How Trade Agreements Can Reform Japan

When it comes to trade, Japan is mainly known for the prowess of its export industries. But the country has begun to join the worldwide movement. That is the move toward free trade agreements (FTAs) Under these arrangements, individual countries agree to eliminate all barriers to their bilateral trade. What is special about the case of Japan is that those free trade agreements may well be the way to reforming Japan itself.

Key Findings

1. Japan has been a latecomer to the process of signing Free Trade Agreements (FTA’s) with other countries. But it recently completed negotiations on an FTA with Singapore.

2. Japan’s next FTAs will be negotiated with Mexico and South Korea. This reflects a firm strategy by Japan’s policymakers to introduce, gradually, the discipline of free trade—especially in the agricultural sector.

3. By gradually adopting FTAs, Japanese leaders hope to break the policy deadlock inside the country—by demonstrating that special interests (such as the agricultural sector) can face competition and reform.

Unblocking the road to reform

Japan is the world’s second-largest economy and aspires to be Asia’s leader in economic and political affairs. But the country faces significant roadblocks—economic, political and historical—on its way to that goal.

The historical roadblocks, of course, are rooted in Japan’s relationship with the countries of Asia before and during the Second World War. As the primary regional power, Japan did not always treat its neighbors gently. The resentments linger on today.

The economic and political roadblocks are intertwined. They arise from Japan’s political system and the power it grants to certain interests—such as farmers.

Creating traction for reforms

Those interests have long been able to block needed economic reforms. Attempts at frontal assault, flanking maneuvers and even cooption from abroad have not succeeded in making the Japanese agricultural sector—or retailing, or other services—more rational.

Given all that, it is hard to imagine how to make reform gain traction in Japan. But Japan’s leaders seem to have come up with a new method: trade policy.

By carefully crafting a set of free trade agreements, Japan’s policymakers are slowly forcing the economic powers-that-be at home to face reality—and loosen their stranglehold on economic policymaking.

The tool of choice

The tool of choice is the Free Trade Agreement (FTA). Under these arrangements, individual countries agree to eliminate all barriers to their bilateral trade.

FTA’s have become quite popular in Europe and in the Americas. The essential idea guiding these arrangements is for two countries that have already built up political trust to simply lower all trade barriers to each other.

Japan’s rivals forge ahead

The United States, for example, started with Canada—and then the two countries brought in Mexico to create NAFTA. And the United States went further down this road, signing an agreement with Jordan and negotiating FTAs seriously with Chile and other Latin American countries.

Meanwhile, the EU—which is already a huge free-trade zone—has been expanding such agreements with a variety of countries in North Africa, Eastern Europe and even Latin America.

While all that happened, Japan basically sat on the sidelines. But recently there are now signs of movement. And those signs are most interesting.

The first FTA

In January 2002, Japan signed its first FTA with another nation. That nation was Singapore. Beside Singapore, Japan’s other candidates for similar agreements are Mexico and Korea. The choice, it turns out, is quite shrewd. Each country’s agreement can contribute to helping Japan to overcome its institutional roadblocks.

The FTA with Singapore—the “Japan-Singapore Economic Partnership Agreement”—represents Phase One. What’s important about Singapore? First, it has a policy of maintaining an internationally competitive business environment. Second, its exports do not include many items that are sensitive to Japanese domestic interests. No surprises so far.

Opening pinholes

What’s surprising about this agreement is that it includes some agricultural items. Believe it or not, although Singapore admittedly is not known for its agricultural prowess, this still required some difficult negotiations back home in Japan.

Why? In essence, the Singapore deal created a “pinhole” for Japan’s policymakers in the barriers surrounding Japan’s agricultural “sanctuary.” Traditionally, the Japanese farm lobby would never have allowed any concessions on agriculture, no matter how small.

The goal was clear: The Japanese negotiators wanted to establish a principle that entire sectors of the economy can no longer be placed off limits by domestic interests fundamentally opposed to free trade agreements.

Common exclusion

The net effect resulting from including the agricultural sector is that from now on, rice farmers and cattle ranchers will have to fight their battles based on the particular issues of their industries—rather than appealing to a common exclusion for all farm products.

Another feature of the Singapore agreement is that it is very broad in scope. It does not just cut tariffs on agricultural and manufactured goods, as a narrowly constructed FTA might do. Instead, it also covers such important areas as liberalization of services, investment, the movement of people, e-commerce and other issues.

