EU-Japan: Free Trade Agreement Commitment to Economic Cooperation

Japan is one of the European Union’s (EU) most important economic partners. A new study of the ifo Institute on behalf of Bertelsmann Stiftung shows that both sides could gain additional benefit from a free trade agreement. More importantly, however, the agreement would signal a clear commitment to economic cooperation and free trade in the era of Brexit and Trump.

Electromobility, robots, computers – in many areas Japan is regarded as one of the most innovative countries in the world. At the same time its economy is facing significant challenges: an aging society, high government debt and stagnating growth. The Japanese government’s reform program (known as “Abenomics”) wants to inject new impetus into the economy by negotiating free trade agreements, among other things.

The EU and Japan, two of the world’s leading trade powers, are negotiating such a free trade agreement at the moment. The negotiations may even be concluded before the end of 2017. Japan is the EU’s sixth-largest trade partner in the world. For Japan, the EU occupies third place. The volume of trade between the two countries amounted to around EUR 125 billion in 2016. However, the full potential is yet to be realized, given that trade barriers continue to exist on both sides. A free trade agreement could lower duties and non-tariff barriers.

Only an ambitious agreement will lead to significant growth

At present a free trade agreement between the EU and Japan that resembles the one concluded between the EU and South Korea in 2011 seems to be the likeliest outcome politically. According to our calculations, this (conservative) scenario could see Japan increase its economic output, as measured by gross domestic product (GDP), by approximately EUR nine billion. This equates to 0.23 percent of Japanese GDP in 2014, the base year for the model calculations in the study. For the EU, GDP increases would amount to approximately EUR 11 billion, equal to 0.1 percent of total EU GDP in 2014. The individual member states would benefit to significantly varying degrees. At EUR 3.4 billion – approximately 0.1 percent of its GDP in 2014 – Germany would have the highest absolute increases. However, for some southern and eastern European countries such as Greece and Romania, the growth effects would be negligible at 0.02 percent. However, a free trade agreement between the EU and Japan would not result in any overall negative effects for any EU member state at all.

Overall, the economic effects on both sides would be rather modest. The situation would be different if both parties strove towards an ambitious free trade agreement in which the non-tariff trade barriers were reduced to the average level of all existing free trade agreements – thus making them much lower than those in the agreement between the EU and South Korea. In this case, Japan’s GDP would be around 1.6 percent higher than without the agreement. In the EU, the effects would range from around 0.1 percent (for countries such as Greece or Romania) to 1.4 percent for Ireland. Germany could expect a GDP increase of approximately 0.7 percent, about 20 billion Euros.

The effects mentioned are long-term effects and would therefore only be observed after the free trade agreement had been in force for around 10-12 years.

Whether an ambitious agreement could be accomplished at all depends above all on the political will of both partners. This would require significantly greater concessions from both sides than the conservative variant. But the calculations show this would be worthwhile, from an economic viewpoint at least.

Cooperation instead of protectionism: EU-Japan agreement would send an important political message

An FTA between the EU and Japan would have positive economic effects for both parties. More important than the potential GDP increase, however, would be its strategic significance: in these times of economic disintegration and rising protectionism, such an FTA would signal a clear commitment to economic cooperation and free trade. Furthermore, the agreement could serve as a first step towards filling the void in the world trade order created by the USA through its apparent rejection of free trade under the Trump Administration.

However, the two economic powers should act quickly and really try to complete the negotiations by the end of this year. Japan should not let itself be unsettled by the USA’s withdrawal from the TPP and should be cautious with regards to potential negotiations on a bilateral FTA with the USA. Japan too can only lose from Trump’s “America First” policy.

Furthermore, both sides should not forget that China has already used the G20 summit in Hangzhou in 2016 and the World Economic Forum in Davos at the start of 2017 to position itself in such a way as to exert a greater influence on the international trade regime and set its own standards (e.g. within the RCEP). This development is unlikely to be in the interests of either Europe or Japan.