The Trans-Pacific Partnership and Japan

Published in the Nikkei Asian Review

November 16, 2015

The Trans-Pacific Partnership (TPP) is the most important trade agreement in world history in both economic and geopolitical terms. It incorporates 40 percent of the global economy, including its largest and third largest countries. It will increase the income of the participating countries by almost $300 billion (in 2007 dollars, so much more in current dollars when it is fully implemented in a few years). It sets the stage for eventual expansion to a comprehensive Free Trade Area of the Asia Pacific (FTAAP) that will include virtually every country in the region, perhaps including China and India. The European Union became a hugely important megaregional agreement over 50 years, but its original Common Market of six countries was much smaller than the TPP, and the several multilateral trade rounds in the General Agreement on Tariffs and Trade (GATT) only made modest cuts in the tariff levels of rich countries rather than virtually eliminating all barriers for all participants.

The TPP includes 12 countries but is largely a free trade agreement between the United States and Japan. These two countries together account for about 60 percent of its economic benefits. Both already have free trade agreements (FTA) with most of the other participants but not with each other. They are the only two individual TPP members whose ratification is required for the agreement to enter into force and hence could veto it. It is unlikely that either could have reached a bilateral FTA, in light of their domestic politics, but the regional umbrella of TPP has made a highly desirable FTA between them possible. They worked effectively together to forge the agreement among the 12.

Japan will clearly be the largest national beneficiary of the TPP. Models at the Peterson Institute for International Economics show that, by 2025, its exports and imports will each grow by $140 billion annually and its national income by more than $100 billion. These absolute increases are greater than for any other member country. In percentage terms, only much smaller Vietnam and Malaysia will enjoy larger gains. Japan's percentage gains will be two and half to five times those of the United States. These benefits will grow significantly when other countries join the TPP in a second stage, as half a dozen (including Indonesia and Korea) are already hoping to do.

These numbers, large as they are, nevertheless undoubtedly understate the potential gains for Japan from the TPP because they cannot capture most investment and structural changes. In the 1980s and 1990s, Japan largely rejected the admonitions of the United States and other countries to continue opening and reforming its economy in order to sustain its previously stellar performance. Partly as a result, it has suffered weak growth for two decades and continues to search for a viable new model. Prime Minister Abe has rightly seized on the TPP as a promising catalyst for the kinds of changes that the country desperately needs, and the agreement indeed offers a major opportunity for Japan. Japan's investment climate will significantly improve as will its ability to participate in global supply chains.

Japan will also benefit from the side agreement on macroeconomic and exchange rate issues that is being organized by the monetary authorities of the TPP countries. The main goal of that agreement, responding in part to the TPP "negotiating objectives" for the United States adopted by the Congress, is to avoid future currency manipulation by partner countries that could undermine the agreement's trade liberalization and balance. Japan has suffered from such manipulation by China and Korea, two of its major competitors that might join the TPP in the future. Those countries have frequently and substantially intervened in the foreign exchange markets, including in yen, to depress their currencies and strengthen their competitiveness, and the TPP group would provide a useful forum to help deter and, if necessary, counter such practices. It would also enable Japan to join with the United States in further reinforcing the widespread consensus that domestic implementation of monetary policy, including quantitative easing, should not be regarded as currency manipulation and is thus fully acceptable internationally. In any event, Japan itself has already committed to avoid future manipulation through the very firm G-7 agreement of February 2013.

The geopolitics of the new agreement are even more important than its economics. The TPP will provide the first binding institutional ties between the United States and East Asia and thus begin to replicate the thick networks across the Atlantic that have been so crucial to maintaining world peace and prosperity. It is central to the US "pivot to Asia," launched in President Obama's historic speech in Tokyo in late 2009 precisely to provide reinvigorated US economic engagement in the region, which is so essential for Japan. It substantially strengthens the alliance between the United States and Japan itself. These geopolitical linkages will become increasingly important as other Asian countries, hopefully including China, join the arrangement in a second phase.

In the meanwhile, the current TPP grouping will pose a constructive challenge to China and other countries in Asia that are outside its initial membership. China alone will suffer trade diversion of about $35 billion annually from the present TPP and over $100 billion if the rest of the Asia Pacific Economic Cooperation (APEC) forum joins while it does not. These pressures of "competitive liberalization" should encourage China to continue upgrading its trade and related internal policies so that it will be able to participate in comprehensive and meaningful regional compacts in the future.

There is a major geopolitical risk that the Asia Pacific region could divide into two broad economic zones if China does not join the TPP. The TPP would then include the United States but not China, while the other zone, probably centered on the Regional Comprehensive Economic Partnership (RCEP), would include China but not the United States. Tensions between the two zones with their presumably very different templates could easily develop, reinforcing the security anxieties between the two powers despite their overlapping memberships.

Hence all countries in the region, especially Japan, should work toward an ultimate amalgamation of the two zones. Only such a fully integrated Asia Pacific would achieve the original Bogor Goals of APEC from over 20 years ago, which pledged to achieve "free and open trade and investment" in the region for fundamental security as well as economic reasons. The TPP achieves about half the Bogor target, but accomplishing the other half will require either an expansion of TPP to include the rest of APEC or a new Free Trade Area of the Asia Pacific with the same comprehensive membership.

Japan has a huge political as well as economic interest in the success of such an effort. A two-track Asia Pacific would mean that Japan would have one FTA with the United States (through TPP) and a totally different FTA with China (through RCEP or maybe China-Japan-Korea), discriminating against both to the extent that the terms of the two agreements differed significantly, as they surely would. Japan would have two different FTAs with countries that participated in both tracks, probably including Korea, which would be commercially confusing at best and potentially divisive politically as well. Most importantly, a comprehensive regional arrangement that included both China and the United States could help overcome the deep mistrust between them that represents the greatest potential threat to the security of Japan and the entire Asia Pacific region, and indeed begin to foster a new sense of partnership instead.

As by far the largest power other than the United States and China, Japan can have a major impact on the outcome. It can be especially influential with its US ally on the issue, as there is a sharp division within the United States between those who want to bring China into a cooperative Asia Pacific trade and investment structure, to improve the prospect that it will contribute constructively to both peace and prosperity in the region, and those who view China as an inevitable enemy that should be excluded from such arrangements. It is clearly in Japan's interest to avoid having to choose between China and the United States, and it should thus strive tirelessly to promote a cooperative fusion over the next several years.