Features | Economy | East Asia

The TPP, Abenomics and America’s Asia Pivot

The TPP talks are critical for both Japan’s future and U.S. Asia policy.

The TPP, Abenomics and America’s Asia Pivot
Credit: REUTERS/Toru Hanai

Japan’s entrance into the Trans-Pacific Partnership free-trade treaty negotiations is arguably the most important event in U.S. relations with the Asia-Pacific in the last decade. This is because the sustainability of long-term American strategic power in Asia and Prime Minister Shinzo Abe’s attempts to resuscitate the Japanese economy are entirely co-dependent. Without an economically resurgent Japan, Asia will be increasingly sucked away from the U.S. and into the Chinese economic and strategic orbit. Washington’s Asia pivot is not complete without a Japan-powered TPP, which both supports its growing Asia-Pacific political and security alliance and acts as an economic containment treaty against China.

Just as the Soviet Union relied on a massive military arsenal for its power, Chinese influence derives overwhelmingly from its economy. Until now, the U.S. has had relatively few economic levers in its Asia pivot, with the exception of free trade agreements (FTAs) with its firmest friends: Australia, Singapore and Korea. Instead, Washington has focused mainly on political and military efforts, whether improving frosty relations with former foes such as Vietnam or deploying additional regional ballistic missile defense resources.

If implemented, the TPP including Japan fixes this economic gap in America’s Asia policy by increasing trade flows among its members, making them less dependent on trade with China and thereby strengthening their economic position relative to their giant neighbor. Importantly, Japan’s participation as the largest Asian economy in the TPP multiplies the treaty’s economic network effects. It also gets the U.S. back in the free-trade game, given that China has already signed, or is pursuing, FTAs with a number of TPP member-countries including Singapore, Australia, New Zealand and Chile.

The TPP also complements Washington’s security relationships. TPP countries are predominantly close U.S. military allies that share concerns about – and often bear the brunt of – China’s aggressive regional military swagger. Tokyo’s reliance on shipping lanes for hydrocarbon imports provides a fulcrum for coordinated efforts on regional energy and security policies, including blunting ongoing Chinese attempts to intimidate TPP members on maritime boundary claims and the valuable oil and gas that lies beneath the seabed.

U.S. strategy in Asia relies on the economic rejuvenation of Japan, which in turn relies on Abe’s three-pronged economic program. The first two elements of Abenomics, fiscal and monetary, are already in place and are set to continue for the foreseeable future. This is the easy stuff of economic policy which sweetens the patient for the bitter medicine to follow. The Bank of Japan’s massive monetary easing (which is bigger than that of the U.S. Federal Reserve’s efforts), record deficit spending and rising inflation expectations are the first caffeine boosts to the Japanese economy. Like double espressos on an empty stomach, the java fix is powerful at first, but eventually fades. This is why Abe intends to implement domestic structural reform to permanently waken Japan from its two-decade economic slumber.

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Politically, Abe is relying on the TPP negotiations as a vehicle to drive this structural reform agenda. The central plank of these reforms is improving Japan’s competitiveness and regaining its export edge. The TPP will lead to lower costs for imported goods, increased regional access for Japanese exporters and reduced Japanese reliance on trade with China. However this export boost requires the successful execution of contentious domestic initiatives, including raising the consumption tax rate, lifting workforce participation, lowering electricity prices through deregulation, and encouraging foreign direct investment. The biggest challenge for the Prime Minister is cutting Japanese tariff and non-tariff barriers on key staples such as rice, given the LDP’s rural voting base and resulting opposition within his own party. Not surprisingly, Abe has already indicated that he will partially protect key agricultural sectors in order to persuade his MPs to support the rest of his agenda.

Domestic Japanese politics will increasingly determine the success or otherwise of the TPP. U.S. and its allies’ policymakers, while recognizing their own national economic interests, should make every effort to support Abe in his reform program. Japan should be allowed a slow tapering of its agricultural tariffs over a long period of time – which will both encourage long-term domestic agricultural reform while preventing a wholesale revolt within the LDP that could effectively end Japanese involvement in the TPP. Maintaining a constructive silence on the devaluation of the yen, particularly in the great unknown of the post-Bernanke era, would also help bolster Japanese exports and serve as an analgesic while the pain of structural reforms hit.

The failure of Abenomics, including the structural reforms driven by Japanese TPP negotiations, may pose severe global stability risks. If Abe fails at home, structural reforms will stall and with these, any hope for a Japanese recovery. There are two worrying scenarios – both bad for Japan and its friends. First, without reform implementation, Abe’s massive monetary easing program combined with aggressive deficit stimulus may lead to stagflation, a terrible mix of high inflation, stunted growth and rising unemployment.

Second, given Japan’s enormous debt burden at 230% of GDP, a mere 2% increase in interest rates on Japanese Government Bonds will lift debt service costs to 100% of the government budget. This scenario is a real possibility given Japan’s persistent trade deficits and sluggish growth. In the worst case this may lead to a run on Japanese bonds – as they lose their safe haven status for foreign investors, with declining numbers of Japanese savers to pick up the slack.

Either of these scenarios would edge Japan towards default with massive global ramifications that would dwarf the Eurozone crisis, let alone trashing the TPP negotiations. Worst of all, an economically desperate Japan would likely turn inwards with virulent nationalism, while ironically falling deeper into the arms of China, wrecking America’s Asia strategy.

Andre Stein and Miro Vassilev are principals of Cryptos Global Investments, a New York-based Global Macro Fund. Stein is a New York Fellow at the Foreign Policy Initiative, and Vassilev is a Fellow at the Truman National Security Project.