Land of the rising FTA

Since the end of the Second World War, the General Agreement on Tariffs and Trade (GATT), and its post-1995 successor the World Trade Organization (WTO), has served as the preferred forum for liberalizing international trade. Multilateral agreements reduce trade distortions, maximize global efficiency and ensure non-discrimination with potential benefits for all parties. Eight rounds of multilateral negotiations have been successfully concluded since 1946, making major contributions to worldwide economic growth and living standards. The Uruguay Round, for example, adopted after 12 years of negotiations in 1994, led to the establishment of the WTO and inclusion of agriculture and services within the multilateral trade regime. It has also provided numerous other benefits that help to facilitate trade flows around the world.

Given the slow and laborious nature of multilateral trade negotiations, however, many nations, including Japan, are now moving to supplement these multilateral mechanisms with regional and bilateral agreements. Traditionally, these agreements have been seen as divisive, given the belief that they can cause trade diversion and distortions, undermining the multilateral system through the preferential treatment given to the parties incorporated within such agreements.

Nevertheless, since the passage of the North American Free Trade Agreement (NAFTA) in 1994, interest in regional trade agreements has accelerated. The GATT and WTO have been notified of over 160 of these arrangements so far, and over 100 new agreements are anticipated by the end of 2005. Regional or bilateral trade agreements are seen to allow faster results, enable trading partners to address specialized issues, and to achieve liberalization beyond what is possible through multilateral consensus alone. Properly drafted and implemented, they can provide building blocks that can be incorporated within the multilateral trade agenda.

Japan has traditionally emphasized multilateral mechanisms within its trade policies. In fact, the nation has been a leader in trying to break the deadlock in negotiations that has prevented the current Doha Round from moving forward. The Japanese Minister of Economy, Trade and Industry (METI), Shoichi Nakagawa, emphasized this commitment in a recent Financial Times interview following meetings with six Asian WTO members that sought to advance current multilateral trade talks. Nakagawa noted: "The benefits to be reaped from these negotiations could help contribute to global economic growth and alleviate poverty...we are taking an offensive stance that can bring benefits to member countries."

Combined with domestic pressure to protect its uncompetitive agricultural sector, Japan has traditionally been circumspect about FTAs as these arrangements generally require a comprehensive elimination of customs duties. The worldwide trend toward a greater reliance on bilateral and regional negotiations, however, as well as the need to navigate an increasingly complex multilateral trade agenda, has caused this attitude to change. Former METI Vice-Minister for International Affairs Tadakatsu Sano commented on this trend following the collapse of talks during the 2003 WTO ministerial-level meeting in Cancun, Mexico: "Japan will now shift a major portion of its focus to FTAs."

FTAs are valued in Japan, as in the United States, for their ability to expand market access. Indeed, many Japanese private companies are calling for FTAs as a vehicle that will facilitate their international activities and provide them with the same terms and access to third countries as those enjoyed by other trading partners who have established FTA/EPAs (Economic Partnership Agreements) in these markets. Equally important, however, is the ability of FTAs to serve as a liberalizing force. This is due to their ability to introduce market forces into sectors that have not been challenged sufficiently in the past through true and open international competition.

This sentiment is reflected in a 2002 article by Visiting Brookings Institution Fellow Naoko Munakata. She stated: "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." In addition, Munakata noted: "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."

Japan's major trading partners are East Asia, North America, and Europe. These three regions account for approximately 80% of Japan's trade. Since North America and Europe are industrialized countries, which possess generally low tariff rates, Japan initially emphasized the development of FTAs in East Asia, where the potential benefits are much greater. According to Japan's Ministry of Foreign Affairs, as of 2002, tariff rates in the US averaged 3.6% and in the European Union, 4.1%. In comparison China possessed an average 10% tariff; Malaysia, 14.5%; the Republic of Korea, 16.1%; the Philippines, 25.6%; and Indonesia, 37.5%.

Japan also moved expeditiously to negotiate an FTA with Mexico. This became a priority as Japanese businesses had to pay relatively high tariff rates, especially in comparison to those countries within the NAFTA and the European Union, which had already concluded FTAs with Mexico. As Munakata noted, "Countries that do not have an FTA with Mexico face a stiff 16.5% average tariff. In other words, if you don't have an FTA with Mexico, you are at a severe disadvantage. That was a real problem for Japan's exporters - and created significant momentum in Japan for achieving an FTA with Mexico."

Domestic inefficiencies as catalysts

The shift toward a greater reliance on FTA/EPAs has not been easy. Nor has it been without problems and pain. Many analysts cite the case of Japanese farmers and agricultural producers, who have traditionally been able to exert strong influence to protect their interests. These analysts note this resistance to change has impinged on the nation's ability to remove the inefficiencies that constrain growth and the overall competitiveness of Japan's domestic economy. Notwithstanding these, and other barriers within sectors that lack international competitiveness, Prime Minister Koizumi and his government understand that Japan's long-term competitiveness is at least partially predicated on the benefits that can be realized through free trade and economic partnership agreements.

On the other hand, Japan's accord with Mexico, which was signed last year following more than 24 months of particularly hard negotiations, became the first FTA to affect Japan's agriculture sector. Bridges, a news digest published by the UN-affiliated International Center for Trade and Sustainable Development reported that the agreement lowers tariffs on Mexican exports, including pork, chicken, and oranges. It notes that within the next 10 years, this agreement is scheduled to phase out tariffs on 90% of goods traded between the two nations, at which time 98% of Japanese exports and 87% of Mexican ones will receive duty-free market access. This includes immediate low tariffs on Mexican pork through the establishment of a low-tariff import quota. Japanese pig farmers have never faced competition before. Similar quotas have been established for chicken, beef, oranges and orange juice. Tariffs on Mexican mangoes and avocados have been eliminated. Bridges reports the quotas will be expanded in 2009. In addition, Mexico established a tariff-free import quota for Japanese automobiles. It is to eliminate these tariffs altogether in seven years.

