The UK and Japan

Forging a Global and Proactive Partnership

Chatham House report Updated 31 August 2021 Published 29 May 2019 ISBN: 978 1 78413 302 3

Shinzo Abe reviews an honour guard at the Foreign and Commonwealth office before his meeting with Theresa May on 10 January 2019 in London. Photo: Getty Images

Dr John Nilsson-Wright

Former Korea Foundation Korea Fellow and Senior Fellow for Northeast Asia, Asia-Pacific Programme

Sir Robin Niblett DPhil

Distinguished Fellow, Europe Programme

Hans Kundnani

Former Associate Fellow, Europe Programme

Email Hans
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Professor Ken Endo

Chair and Professor of International Politics, University of Tokyo

Yukiko Fukagawa

Yuichi Hosoya

Professor in International Relations, Keio University

Yohei Sasakawa

Harukata Takenaka

Tomohiko Taniguchi

Professor Akiko Yamanaka

As Japan and the UK face serious challenges at home and in their respective regions, this report makes the case that a stronger relationship could advance each country’s ability to address shared global concerns.

A Japanese translation of the report is also available as a PDF via this link.

Japan’s Response to Globalization and the Prospects for Closer Cooperation with the UK

Yukiko Fukagawa

Introduction

In recent years, supporters of the liberal international order have had little to cheer about. Particular low points include the introduction of the Trump administration’s ‘America First’ trade policy and the UK formally announcing its intention to leave the EU. Observers have highlighted commonalities in these events, primarily the anti-establishment or anti-globalization sentiments, which reflect weakened social cohesion in the West. Meanwhile, in Japan, partly due to ‘Abenomics’,94 there is a growing consensus that traditional protectionism is no longer sustainable. Over the same period, Japan has taken a more open approach to trade as demonstrated by its signing of the original Trans-Pacific Partnership (TPP)95 in 2016 and the EU–Japan Economic Partnership Agreement, which increased liberalization of agricultural trade. After Washington walked away from the TPP, Tokyo led the process with the remaining 11 TPP members to revise the agreement in the form of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which came into force at the end of 2018. The Abe administration has stressed that increasing economic integration will enhance growth momentum, and arguably it is this approach that has enabled it to survive several successive general elections; in February 2019 it became the second longest administration in the history of Japan’s constitutional government.

Why does Japan remain positive about having an open trade policy, at a time when historically open economies are shifting to a more closed agenda? This chapter seeks to answer this question by exploring Japan’s response to globalization. It also considers the opportunities for enhanced cooperation between Japan and the UK after Brexit, keeping in mind that, at the time of writing, there remains much uncertainty regarding the nature, timing and even the likelihood of any possible Brexit agreement between the UK and the EU.

Lessons from the ‘two lost decades’ and catching up with globalization

One important factor that differentiates Japan from Western liberal economies is that it did not reap the early benefits of globalization. It took more than a decade to recover from the unprecedented economic shocks of the 1990s, which lasted until Prime Minister Jun’ichiro Koizumi restructured the economy in the early 2000s. In retrospect, the country was slow to make these reforms a priority, as at that time the world economy was enjoying vigorous growth, which continued until the global financial crisis in 2008. The government’s perception that Japan lagged far behind in the globalization process meant it was surprisingly naive about the impact the 2008 crisis would have on its economy. In fact, Japan was one of the most severely affected among OECD members, recording a fall in GDP of 5.4 per cent in 2009. In the same year, the policy failures of the ruling Liberal Democratic Party (LDP), combined with a series of political scandals, triggered a historic political change and the Democratic Party of Japan (DPJ) came to power. The DPJ ambitiously tried to crack down on the LDP’s vested interests in areas including public works, agriculture and big business, claiming that switching subsidies from these traditional sectors to benefit households would boost private consumption, which represented more than 70 per cent of GDP. However, political instability and the DPJ’s inexperience in the policymaking process meant that domestic demand-led growth, as envisaged by the new government, never happened. Instead, deflationary pressure accelerated. Furthermore, the shock of the Tōhoku Earthquake followed by the Fukushima nuclear tragedy in Japan in 2011 ended the DPJ’s rule after just three years and ushered in a comeback for the LDP with the second Abe administration beginning in 2012.