Heading for solutions—not a law code

Just as important, the Japanese negotiators working on the agreement with Singapore took an unusual tack. They viewed the entire agreement as a set of hands-on solutions for real problems—rather than simply as a legal template. To achieve that goal, they actively sought business inputs in the process.

All of this is very different from the traditional Japanese thinking about trade. This creative experience opened up new ways of thinking about trade and economic policy in Japan.

True, many critics around the world believe that the Japan-Singapore Free Trade Agreement was a special case. These critics assume that Japan cannot go beyond the minor provisions in the agreement with Singapore because of the agricultural sector’s political power.

After Singapore, cross the Pacific

If that were true, however, one has to wonder why Tokyo’s next negotiating step nevertheless turns out to be attempting to obtain a trade agreement with Mexico. In essence, this turns out to be Phase Two—widening the “pinhole” in the face of real political resistance.

Why is Mexico so important? For starters, it is one of the most active promoters of free trade agreements in the world. It is a member of the North American Free Trade Association (NAFTA) and has an FTA with the European Union—as well as with a number of other countries. As a result, the lion’s share of Mexico’s trade is now governed by the preferential rules of FTAs.

Incentives to support the FTA

Countries that do not have an FTA with Mexico, however, face a stiff 16.5% average tariff on imports to that country. In other words, if you don’t have an FTA with Mexico, you are at a severe disadvantage. That is a real problem for Japan?s exporters—and creates significant momentum in Japan for achieving an FTA with Mexico.

The real importance of choosing Mexico, however, lies elsewhere: About 20% of Japan’s imports from Mexico are agricultural. The World Trade Organization stipulates that FTAs have to cover “substantially all the trade”—which is widely interpreted as more than 90% of trade volume.

Therefore, in reaching a free trade agreement with Mexico, Japan cannot exclude agriculture. It has to face the very real challenge of eliminating tariffs on some agricultural items—which, in turn, could have a significant effect on market share in Japan.

Incentives for an agreement

Can the Japanese government succeed in negotiating such an agreement? The steep tariff imposed by Mexico in the absence of a free trade agreement makes it possible to explain to the Japanese public the benefits of the FTA.

Even on the agricultural side, things are a bit easier than might be expected. Mexican produce—because of geography—tends to be complementary to—rather than competitive with—Japanese produce. Some of Japan’s tariffs on Mexican goods are less than 5%—and so would be easy to eliminate.

Putting Japan’s political process on the line

There seems, therefore, to be a substantial chance that Japan’s government can negotiate a politically acceptable FTA with Mexico.

Ultimately, of course, success depends on whether the Japanese political process can overcome resistance in the agricultural sector in order to advance broader public interests.

Thus, Mexico’s unique trade position gives Japan a potential test of its political capacity for structural reform.

Third in line—but the ulimate priority

Intriguingly, the third country Tokyo chose for an FTA partner is South Korea. Actually, that country has always been the first priority. It is the most natural choice given that it is located so close to Japan—and that both countries are U.S. allies and OECD members. Korea’s experience with deep economic reforms after the 1997 financial crisis also offers Japan a lot to learn from.

Set against these compelling reasons for agreement, there is one major roadblock—as in dealing with many other Asian countries—a deeply-rooted historical antagonism. This is particularly the case with Korea, because that country was a Japanese colony in the first part of the 20th century.

Heading for solutions—not a law code

Now, it appears as if some of that historical baggage is finally going away. South Korea has become a democratic society—and its government does not need to base its legitimacy on an anti-Japanese policy stance any more.

Particularly among the younger people in both countries, sentiments are much more favorable than previously. Thus, Korea is well positioned to urge Japan to face the problems of its past—and, in the process, to become more trusted and accepted in the region.

Thus, the significance of forging a trade agreement with Korea is not limited to economic benefits. It has broader social, political—and especially historical—implications.

A process for reform

At the present time, it is certainly far from certain that Japan will succeed in signing FTAs with Mexico and South Korea.

But it is fair to say that Japanese officials have designed the process carefully in a step-by-step fashion.

Political momentum

No particular challenge is too overwhelming—or politically sensitive. Instead, each potential agreement, if concluded, presents Japan with major rewards that can help overcome the inevitable domestic resistance.

In conclusion, while FTAs are not a comprehensive solution to all of Japan’s economic problems, one can hope that the successful experience with these agreements would change the expectations of the Japanese.

That would create political momentum—opening up opportunities for the more difficult reforms down the road and an ever-higher degree of openness.