Editor's Note: This assessment is part of a series of analyses supporting Stratfor's upcoming 2019 Annual Forecast. These assessments are designed to provide more context and in-depth analysis on key developments in the coming year.
Japan will need to make some tough decisions on trade in 2019. This past year has been one of successes for Tokyo with the completion of its long-hoped-for Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) agreement and the signing of an economic partnership with the European Union. Both will take effect in 2019. But just as these kick in, Japan will enter potentially contentious bilateral talks with the United States, Japan's largest export market and its second-largest trading partner overall.
At issue is the U.S. trade deficit in goods with Japan ($61 billion in 2017), which has come under fire as the administration of President Donald Trump pushes for broader protectionism. Automotive trade accounts for about two-thirds of this deficit, making it the prime target for U.S. negotiators who will brandish the threat of tariffs against the sector. Washington's secondary focus will be on further prying open Japan's agricultural market, where U.S. imports dominate but still must contend with Japanese domestic protectionism and competition from the European Union, China and Australia. Third, the U.S. hopes to shape the deal so it serves as a counterweight to China's economic heft in the region.
Japan has been a major target of the broader U.S. push to lower trade deficits and build up domestic manufacturing. Next year will see the start of landmark bilateral trade talks, focused largely on automobiles and agriculture. Though Japan has fewer nonnegotiable topics than the European Union in trade talks, it still has some sticky issues that need sorting out.
Trade, Talks and Tariffs
The Trump administration has long pushed Japan to enter bilateral talks, but Tokyo rejected the idea and urged the United States to return to a multilateral trade arrangement. It wanted to get the United States back into the CPTPP to help counterbalance China and to reshape the regional trade structure in Japan's favor. The U.S. tariffs on steel and aluminum in March did not shake Japan, because the United States wasn't a critical market and Japan retained a proportion of its high-grade steel exports through individual carve-outs.
However, the announcement of potential 25 percent U.S. tariffs on all automobile and parts imports changed the equation for Japan. In September, Prime Minister Shinzo Abe and Trump signed a joint statement on starting talks for a bilateral agreement addressing goods, services and earlier proposals for concessions, known as early harvest deals. Once this agreement is completed, discussions on additional trade and investment items can begin. Their statement specifically mentioned that access to the U.S. automotive market would be tied to increasing U.S. jobs and production and stipulated that Japanese concessions on agriculture would not exceed those of previous economic agreements. In exchange, the United States said it will refrain from imposing tariffs on Japanese autos as long as these negotiations proceed. The talks could begin as early as mid-January, while the U.S. investigation necessary for the imposition of automotive tariffs is due in February at the latest.
Japan's No. 1 Goal
In these negotiations, Tokyo's main objective will be to protect its access to the U.S. auto market, which receives 40 percent of its vehicle exports and 5 percent ($40 billion) of its total exports. As a whole, its automotive sector accounts for 11 percent of total exports, contributes about 3.3 percent to its gross domestic product and employs 5 million people. And Japan has even more reasons to guard its access to U.S. consumers. In October 2019, it will raise the consumption tax from 8 percent to 10 percent. Meant to shore up government revenue, the increase has been delayed since 2015 out of concern that it could hurt the economy — the last hike, in 2014, tipped the country into recession. With the tax increase set to deal a blow to consumer spending and with Japan facing long-term demographic decline, external markets will become even more critical. Though China has lowered barriers to Japanese autos, the European Union and the CPTPP countries will help it to diversify its markets further, but the United States remains the single most important export destination.
But unlike the European Union (which has 10 percent duties), Japan has no tariffs on car imports, so negotiations with the United States will need to center on Japan's non-tariff barriers, which the United States has long criticized. Luckily for Japan, the two countries had already reached a degree of understanding over the automotive sector before the United States abandoned the Trans-Pacific Partnership. And those earlier talks would have addressed U.S. concerns about the onerous requirements of Japanese safety standards, the lack of transparency in regulations, the barriers to distribution networks and other non-trade barriers. Additionally, TPP negotiations covered a proposed U.S. safeguard against a surge in Japanese auto imports and mechanisms for consultations between the two sides.