The launch of Abenomics signalled that economic integration between Japan and the wider world was to become the centrepiece of the country’s growth strategy

During its time in office, the DPJ criticized former Prime Minister Koizumi’s restructuring as a type of ‘market fundamentalism’ and vigorously advocated a narrowing of the income gap between high and low earners, while simultaneously avoiding the anti-globalism narrative. With the support of the unions, it tried to increase labour protection but did not embrace the arguments of critics who suggested that the preoccupation of Japanese multinationals with global supply chains had eliminated jobs at home (the so-called ‘hollowing out’ phenomenon). Indeed, at the very end of the DPJ’s time in government, its leaders, including Prime Minister Naoto Kan, had put forward the idea of Japan joining the TPP – a commitment to a high-standard, market-opening trade agreement that seemed to reflect an acceptance of the inevitability of globalization. When Shinzo Abe returned to power with the LDP in 2012, his launch of Abenomics signalled that economic integration between Japan and the wider world was to become the centrepiece of the country’s growth strategy.

Since the introduction of Abenomics, the government has developed different growth strategies including the ‘Japan Revitalization Strategy’ (JRS), which was revised annually until 2016, followed by a ‘Future Investment Strategy’ (FIS) in 2017, and the ‘New Economic Policy Package’ (NEPP) in 2018. The early period of the JRS concentrated on industrial restructuring through deregulation and investment promotion (see Table 4.1), but since 2016 the focus has been on promoting initiatives such as ‘Society 5.0’,96 which includes IT-driven innovation. Within these growth strategies, economic integration is considered the way forward for expanding markets, encouraging FDI and promoting productivity. In addition, Society 5.0 has sought to attract talent and ideas to Japan from across the world by substantially deregulating residency conditions.

Table 4.1: The changing focus of growth strategies – JRS, FIS and NEPP

		JRS	JRS 2014	JRS 2015	JRS 2016	FIS 2017	NEPP
Industry focus	Healthcare/nursery	●	●	●	▲	▲
	Industry 4.0		●	●	▲	▲
	Telecom/logistics				●	▲
	Fintech			●	●	▲
	Next generation SC				●	▲
	Energy/environment	●	●	●	●	●
	Sharing economy					●
Sectors	SME	●	●	●	●	●	●
	Agriculture	●	●	●	●	●
	Inbound tourism	●	●	●	●	●
Integration	FTA/EPA	●	●	●	●	●
	Inbound FDI	●	●	●	●	●
	Infrastructure/content export	●	●	●	●	●
Infrastructure	PPP/PFI	●	●	●	●	●
	Digitization/cybersecurity	●	●	●	▲	▲
	Innovation/venture system	●	●	●	●	●	●
Regulation reform	Strategic zones/sandbox system	▲	▲	●	●	●	●
	Corporate tax reduction	▲	▲	▲
	Corporate governance reform	●	▲	▲	▲	●	●
	GPIF reform	●	●	●	●	●
	Electricity system reform	●	●	●	●	●
Human capital	Women’s empowerment’s	●	▲	▲	▲	●	●
	Working style reform	●	▲	▲	▲	▲	▲
	Education reform					▲	▲

Key: SC = Supply Chain; GPIF = Government Pension Investment Fund; PPP = Public–Private Partnership; PFI = Private Finance Initiative.

Note: Very significant (▲) and Significant (●) are as judged by the author, depending on whether the quantitative goals were set and checked as ‘Key Performance Indicators’, and what budgetary allocation was received.

Source: Prime Minister of Japan and His Cabinet (2018), ‘これまでの成長戦略について’ [On the Growth Strategies up to the Present], https://www.kantei.go.jp/jp/singi/keizaisaisei/kettei.html (accessed 3 Jan. 2019).

