australia), and Malaysia (U.S., Australia, and India).

Second, as is true with FTAs negotiated by any country, Japan’s all have slightly different rules. Therefore, the totality of a set of individual agreements with separate countries does not add up to a regional structure. The content of an eventual Japan-ASEAN agreement remains unknown, but would certainly be less complete than any of the individual agreements Japan has negotiated with individual ASEAN members. Moreover, the rules of any Japan-ASEAN agreement will certainly be quite different from the emerging China-ASEAN agreement.

Third, there is no consensus in the region on the question of which countries should participate. Indeed, the past several years has seen a proliferation of regional dialogues that involve separate but overlapping sets of participants. Should the region be ASEAN+3 (ASEAN plus Japan, China, and South Korea)? What about Taiwan, or Papua New Guinea, both of which are in this geographical region but not part of this grouping? Or should the boundaries of East Asia be expanded to include India, Bangladesh, Central Asia, South Pacific nations, or Australia and New Zealand? The breadth of new government-level dialogues is interesting, but the widely varying pattern of participants indicates a lack of clarity in what constitutes the region.

Fourth, no set of individual or even sub-regional agreements will lead toward a broad East-Asian bloc until or unless Japan and China are willing to deal with each other. Since the late 1990s, Japan-China relations have deteriorated. The causes of that deterioration are complex, but revolve mainly around growing anxieties of the Japanese about the rise of China (both economically and politically) and the aggressiveness of the Chinese in pushing their newfound clout in the region. Over the past five years, the Japanese have been more provocative toward China, and the Chinese have responded in kind. With Shinzo Abe having taken office as Japan’s prime minister in September 2006, there is an opportunity to repair some of the damage, even though he is known as a nationalist. Any short-term improvement, however, does not negate the broader and longer-term problem of rivalry between Japan (the de facto “leader” of East Asia due to its tremendous economic size and success over the past sixty years) and China (the current high-growth star, with a role buttressed by both a huge population and possession of nuclear weapons). The most likely scenario is one of continued uneasiness between these two major powers. While they are likely to paper over their immediate problems sufficiently to keep their bilateral economic relationship stable, the possibility of a broad East Asian FTA remains problematic. This is an important conclusion, given the tendency for optimistic talk in Japan about gradually creating the equivalent of the EU in East Asia. One cannot rule out the possibility that within the near future the Japanese concede de facto leadership in the region to China, but a prolonged struggle over self-image and regional political role is equally likely. In this latter case, no substantial regional trade bloc will emerge.

Implications for the United States

The central issue for the United States is whether Japan’s move toward FTAs will disadvantage American economic or security interests in the region. Some fifteen years ago, there was concern among some Japan specialists in the United States that East Asia would coalesce as a trade and investment bloc under Japanese leadership.[4] Given the mercantilist nature of Japan’s own trade policies, this prospect was widely regarded as a problem for the United States, with American firms likely to be disadvantaged with respect to their Japanese competitors in doing business in the region. Today however, this possibility is much weaker. With the Japan-China rivalry, a true regional bloc is unlikely. Furthermore, Japan itself has become somewhat more open, and China itself has pursued policies that are not as protectionist as Japan in the past.[5]

Nevertheless, Washington has responded to the possibility of an East Asian economic bloc with a strategy of negotiating its own FTAs with individual Asian countries. An agreement with Singapore has been completed, negotiations with South Korea are underway, and Washington has announced its intent to negotiate with others, including Malaysia. Negotiations with some other ASEAN members are likely in the next several years.

On the security front, the question is whether efforts by Japan to expand its network of FTAs with other countries in the region would diminish the “glue” in the U.S.-Japan security relationship. One can imagine pressures from either side. The Japanese might question the value of the treaty if they were creating a more cohesive economic region, which would reduce perceptions of regional threat from the Japanese standpoint). Or, Washington might balk at maintaining a commitment to protect a nation that was turning away from the United States economically. Given the conclusion above that an East Asian economic bloc under Japanese leadership is not emerging, these security concerns are largely moot.

