As a piece of geopolitical theater, the announcement of the EU-Japan trade agreement on July 6 could not be beat. On his way to the G20 Summit in Hamburg, Germany, Japanese Prime Minister Shinzo Abe made a detour to Brussels where he and European Council President Donald Tusk announced the conclusion of an EU-Japan trade agreement that has been four years in the making.
The agreement, which will eventually lower barriers on almost all goods traded between the two, has certainly generated a lot of headlines. Publicity touting the European Union’s largest ever bilateral trade deal has fed nicely into the narrative of the EU as a unified bloc, moving forward on free trade and progressive globalization. PM Abe has benefited too, being able to showcase Japan as an increasingly important player in global trade.
The deal is certainly impressive in its scope. A few months ago the European Commission published its EU-Japan Trade Sustainability Impact Assessment, which concludes that: “The economic gains from this agreement are of the same magnitude as a free trade agreement with the United States, and could lead to major increases in exports (notably in the food and feed, processed food sectors). There are also considerable benefits for consumers, business and employment from an effective liberalisation of both markets that encompasses tariffs and regulatory issues. These gains are more symmetrically distributed than earlier FTAs, and benefit groups that do not always stand to gain from trade liberalisation.”
It also has significant longer-term implications, both for the signatories and for other countries. As ever when it comes to global trade developments, however, there is still a lot of ground to cover before those “considerable benefits” will be realized.
Outline of the Agreement
The agreement, set to come into effect in early 2019, encompasses over 600 million people living in two economic areas that together account for over 30% of the global economy and 40% of world trade. Customs duties between the two, which currently total some €1 billion annually, would be almost entirely eliminated. According to data from the European Commission, Japan is currently the EU’s sixth largest trading partner worldwide and its seventh largest export market. EU firms already export over €58 billion in goods and €28 billion in services to Japan every year. All told, the Sustainability Impact Assessment concluded that the deal could raise the EU’s exports to Japan by 34% and Japan’s to the EU by 29%.
The two sectors that may see the greatest impact are exports of EU food to Japan and exports of cars and car components from Japan to the countries of the EU. Around 85% of the tariffs on agricultural exports from the EU to Japan (tariffs that average 21%), will be eliminated. With the tariffs on certain cheeses currently as high as 40% and on chocolate 30%, the agreement will make some European food exports to Japan significantly more competitive. Japan will also recognize over 200 certified European food delicacies, shortening the long and costly approval procedures for products like Dutch Gouda cheese and Irish whiskey. The Commission estimates that EU exports to Japan of processed food could rise by up to 180%. Reaching an agreement that overcomes Japan’s complex regulations around dairy foods is particularly notable. To date, the Japanese have not been big dairy consumers; that may start to change.
In the other direction, Japanese cars and components entering the EU currently face 10% tariffs, but under the deal these will be lowered over a seven-year period. This is potentially a very large market for the Japanese automotive firms such as Toyota and Honda, whose market share in Europe is smaller than in, for example, the United States. Other aspects of the agreement allow EU companies more leeway to bid on Japanese government contracts. This could benefit manufacturers such as Siemens (Germany) and Alstom (France). Whaling and logging are both exclude from the agreement, and will be continue to be handled under separate agreements (to the irritation of environmental groups such as Greenpeace). However, the deal does include deeper regulatory agreements covering trade in pharmaceuticals; the Commission estimates that EU chemicals exports to Japan could rise by over 20%.
One of the more interesting and potentially far-reaching aspects of the agreement is its emphasis on the investment court system, although this has yet to be fully fleshed out. The EU is pushing the use of an investment court system in all of its trade agreements; it formed part of last year’s CETA, the EU-Canada Comprehensive Economic and Trade Agreement. The EU argues that a public, international court with an independent judiciary and transparent working methods would replace the thousands of private arbitration arrangements currently contained in the world’s bilateral trade deals. According to the EU, “this represents another important step in shaping globalisation and ensuring a fair, rules-based system founded on the highest standards.”
Potential Stumbling Blocks
So far, so impressive. There are, however, plenty of devils still buried in the details. For one thing, the agreement has yet to be fully drafted and signed. For all the hoopla, the July 6 announcement was just a statement that the two sides had reached an agreement in principle on the main elements.
There are also likely to be long transition periods of up to 15 years on some aspects of the agreement, to allow countries and sectors to adjust to the new competition. Cecilia Malmstrom, the European trade commissioner, told reporters on July 6 that Europe could still reimpose restrictions on automotive imports if there was a “very big increase as compared to normal” of imported Japanese cars (she did not specify what level would cause that kind of concern).
In addition to a number of smaller ‘details’ still to be decided, such as persuading the Japanese to accept guarantees on freer flows of data, the biggest outstanding issue is reaching an agreement on the aforementioned investment court system. Japan argues that existing institutions are robust enough to handle any complaints that may arise as a result of the treaty. The Europeans argue that the current system of ad hoc arbitration can be too soft on industry interests and gives too much power to multinationals. European parliaments nearly blocked last year’s CETA deal with Canada over just this issue.
Once it has been finalized, the full agreement then has to be approved by both the Lower and Upper Houses of the Japanese Diet (parliament) and by each of the (currently 28) national governments in the EU, as well as the European parliament. As part of this process, the European Commission will also have to decide whether the trade deal is a ‘mixed agreement,’ i.e., whether it covers areas that go beyond EU competence to involve member state competence too. Given the breadth of the deal, it may well be declared a mixed agreement, meaning it will also have to gain the approval of each of the Union’s national and regional parliaments. However, the Commission may try to avoid the designation after the flurry of last-minute panic around CETA, which was deemed a mixed agreement. The whole deal nearly came a cropper when the regional Belgian parliament in Wallonia baulked at signing, ostensibly on concerns over the workability of the investment court system, but likely on fears that cheaper farming and industrial imports could lead to job losses for local workers.
