22 October 2020

Dr Minako Morita-Jaeger, International Trade Policy Consultant and Fellow, UK Trade Policy Observatory at the University of Sussex.

The Japan-UK Free Trade Agreement will be signed soon, the UK’s first post-Brexit trade agreement. While the Agreement has a certain political significance, its economic impact is likely to be very small. This is because it contains very limited improvements relative to the EU-Japan Economic Partnership Agreement (EPA). While a detailed examination will only become possible once the text is put on the public domain, one of the key shortfalls in the agreement appears to be the treatment of investment.

Strong political motives

The UK-Japan Free Trade Agreement (FTA) is a domestic political gain for the UK Government. The UK is still on a cliff-edge regarding the EU-UK future relationship and the possibility of a no-deal has risen in recent days. The FTA with the US, originally pitched as a key element of the post-Brexit agenda, appears some way off. In part, this is due to uncertainty from the US presidential election but also because of disagreements over key areas, such as food safety standards of US agricultural products.[1] Under these circumstances, the UK has been under political pressure to demonstrate its capacity to conclude its first FTA as an ‘independent’ nation. Hence, the trade deal with Japan, the world third-largest economy and the UK’s 4^th largest non-EU export market,^[2] is being touted as a ‘historic Free Trade Agreement’ for the UK.[3]

Unlike the UK, Japan did not have the same levels of domestic political pressure to conclude an agreement. Japan already has 17 FTAs that cover major trading partners, including the EU (EU-Japan Economic Partnership Agreement) and the Asia Pacific countries (Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)). In addition, Japan has concluded the trade in goods agreement and digital trade agreement with the US (entered into force on January 2020). Domestically there is a high expectation on concluding the Regional Comprehensive Economic Partnership (RCEP) which includes China.[4] With regard to the UK-Japan FTA, Japan wanted to signal that it is a close strategic economic partner for the UK and build a strong foundation to develop its strategic relations on trade and beyond to pursue its foreign policy.[5]

Downgraded ambitions to achieve ‘continuity’ and limited economic impacts

Japan’s original refusal to ‘roll-over’ the EU-Japan Economic Partnership Agreement (EPA) was driven partly because Japan wanted greater clarity regarding UK-EU future trade relations, and in part because of a desire to negotiate something more ambitious by upgrading the UK’s market access commitments and reviewing some rule-making issues rejected by the EU during the EU-Japan EPA negotiations.^[6] However, over time Japan repositioned itself in order to prioritise ‘continuity’. There was strong pressure from Japanese business to ensure a smooth transition from the EU-Japan EPA framework to the Japan-UK FTA from 1^st January 2021.

While the UK Government has presented the Agreement as going ‘far beyond the EU-Japan Economic Partnership Agreement (EPA)’,[7] the Japanese Government’s evaluation is more downbeat and highlights the importance of maintaining market access at the EU-Japan EPA level with some improved rules for example with regard to e-commerce.[8] The reality is that in order to conclude the deal within an unprecedentedly short negotiating time frame of two-three months (even though based on the EU-Japan EPA), both governments had to downgrade the scope and the level of ambitions. ^[9]

The value-added elements (relative to the EU-Japan EPA) are limited to some finely narrowed-down improvements in rules (e.g. e-commerce, rules of origin, and financial services) and the UK’s immediate reductions of tariffs on some car and rail manufacturing products.[10] The last-minute deal for the UK’s stilton cheese exports was made within the EU-Japan EPA framework by allocating EU’s left-over quotas to UK cheese exports. Achieving ‘continuity’ was set as the first priority in order to avoid the negative economic impacts of falling into bilateral trade on WTO terms.

The economic impacts of the Agreement look very small due to its minimum value-added. According to the Department for International Trade (DIT), the long-term economic gains from the Japan-UK FTA relative to no-deal account for £1.5 billion in the case of the UK (0.07% increase in UK’s GDP) and equally £1.5 billion (0.04 % increase in Japan’s GDP) in the case of Japan.[11] However, even these estimates probably exaggerate the gains, as the UK is currently already enjoying benefits of the EU-Japan EPA since February 2019.

Lack of UK’s comprehensive investment strategy

As the Japan-UK FTA has become the UK’s first post-Brexit FTA, it is notable that investment is a shortfall area, and this reflects the lack of UK strategic policy-making. It is unclear what kind of FDI policy framework the UK would like to design Post-Brexit and the role that FTAs might play in achieving investment-related policy objectives. This is particularly important in the context of the Japan-UK economic relationship, in which the investment relationship plays a significant role.