Elements of Abenomics have been sustained partly by echoing the ‘make America great again’ phenomenon associated with Donald Trump’s election in the US.97 This has been justified by the need to respond to China’s growing economy (which is now more than double the size of Japan’s) and the fact that Japan’s domestic market is plagued by deflation. The role of trade and its benefits for domestic growth have been pivotal in gaining public support for further global economic integration. In addition, since 2016, demographic changes and labour shortages have become a bottleneck for sustained growth. Changing global realities, shifting public perceptions and lessons from the country’s ‘two lost decades’, have pushed Japan towards a path of globalization.

Lesson 1: Business environment reform matters

During the period of economic stagnation in the 2000s, manufacturing firms in South Korea and China rapidly caught up with their competitors in Japan. After the global financial crisis, Japanese firms were challenged by South Korean business conglomerates (chaebols), which had the advantage of speedy decision-making and a commitment to globalization. Japanese firms lost global market share in various hardware manufacturing sectors, from heavy and chemical industries to high-tech machinery such as telecom devices, semi-conductors and even, in part, the car market. This experience highlighted the importance of reforming the business environment to ensure global competitiveness. During this time, Japan was disadvantaged in several ways relative to South Korea. The yen appreciated consistently against most major currencies and electricity prices soared, particularly after the Fukushima tragedy. Japan’s effective corporate tax remained among the highest in the world, and businesses had to comply with high environmental standards and labour protection policies initiated by the DPJ. FTA negotiations were slow and Japanese firms were restricted by higher tariffs and inferior market access relative to South Korean and other Asian exporters.

Japan’s first bilateral FTA was signed with Singapore in 2002, although it was several years before it signed its second, with Mexico (see Table 4.2). This can partly be linked to agro-protectionism within the Japanese economy.98 Japan later shifted to a plurilateral FTA focus, including the TPP and Regional Comprehensive Economic Partnership (RCEP, see Table 4.3).99 Compared with other trading powers, Japan has fewer FTAs covering export markets. However, Japan’s successful conclusion of an FTA with the EU, agreement on CPTPP, and the anticipated conclusion at the end of 2019 of the RCEP, will mean that most of Japan’s major export markets will fall under these trade liberalizing agreements.

As opening the economy will not automatically kick-start growth or generate jobs, integration strategies have been carefully designed to complement the government’s growth strategies. Table 4.3 shows these strategies and their links to prospective major trade pacts. In order to cope with increased competition from the prospective TPP, an Industrial Competitiveness Enhancement Act was introduced in 2014 to promote effective deregulation and rationalization of excessive competition and supply, and the corporate tax rate was cut from 37 per cent in 2013 to 29.7 per cent in 2018.100 In addition, the government has put in place electricity reforms to lower prices through deregulation of sales and price controls, and power generation and distribution systems are to be separated by 2020. The regulatory sandbox101 has also been utilized to promote experiments in innovation, and authorities are encouraging investors to adopt the Stewardship Code that governs UK company law to reform corporate governance. Furthermore, the government has encouraged women to participate in the workforce and improved conditions for irregular workers to enhance flexibility in the labour market. The yen has also effectively been made cheaper by quantitative easing. As a result, Abenomics has made Japan’s business environment more competitive in the global market.

Table 4.2: Progress of Japan’s FTA/EPA* negotiations (as of April 2019)

Date	FTA/EPA	Status
Nov. 2002	Japan–Singapore	In effect
Apr. 2005	Japan–Mexico	In effect
Jul. 2006	Japan–Malaysia	In effect
Sep. 2007	Japan–Chile	In effect
Nov. 2007	Japan–Thailand	In effect
Jul. 2008	Japan–Indonesia	In effect
Jul. 2008	Japan–Brunei	In effect
Dec. 2008	Japan–ASEAN	In effect
Dec. 2008	Japan–Philippines	In effect
Sep. 2009	Japan–Switzerland	In effect
Oct. 2009	Japan–Vietnam	In effect
Aug. 2011	Japan–India	In effect
Mar. 2012	Japan–Peru	In effect
Jan. 2015	Japan–Australia	In effect
Feb. 2016	TPP	Signed
Jun. 2016	Japan–Mongolia	In effect
Dec. 2018	CPTPP	In effect
Feb. 2019	Japan–EU	In effect
	Japan–Colombia	In negotiation
	Japan–Turkey	In negotiation
	RCEP	In negotiation
	Japan–China–S. Korea	In negotiation

Source: Ministry of Foreign Affairs (http://www.mofa.go.jp/mofaj/gaiko/fta/).