Structural reforms

Despite continuing resistance from domestic special interests that would suffer from increased international competition, the general trend toward a greater reliance on FTAs is providing reformers with an opportunity to accelerate change in Japan's domestic economy.

Many analysts also point out the Koizumi administration's reform policies have the full support of urban voters, who must bear the higher prices that must be paid for protected Japanese agricultural products. This provides another important force for change. The prime minister's commitment to reform can be seen in his appointments of agricultural ministers - who have been entrusted with the mission of promoting FTAs and agricultural reform. Former Agriculture Minister Kamei and the current minister, Shimamura, are both from urban areas. So are their primary constituencies. Shimamura, in particular enjoys the support of Japan's restaurant industry, which has increased its revenues and profitability partially through the use of inexpensive imported products.

In another significant development, Japan's Ministry of Agriculture, Forestry and Fisheries is now developing a new agricultural policy, which will be announced in the near future. It will constitute a change from the maintenance of prices through high customs duties to one that implements a system for supporting the incomes of farming families. The origins of this policy change were described in a December 2003 Nihon Keizai Shimbun column by Kazuhita Yamashita, a ministry official serving as a senior fellow at Japan's Research Institute of Economy, Trade and Industry.

In this article, Yamashita said: "If agricultural land is concentrated in the hands of farmers through direct payments, the nation will foster farming households that can take responsibility for supplying food as well as cut expenses by increasing the size of farms. Such a move will reduce costs and transform the fiscal burden imposed by the current agricultural policy into benefits for consumers. This is an agricultural policy that puts consumers first. Isn't it time to return agricultural policy to the long-ignored reformist roots of the former Agricultural Basic Law?"

In addition, the Council on Economic and Fiscal Policy, which reports directly to the prime minister, has repeatedly said, through Toyota chairman Hiroshi Okuda, that serious attention should be given to domestic structural reform in areas such as agriculture, services, and labor force mobility. This sentiment is echoed in a January editorial in the Nihon Keizai Shimbun. It emphasized the relationships between FTAs and structural reform, concluding: "With more FTA negotiations ahead, Koizumi will have to make a major political push to achieve significant structural reform in agriculture."

Banking on Australia

Australian Prime Minister John Howard views an FTA with Japan as a priority. Two-way trade between Australia and Japan totaled approximately $44.3 billion last year; goods imported into Japan from Australia include steel, but just as importantly, wheat, sugar, beef, and dairy products. At the same time, Australian companies and consumers provide a ready market for Japanese firms.

An FTA with Australia could impact Japan more than any other agreement to date. That's because this would be its first agreement with an advanced economy, which possesses highly competitive agricultural and service industries. Progress in these areas will serve to introduce efficiencies and structural reform into sectors that have lacked free and open competition. Closer relations with Australia would also help to strengthen Japan's energy and food security and provide it closer relationship with a nation that shares its strong commitment to the modern values of democracy, constitutionalism and capitalism.

While the benefits of a Japan-Australia FTA are clear, Australia is also a major agricultural exporter. It is therefore not likely to be satisfied with Japan's practice - utilized in previous FTA negotiations - of freeing up small portions of its agricultural product market and leaving the rest of the transition to a gradual process. In fact, many Japanese special interests would move to block these negotiations. Howard, however, is said to have invested a lot of time and political capital in developing a close relationship with Japan. This is perhaps best exemplified in his move to break a two-year policy not to increase Australia's military in Iraq, following a request by Koizumi that Australia provide increased security in Samawah, Iraq, where Japanese Self-Defense forces are stationed.

Australia's commitment to place 450 troops in harm's way - doubling its military presence in Iraq to help protect Japanese forces - should not be seen as a factor in these trade talks. Australian Foreign Minister Alexander Downer emphasized this point in a recent comment: "We don't put people's lives on the line to get access to markets." Nevertheless, this gesture on Australia's part will make it very difficult for Japan to reject the prospect of an FTA with Australia without serious consideration.

Whether Japan will enter into these negotiations is still unclear. However, it is inevitable that should negotiations begin, the use of technical support mechanisms to avoid opening Japan's domestic market will not be acceptable to Australia. Japan's ability to implement domestic structural reforms through more comprehensive and rapid trade liberalization will then be put to test. Should high customs duties be removed on grain, meats, and other products in an FTA relationship with Australia, other nations will be interested in gaining the same benefits as well.

In addition, Australia is also known for its strong service sector. This includes businesses such as the media group managed by Rupert Murdoch, while Japan's services - including telecommunications, broadcasting, transportation, and construction - lack competitiveness as they have not been exposed to the same degree of international competition. A Japan-Australia FTA, therefore, may be expected to also impact Japan's service sector.

Additionally, there is growing sentiment in Japan for the need to further diversify its trade so as to end its reliance on Asian markets. An FTA with Australia would therefore constitute a major step toward a new stage in Japanese trade policy and a valuable opportunity to improve competitiveness and transparency within its economy.

A Japan-Australia FTA/EPA could also pave the way to a future Japan-US FTA/EPA. Thomas Schieffer, the new US ambassador to Japan, was incidentally the US ambassador to Australia. During his tenure there, the US-Australia FTA was negotiated. So he might be expected to push for a Japan-US FTA. In any case, with negotiations of an ASEAN-Australia-New Zealand FTA and a China-Australia FTA already under way, building an FTA relationship with Australia is essential if Japan is to maintain its role as a leader in developing an FTA structure in the Asia-Pacific region.

Compiled by the Japan External Trade Organization (JETRO) in New York in cooperation with KWR International, Inc.