Not Just Widgets but Shared Values
Despite the pitfalls that could delay or even derail parts of the EU-Japan agreement the sheer size of the deal, the fact that it has made this much progress, and the way in which it was announced do have profound implications for global trade and geopolitics, and not least for the US.
For starters, both sides have embraced the notion of trade agreements as going beyond tariffs and quotas covering specific products to encompass broader standards and procedures. The EU-Japan agreement not only incorporates the labor and sustainable development protections included in CETA, it is also the first such trade agreement to include a specific commitment to implement the Paris climate accord.
The leaders who spoke at the July 6 announcement said a lot about shared values. Coming on the eve of the G20 meeting in Hamburg, where the US was expected to be isolated on a number of issues, the press conference was a primer in geopolitical positioning. President of the European Council Donald Tusk said that the agreement is not just about trade but about “the shared values that underpin our societies, by which I mean liberal democracy, human rights and the rule of law,” adding that “although some are saying that the time of isolationism and disintegration is coming again, we are demonstrating that this is not the case.” Japanese Prime Minister Shinzo Abe said, “Japan and the EU are demonstrating our strong political will to fly the flag for free trade against a shift toward protectionism,” and added that the deal signifies the creation of “the world’s largest free, advanced, industrialized economic zone.” Indeed, the announcement gave the embattled Abe a rare political victory, allowing him to portray Japan to the world as a leader on trade issues. European Commission President jean-Claude Juncker also weighed in saying, “There is no protection in protectionism.”
This “shared values” narrative also feeds into the ongoing negotiations over the UK’s Brexit from the European Union. The UK government is eager to sign bilateral trade deals with major partners, but the July 6 announcement allowed the EU to portray itself as a member of the outward-oriented, progressive trade camp and the first European port of call for partners looking to make a deal. A few days later, the pro-Brexit corners of the British media were eager to report that the Japanese ambassador to the UK had said that the country could sign a similar deal with Japan. That assertion is questionable, however. Japan made some pretty big concessions over issues such as imports of dairy products; would they be as willing to bend as far when the negotiator on other side of the table represents a much smaller economic market? More ominously for the UK, Japan’s big auto companies—Nissan, Toyota, and Honda—all have large manufacturing operations in the country, which they use to supply customers elsewhere in the EU. Once the tariffs for importing components to the EU drop and operations located there become more competitive, might these manufacturers be more inclined to invest within the Union rather than in Britain?
Theoretically, if the EU-Japan deal is ratified before the UK leaves the EU, Britain might be able to grandfather in the deal with some tweaks. Leaving aside the ambitious timeline that would need to be met for this to happen, however, British producers could struggle to claim the lower tariffs on their exports to Japan if they are no longer producing within the EU customs union. Part of the problem here lies with content rules—basically, to qualify for the lower tariff under any trade deal, it is likely that at least 50% of the product involved would have to originate in the relevant country. While Britain is inside the EU customs union, a manufacturer can pool EU and UK content toward that threshold. Outside the Union, meeting the requirement would be harder. This is particularly relevant for the auto industry, where manufactures are reliant on components produce elsewhere in the EU, making it much harder to meet the rules of origin.
A Challenge to the USA
Finally, this deal is a significant challenge to the United States. The EU-Japan agreement has been under negotiation for four years, but talks were speeded up after President Trump pulled the U.S. out of the TPP trade deal (the Trans-Pacific Partnership, which had included the U.S. and 11 other nations around the Pacific Rim). This new agreement will create a trading bloc that is a rival in size to NAFTA (the North-American Free Trade Agreement)—a fact not lost on the headline writers in Europe—and in many ways is tailor made to emphasize the increasing isolation of President Trump’s approach to global affairs. The inclusion of a commitment to implement the Paris climate accord stands in stark contrast to Trump’s vow to pull out (as evidenced in the subsequent 19-1 vote on the climate accord at the G20 meeting).
As EU-Japan tariffs fall, so U.S. products will become less competitive in both markets. The greatest challenges are likely to be in the food production and auto manufacturing sectors. Pork, beef, and dairy producers will struggle to export to Japan faced with lower prices from their EU counterparts, as will machinery manufacturers and chemicals companies. If Europe succeeds in imposing its geographic mandate on some food products (for example, stipulating that only cheese produced in a certain region can call itself parmesan), U.S. producers could find themselves locked out of the Japanese market altogether. American automakers, who currently face 10% tariffs on their exports to the EU, will become less competitive in the European market. If Japan agrees to meet the more stringent European auto safety standards, U.S. manufactures will be pressured to do the same, a potentially costly move. Conversely, a mutual standards agreement will make it easier for European automakers such as BMW and Audi to sell their vehicles in Japan, another competitive challenge for the U.S. manufacturers.
For all the political hype surrounding the announcement on July 6, the EU-Japan trade agreement is, indeed, a big deal. It cements the notion that trade agreements are no longer simple bilateral deals around a few specific products or tariffs. Not only do such agreements now include clauses about workers’ rights and environmental impacts, they also address broader geopolitical challenges by incorporating accords on investment courts and climate change. With the precedent set by this agreement, the EU and Japan may have made it harder for the current U.S. administration to reach its own bilateral trade deals going forward.