* Japan has negotiated package deals, including combined trade in goods, services and investment, and the title Economic Partnership Agreement (EPA) has been used officially instead of FTA.

Table 4.3: Japan’s growth strategies and their interface with prospective mega-FTAs

		TPP	RCEP	CJK	UK
Industry focus	Healthcare/nursery	●		●	●
	Industry 4.0	▲		▲
	Telecom/logistics	●	●	●
	Fintech			●
	Next generation SC	▲	▲	▲
	Energy/environment	●	▲	●	▲
	Sharing economy	●			●
Sectors	SME	●	▲	▲	●
	Agriculture	▲	▲	●	●
	Inbound tourism	●	▲	▲	▲
Integration	FTA/EPA	▲	▲	▲	▲
	Inbound FDI	▲	●	▲	▲
	Infrastructure/content export	▲	▲	●	▲
Infrastructure	PPP/PFI	●	▲	▲	●
	Digitization/cybersecurity	▲	●	●	▲
	Innovation/venture system	▲	●	●	▲
Regulation reform	Strategic zones/sandbox system	●
	Corporate governance reform	●			▲
	Electricity system reform	●	●	●	●
Human capital	Women’s empowerment				●
Human capital	Education reform		●	●	●

Key: SC = Supply Chain; GPIF = Government Pension Investment Fund; PPP = Public–Private Partnership; PFI = Private Finance Initiative; CJK = China–Japan–South Korea; UK = United Kingdom.

Notes: 1) Very significant (▲) and Significant (●) are as judged by the author, depending on whether the quantitative goals were set and checked as ‘Key Performance Indicators’, and what budgetary allocation was received; 2) There were 12 original TPP members: Australia, Brunei, Chile, New Zealand, Singapore, Peru, Malaysia, Vietnam, Mexico, Canada, Japan and the US. After the US decided to leave, the new pact was renamed CPTPP; 3) There are 16 RCEP members, including the 10 ASEAN countries, Australia, China, Japan, South Korea, New Zealand and India.

Lesson 2: Open innovation matters

Globalization has continued to challenge Japan’s traditional innovation system. In the past, the country’s manufacturing companies were characterized by comprehensive, in-house R&D activities. It is these firms that have typically manufactured ‘truly innovative’ products, which bear a significant R&D cost that leads firms to go to great lengths to protect their intellectual property. However, ‘truly innovative’ products are not guaranteed to be a success if consumers are not considered in their development, particularly due to their complexity and often excessive functionality. Sluggish revenues from 2008 to 2012 have restrained R&D budgets. As a result, innovative engineers and workers have ended up employed in the high tech companies of Japan’s rivals, such as China or South Korea, which has contributed to a vicious competitive cycle.

Since the 2000s, innovation has shifted to become a more market- or consumer-driven activity, rather than focusing on the latest engineering technology. The rise of manufacturing capabilities across Asia has made it difficult for Japanese firms to compete, while continuing to take risks in R&D. This is because their competitors avoid basic research costs by focusing on production of the most marketable technologies to produce customer-friendly products that are influenced by constant changes in trends and fashions. While originally committing to open innovation, these competitors gained their advantage by introducing modularized production processes. Even though these structural changes deprived Japanese firms of market share, it has taken a long time for Japanese companies to recognize them and respond by abandoning expensive in-house R&D. In response, the government has recently begun to push for open innovation by increasing coordination between business and academia. For instance, it has attempted to double the number of large joint research projects between universities and businesses from 690 in 2013 to 1,380 in 2020, as well as significantly increase the level of company investment into academia.102 Both of these initiatives are listed as key performance indicators to which Abenomics is committed.