As explained in Morita-Jaeger (2020), the UK has been a hub for Japanese business in Europe and a gateway to the EU market for Japanese companies since the 1980s. Recalling that Japanese investors’ main concerns are regulatory changes and the end of free movement of people between the EU and the UK,[12] the end of frictionless trade between the EU and the UK, even with an EU-UK FTA will inevitably impact on Japanese investment in the UK. Given the concurrent economic shock of Covid-19 on the UK economy (-10.1% projected real GDP growth in 2020 (OECD)),[13] FDI will be an important source of UK’s mid to long term economic recovery. In this context, it is worth noting that Japan is the largest investor abroad in the world (14%) of the world total in 2018.[14] And the UK is the second-largest FDI destination for Japan accounting for $171.9 billion of FDI stock in 2019 following the US (533.3 billion).^[15]

Looking at the Agreement, some concessions have been agreed with regard to tariffs and rules of origin to protect Japanese automotive and rail investments in the UK. These are in response to the strong demands of the Japanese Government. With regard to tariffs, the UK accepted the immediate reductions of tariffs on specific automotive and rail manufacturing inputs.[16]. With regard to rules of origin, the agreement allows for extended cumulation for EU inputs in Japanese products and lowered threshold of automotive components from 55% (under the EU-Japan EPA) to 50%. However, trilateral diagonal cumulation with the EU is unresolved as this would require agreement also with the EU. It is highly unlikely that the EU would provide such a concession that could bring a competitive edge to the UK. The important point is that these arrangements cover only certain targeted sectors and are far from comprehensive.

A major shortcoming is that the investment section of the EU-Japan EPA, which covers only investment liberalisation, seems untouched. The UK Government could have shown a strong commitment to Japanese investment by including a comprehensive investment chapter encompassing investment protection and dispute settlement for three reasons. First, further investment liberalisation is no longer a contentious issue for the Japan-UK investment relationship since investment policy environments in both Japan and the UK are already quite liberal,^[17] Second, the EU 27 and Japan agreed to negotiate a bilateral investment treaty (BIT) but have not yet reached the agreement. The UK could have taken a lead in this respect. Third, Japanese business is interested in investment protection in the UK as there is no BIT between Japan and the UK while the UK has 92 BITs in force.[18]

In conclusion, the UK Government needs to strategically analyse investment relations with its FTA partners especially from the inward FDI perspective, and the importance of this is heightened amid the double economic uncertainty from Covid-19 and Brexit. A policy discussion on investment and the role of FTAs is required at the domestic level, so that the UK can position itself better in future FTA negotiations. Enhancing investment policy cooperation through investment liberalisation, protection and dispute resolution mechanism is one way in which the gains from UK FTAs could be higher than the currently projected gains which are typically very small.

Footnotes

[1] “Long road lies ahead for UK-US trade talks”, Financial Times, 6 October 2020.

[2] ONS (2020). UK total trade: all countries, non-seasonally adjusted. UK’s goods exports to Japan account for 1.9% (£7,262 million in 2019) of its total goods exports and services exports accounts for 1.6% (£7,987 million in 2019) of its total services exports.

[3] The UK government press release, 11^th September 2020. https://www.gov.uk/government/news/uk-and-japan-agree-historic-free-trade-agreement

[4] RCEP covers 15 countries: ASEAN plus Australia, China, Japan, New Zealand, and South Korea. These countries aim to conclude the negotiation by the end of 2020.

[5] The Japanese government press release (in Japanese), 11^th September 2020. https://www.mofa.go.jp/mofaj/files/100092224.pdf

[6] Morita-Jaeger, M. (2018). New economic partnership between the UK and Japan – Does rolling over the EU-Japan EPA make sense?. https://blogs.sussex.ac.uk/uktpo/2018/07/06/new-economic-partnership-between-the-uk-and-japan/

[7] See the UK press release above.

[8] See the Japanese government press release above.

[9] Morita-Jaeger, M. (2020). The Japan-UK Free Trade Agreement –Continuity or no continuity? How can it be still be ambitious?, UKTPO Briefing Paper 46. https://blogs.sussex.ac.uk/uktpo/files/2020/07/Briefing-paper-46.pdf

[10] The author examined the points made in the Japanese and UK governments’ press releases and the media reports in comparison with the EU-Japan EPA. It should be noted this is a preliminary assessment.

[11] Department for International Trade (2020). UK-Japan Free Trade Agreement: The UK’s Strategic Approach, May 2020, pp28-29.  https://www.gov.uk/government/publications/uks-approach-to-negotiating-a-free-trade-agreement-with-japan/uk-japan-free-trade-agreement-the-uks-strategic-approach

[12] Morita-Jaeger, M. (2019). How is Brexit uncertainty disturbing UK-Japan trade relations?, The UKTPO blog, April 2019. https://blogs.sussex.ac.uk/uktpo/2019/04/30/how-is-brexit-uncertainty-disturbing-uk-japan-trade-relations/#more-3470

[13] OECD Economic Outlook, Interim Report September 2020.

[14] UNCTAD World Investment Report 2020.

[15] Japan External Trade Organization (JETRO), FDI stock data.

[16] For example. electronic control panels, the tariff of which is scheduled to be eliminated in six years under the EU-Japan EPA.

[17] According to the OECD FDI regulatory restrictiveness index (the most restrictive is 1 and open is 0), Japan’ restrictiveness accounts for 0.052 and that of the UK accounts for 0.04 while the OECD average accounts for 0.065 in 2018.

[18] See Morita-Jaeger, M. (2019). P4.