The remaining question for the United States is whether the strategy of countering any Asian regionalism by negotiating its own agreements with individual participants should extend to Japan itself. When the idea of a U.S.-Japan FTA was first broached in the late 1980s (principally by U.S. Ambassador to Japan Mike Mansfield), the concept received a chilly response from both Washington and American businesses. At the root of this opposition was a conviction that Japan would be unable to make meaningful concessions on agriculture and that most disputes on industrial goods or services involved either regulations or collusive behavior (tacitly condoned by the Japanese government) that would be impossible to address in a formal agreement.

Today, however, the situation has changed in two important ways. First, Japan has changed to some extent. Problems of market access that were very important a decade ago have diminished. While trade problems remain, including on agriculture, the overall prospects for a bilateral FTA do not appear to be as bleak as they were previously. For example, the American Chamber of Commerce in Japan has recently been advocating such an agreement--a major contrast to its position in the past.

Second, Japanese attitudes may have changed as well. In the wake of the 1997 financial crisis, it was popular in Japan to denigrate the United States for initially ignoring the crisis and then insisting on the wrong policies to resolve it. Simultaneously, Japanese officials and pundits advocated strengthening regional ties through ASEAN+3 as the opening step in constructing a new regionalism independent of the United States. However, since about 2003, the Japanese--government, business, and academe--have become somewhat disenchanted with the regional approach. When they deal on their own with East Asia, they must confront a resurgent China without U.S. backing. This has proven difficult, and often the Chinese have been more active in engaging the interests of developing countries in East Asia than has Japan, as noted earlier. This discouraging experience has led Japan back toward the United States, a shift that was encouraged by the Bush administration (though mostly on the strategic front). One element of this has been renewed Japanese interest in a bilateral agreement with the United States.

Where all these trends lead remains much in doubt. Whether the Bush administration will choose to initiate something as major as an FTA negotiation with Japan is doubtful. Unlike agreements with small countries, this one would be long and difficult. Whether Japan and China can find sufficient common ground to build an East Asian economic bloc without the United States is also quite doubtful. The ideal outcome is that all parties realize that their common interests lie in a successful conclusion to the Doha Round of WTO negotiations rather than various bilateral or regional possibilities, but even that outcome remains in considerable doubt.

Conclusion

The change in Japan’s trade policy in favor of FTAs is substantial, even though the number of agreements concluded to date has been modest. Although it is not entirely Asia focused, the policy does lean in that direction, raising the question of whether the United States will face an East Asian trade bloc as Japan and others in the region continue to build a network of agreements across the region. This outcome does not appear likely at the present time. Japanese anxiety about China, problems in its relationship with South Korea, broader difficulty in defining which nations should belong to an East Asian grouping, and other issues currently militate against rapid movement toward a more cohesive economic bloc.

Table 1. Japan’s FTAs or Economic Partnership Agreements
Source: Ministry of Foreign Affairs, "Japan’s Efforts on Economic Partnership Agreement (EPA)," July 2006, at www.mofa.go.jp
Completed Singapore January 2002
Mexico April 2005
Malaysia July 2006
Philippines September 2006
Under Negotiation Thailand Agreement "in principle" September 2006
Indonesia Negotiations begun June 2005
Brunei Negotiations begun June 2006
ASEAN Negotiations begun April 2005
South Korea Negotiations begun December 2003 but currently stalled
Chile Negotiations begun November 2005
GCC Preliminary meeting May 2006
Official Study Vietnam Negotiations expected soon
India Study launched July 2005
Switzerland Study launched October 2005
Australia Study launched November 2005

Notes

  1. See Saadia Pekkanen, “The Politics of Japan’s WTO Strategies,” Orbis, Winter 2004. [back]
  2. WTO, “Regional Trade Agreements: Facts and Figures,” at www.wto.org. [back]
  3. The principal intellectual voice within the Ministry of Economy, Trade and Industry who has written publicly about the causes for Japan’s shift in trade policy is Naoko Munakata. See, e.g., “Evolution of Japan’s Policy toward Economic Integration,” Brookings Working Paper, June 2002. [back]
  4. Typical of this genre, see Walter Hatch and Kozo Yamamura, Asia in Japan’s Embrace: Building a Regional Production Alliance (Cambridge University Press, 1996). [back]
  5. See American Chamber of Commerce in Japan, “ACCJ Urges the US and Japanese Governments to Commit to an Economic Integration Agreement,” press release June 22, 2006, at www.accj.or.jp. [back]

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