Pacific Money

Why Japan Must Join the TPP

For Japan to really be “back” it needs to sustain its growth. Joining the TPP would be an important first step.

If Japan really is “back,” as Prime Minister Shinzo Abe stated in Washington last February, the government must prove the long-term sustainability of Japan’s current short-term growth. In this sense, the success or failure of its Trans-Pacific Partnership (TPP) negotiations will likely determine the success or failure of efforts to revitalize Japan domestically and internationally.

Since taking office last December, the scope and pace of Abe’s initiatives have propelled Japan back into the global spotlight. After two decades of stagnation and deflation and a half-decade of political discontinuity, Abe opened his term with a massive public spending program worth 2.6 percent of GDP, and then set to work fighting Japan’s falling prices. The Bank of Japan will buy $70 billion in new bonds every month and double the monetary base by the end of 2014. Politically and internationally, Abe is also moving boldly, initiating the first defense spending increase in over a decade, taking a productive first trip to Washington, and sweeping through several ASEAN nations with a message of strengthened economic ties and rules-based diplomacy.

The difficulty of undertaking these initiatives should not be understated, and yet they pale in comparison to the difficulty of resolving Japan’s many long-term problems. Japan’s debt-to-GDP ratio is the highest in the world, and will become untenable as the population shrinks and inflation rises. A smaller population will produce drops in both domestic demand and the labor supply, while rising inflation rates will lead investors to demand higher interest rates to finance government bonds. In that environment, and without real growth, a debt crisis could materialize.

To tackle these issues, the flashy smoke-and-mirrors game of stimulus must be backed up with real structural changes that support sustainable growth, such as regulatory reforms and increased labor market openness. Pursuing structural reform would not only boost Japan’s domestic economy but also give credence to its international agenda by granting an opportunity to be an architect of 21st century economic rules.

This is where the TPP comes in. Japan’s centricity in global supply chains should yield massive economic gains through greater trade, but previous failed attempts to modernize its financial, high-tech manufacturing, and agricultural regulatory regimes casts a pall over the negotiations. Reforming antiquated, cost-imposing structures would attract more foreign investment in Japan’s domestic production, while increased exports – particularly of intermediate manufactured goods – will smooth the transition from stimulus to real growth.

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According to many estimates, Japan’s economy will be about 2.5 percent larger in 2025 with the TPP than it would be without it. These estimates understate the potential gains, however, by leaving medium-term productivity growth and capital investment returns static. If Japan is able to negotiate agreements in line with World Trade Organization norms, both of these items should rise much more quickly over the next decade. In this scenario, gains to the Japanese economy more than double, to nearly 6 percent of GDP over 10 years. Moreover, the types of international standards in labor, capital, and service markets sought by Japan’s TPP counterparties will by necessity generate requisite reform without as many behind-the-border battles.

The TPP will also give Japan a stronger bargaining position in its other outstanding trade negotiations, such as the ASEAN-led Regional Cooperative Economic Partnership (RCEP) and the accord with China and South Korea. This is economically important for Japan because the combination of its current FTA negotiations covers 63 percent of its industry, with the potential for real economic gains as high as 2 percent of GDP annually from streamlined, reduced trade barriers. Moreover, as the only major developed economy party to all three agreements, Japan is in a unique position to demonstrate leadership in pursuing the highest standards that can eventually serve to harmonize and modernize trade disciplines and put the Asia-Pacific on a path towards a region-wide free trade area.

Before Japan can accede to leadership status, however, it must confront the challenge of negotiating the TPP and updating its own rules for 21st century commerce. Though Abe speaks confidently, the hard political work lies ahead. His Liberal Democratic Party, coalition partner the New Komeito, and the opposition Democratic Party of Japan support exceptions in agriculture and/or insurance, calling into question Japan’s commitment to structural reform in atrophying sectors and, by extension, to attaining the high benchmarks required for the TPP to become a standard-bearer of future free trade agreements. Unless Abe can find political middle ground, current negotiations might prove to be just another false start.

The TPP is the best way for Japan to prove that it is back. By spurring on the real economy, the TPP can entrench the Abe economic plan as a success and demonstrate Japan’s commitment both to domestic revitalization and the fostering of a rules-based regional order in the Asia-Pacific. Failing to meaningfully conclude the TPP could mean further disappointment for Japan, only with higher inflation, an attendant debt crisis, and less international credibility.

Daniel Hanson is an economics researcher, and Lara Crouch is a researcher in Asian Studies at the American Enterprise Institute.