These previous negotiations have helped to lay the groundwork for Japan to offer concessions that would mollify the Trump administration's calls for greater access; South Korea successfully pursued a similar strategy in the recent reworking of the U.S.-Korea Free Trade Agreement. Washington could still push for some sort of limit on Japanese automotive exports, but this is an eventuality that Japan has faced before (1981-94) and has partly adapted to by building up its manufacturing within the United States.
Agriculture: Small but Mighty
Agriculture will be a stickier issue. It accounts for slightly over 1 percent of Japan's GDP and employs about 3.5 percent of the working-age population, serving as the backbone of the economy in many rural areas. Japan's agricultural sector is largely oriented inward — making up only 1 percent of exports. All told, domestic production meets only about 44 percent of domestic demand; imports make up the balance. In 2017, the country was among the top global importers — and the fourth-largest destination for U.S. agricultural products, topped only by Mexico/Canada and China. But the Japanese agriculture sector operates behind steep protections, which have long limited the market share for imports and provoked complaints from Japan's trade partners. And now the United States faces even stiffer competition from countries in the CPTPP (namely Australia) and the European Union, which are poised to gain greater access to the Japan in 2019.
Before the United States pulled out of the TPP, Washington identified Japan as the top agricultural market priority due to its high levels of protection, high per capita GDP and large population. In 2014, Washington estimated that the treaty would boost U.S. agricultural exports $7.2 billion (2.6 percent), with Japan accounting for $3.6 billion. During TPP talks, the United States had already secured concessions for greater access to the Japanese market with tariff and quota changes on beef, pork, dairy, corn, soy, wheat, rice and sugar. In the upcoming talks, the United States will likely begin by pushing for the inclusion of these provisions in a bilateral deal or as early harvest concessions. Washington will also probably push for the same access for U.S. pork as the European Union secured, gaining unprecedented tariff cuts in its recent deal.
If the United States holds to its September commitment on agriculture, Japan's government should be able to deliver on a deal. However, agriculture has long been a sensitive political issue in Japanese politics — with the power to make or break political fortunes. A long-term trend sees this influence waning with rural demographic decline and the graying of the agricultural workforce. Despite these trends, and efforts to undermine its clout, the powerful agricultural lobby, JA-Zenchu, still has a strong hand in politics. Protections in the EU deal and the CPTPP reflect the ruling Liberal Democratic Party's (LDP) concerns about pushing farmers too far. And in November, Japan suspended trade negotiations with South America's Mercosur trade bloc after just six months — reportedly over agricultural issues.
So a hard line by the Trump administration on agriculture would force the LDP to choose between facing a backlash at the polls and giving in to steeper U.S. demands for access. In July, half of the lawmakers in Japan's upper house will be up for election. JA-Zenchu's influence could cause some LDP lawmakers to balk out of concern for their seats. However, the government now has greater insulation from such a backlash because of reforms that lowered the clout of rural voters, the LDP's supermajority in the Diet, and Abe's strong internal position and penchant for overruling rank-and-file party members. The U.S. threat to the automotive sector, as long as it remains workable, will make the negotiations on agriculture easier.
But the United States and Japan could clash if a clause putting up barriers to a future Japan-China trade deal were included. The recently signed U.S.-Mexico-Canada Agreement included a provision that required the parties to submit a special notice if they intended to enter trade talks with a nonmarket economy — clearly referring to China. Given that China is Japan's largest trading partner, Tokyo would like to reserve the right to forge an agreement with it in the long term, possibly including South Korea in a multilateral deal. However, Japan might allow such a provision if it didn't bar Tokyo from a China deal but simply meant that such talks would trigger re-examination of the agreement with United States — and not kill it.