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A nation must think before it acts.
Speculation about the outbreak of trade wars is high, as the Trump administration seemingly has no plans to deescalate threats of imposing tariffs to decrease the U.S. deficit. Never mind that none other than the Federal Reserve is cautioning that tensions over trade could hurt an otherwise fairly stable domestic economy, while the International Monetary Fund (IMF) has warned that current trade tensions pose the greatest threat to global growth. With no end in sight for U.S. unilateralism, the fact that the European Union (EU) and Japan have signed the world’s biggest free trade agreement (FTA) to date is significant not just economically, but politically as well. Without doubt, the bilateral deal has raised hopes for open markets and order to remain in the global trading system. For free trade supporters, this FTA will be one of the first litmus tests to see whether an economic zone without the United States or China can thrive.
The numbers behind the economic partnership agreement between the EU and Japan are certainly striking. Together, the 28-member nation union (currently including the UK) and the third-largest economy account for nearly 30 percent of global gross domestic product (GDP), and plans to effectively eliminate tariffs across the board within the next decade. That includes phasing out import duties on Japanese cars sold in Europe currently levied at 10 percent. Meanwhile, tariffs on European produce including cheese, which currently faces tariffs as high as 40 percent, 15 percent on wines, and 30 percent on chocolates, will be eliminated as soon as the agreement is in effect. The deal with the EU would also come into effect just as the UK is expected to pull out of the union. Since the late 1980s, Britain had been the gateway to the European continent for Japanese companies, and Japan has been the fourth-largest source of foreign direct investment in Britain. The EU deal would therefore make it easier for Japanese companies to transition their European operations from the UK to the continent.
Nevertheless, eliminating such tariff barriers have faced considerable political turmoil on both sides since negotiations first started in 2013, and as both the EU and Japan seek final ratification from their respective parliaments, there will be opposition to the deal. Like any trade agreement, there will be losers as well as winners as a result of open markets. The car sector is a good example of friction within Europe against the lofty trade agreement. After all, the EU itself is the second-largest producer of automobiles in the world, manufacturing nearly 18 million units per year. Granted, the FTA will push Japan to eliminate its non-tariff barriers against European cars. Nevertheless, according to management consultants Deloitte, about 7,780 additional European autos will be exported to Japan, while 443,000 more Japanese autos will be entering the EU, which would ultimately hurt European auto manufacturers.
For Japan, meanwhile, the influx of European agricultural products will threaten Japanese farmers, especially pork producers and the dairy industry. Japan is the 10th largest producer of pork in the world, but is actually the third-largest importer of pork as well. There are less than 5,000 farms left that produce pork, which supply about half of the nation’s pig meat. One of the major obstacles for the trade deal with the EU, and indeed in passing the Trans-Pacific Partnership agreement as well, was precisely because of concerns from Japanese pork farmers being crippled by imports. So while European and Japanese consumers will ultimately benefit from lower prices across the board, there will clearly be losers on both sides as a direct result of the bilateral agreement.
The deal, however, represents much more than a trade pact. Since June, both Japan and the EU have already been hit by the tariffs imposed by the Trump administration on steel imports to the tune of 25 percent and 10 percent on aluminum in the name of U.S. national security under Section 232 of the Trade Expansion Act of 1962. The EU, for its part, has retaliated by imposing duties on $3.3 billion worth of U.S. goods. At their July meeting in Washington, President of the European Commission Jean-Claude Juncker and U.S. President Donald Trump agreed in principle to resolve the steel tariff issue, even though details remain vague. More broadly, while both sides seemingly were able to reach a detente in trade tensions, details about just how conflicts and future tariffs could be avoided still remain up in the air. Specifically, the possibility of their respective car industries being hit by similar tariffs before the midterm elections remains high, which could slap on tariffs as high as 25 percent on imported autos and auto parts. In the meantime, Tokyo and Brussels have gone ahead and agreed to open their auto markets to one another which will be able to deflect some of the pain that comes as a result of uncertainties about Washington’s actions. More importantly, though, the two sides have made clear a global commitment to ensure that there is an alternative to raising tariffs in response to tackling deficits and that a protectionist approach to trade would actually limit longer-term growth.
At the same time, the bilateral FTA makes clear that a vacuum created by a U.S. retreat from free trade does not necessarily mean that only China can fill that void. In fact, the deal has probably increased concerns within the United States about Washington becoming increasingly isolationist as well as protectionist on trade, which would ultimately lead U.S. companies to lose out in overseas markets. Meanwhile, traditional U.S. allies are increasingly taking steps to hedge against Washington’s trade policies that continue to focus on reducing the U.S. deficit of goods.
Prime Minister Shinzo Abe has been at the forefront of ensuring that Japan hedge its trade relations risks. While the country was the last of the 12 original member nations to join the TPP, Abe has been key in ensuring that the multilateral trade deal continued to survive even after the United States pulled out of the deal. Japan became the second country after Mexico to ratify the Comprehensive and Progressive Tran-Pacific Partnership (CPTPP), which is the updated TPP deal minus the United States, earlier this month. The deal now needs four other member countries to ratify it before being entered into force. Expectations for Canada, Australia, Chile, New Zealand, and Vietnam to follow suit soon is high, while neither Singapore nor Brunei need further approval to move forward.
As the largest economy of the CPTPP, and having signed a trade deal with the EU, Japan is now well on its way to being the central force driving global resistance against protectionism. But Prime Minister Abe remains a begrudging global leader of free markets, especially amid concerns about antagonizing Washington both economically and politically. Rather, Abe’s strategy is to take on more of a caretaker role of the international liberal order as he continues to push for the United States as well as other countries to join the CPTPP eventually on the one hand, while evading getting cornered into a bilateral trade deal that would put Tokyo at a disadvantage on the other.
The immediate concerns of trade relations with the United States, however, are far more pressing for both Japan and the EU. While the Trump administration is likely to impose auto tariffs in the near future, just how long such tariffs would actually be in place remains unclear, especially as the move would hurt U.S. consumers as well. Short of preventing the tariffs from coming into effect in the first place, Japanese and European efforts must focus on how to minimize the impact of such tariffs on the auto and auto parts industries in the medium- and longer term. The sheer size of the U.S. economy continues to make the United States an attractive market, but growing uncertainties about tariffs and trade policy more broadly will make it increasingly difficult for manufacturers to develop marketing and investment strategies in the country. The longer the uncertainties remain, the more Europe and Japan will be motivated to bolster their respective trade relations to offset some of the losses that would invariably be made in the United States.