The shift towards open innovation is slow. Previously, open innovation was narrowly interpreted in Japan simply as cooperation among government, business and academia. In an open innovation environment that requires exchange and cooperation, businesses had limited understanding of how to access and acquire research. Reforms in state universities were also slow, as they struggled to establish a platform to promote research exchange with companies. Technology licensing organizations in universities became common around 2000, but the lack of professionals necessary to manage and coordinate them remained a long-term challenge, as is the declining number of researchers in science itself. Moreover, introducing a flexible, efficient and transparent accounting system in state universities also required an enormous amount of trial and error, and failed to provide sufficient incentives for organizations and individuals to engage in open innovation. In recent years, big business has finally started to show more interest in cooperating with venture firms, including Asian firms, rather than universities, to shape the venture ecosystem through active M&As. Whether this alternative approach will really lead to open innovation in Japan remains to be seen.

The rise of manufacturing capabilities across Asia has made it difficult for Japanese firms to compete, while continuing to take risks in R&D

Lesson 3: Market pressure matters

Market pressures have prompted Japan to respond to the challenges of global competition by improving the domestic business environment and creating an open innovation system. In the face of political constraints at home, policymakers strategically used outside pressures (so-called gaiatsu103), such as standards and market rules stemming from the TPP, to bring about economic reform. The government has spent enormous political capital on gaining support from the agricultural sector for the TPP, which required much deeper trade liberalization than most other FTAs.104 The TPP has thus been used to push comprehensive agricultural reform.

The labour market has tightened rapidly since 2016, and even conservative, traditional firms have started to feel the pressure. This was partly the impetus for labour market reform, in the shape of the 2016 Act on Promotion of Women’s Participation and Advancement in the Workplace. This policy set numerical targets for the employment of women and for the dissemination of information on employment vacancies for women. As a result, there has been a marked increase of women in the Japanese workforce.

The Japanese government also passed an immigration law, which enabled 345,000 foreign workers to work in 14 specific areas, including nursery care, restaurants, construction, fisheries and various manufacturing sectors. The number of foreign workers has almost doubled, from 682,000 in 2012 to 1,279,000 in 2017.105 These quantitative changes do not mean there is a qualitative improvement for those employed, for example in the proportion of regular (versus irregular) workers106 or in terms of minority empowerment, but they do provide incentives for both government and business to work towards increased diversity management through market pressures, rather than having policy dictated by political ideologies.

Integration as a strategy for growth

As shown above, Japan’s globalization has been shaped by both its domestic situation and external market pressures. The third arrow of Abenomics, ‘structural reform’, targets annual GDP growth of JPY 600 trillion by 2020, with economic integration regarded as an essential part of this.

Japan was the last of the G7 economies to define R&D and other business services as ‘investment’ when it adopted the System of National Accounts (SNA) policy. Following the application of this new standard, Japan’s nominal GDP stood at JPY 547 trillion in 2017.107 However, its potential growth rate is currently only around 1 per cent, having bounced back from zero in 2009, but still unable to recover the 2 per cent level it enjoyed in the early 1990s.108 Therefore, substantial reforms are still required to increase productivity while countering the impact of the country’s rapid population decline. As the labour reserve provided by women, seniors and even those with disabilities has started to decline, Japan’s growth needs to focus more on boosting labour productivity through reform of working practices as well as total factor productivity through innovation. Experiments in the use of robots in elderly care, driverless cars to counter truck driver shortages, and product distribution by drones are currently taking place. These are encouraged by subsidies, tax breaks and deregulation until 2020. However, in an ageing society there are constraints on adopting these new technologies. For instance, the slow spread of smartphone use among older people and a preference for cash-based commercial transactions have remained and provide a poor basis for effective service innovation. Economic integration is therefore needed, not only to tap export potential, but also to accelerate innovation through the input of new ideas from abroad and competitive pressures.

The TPP: Supply chains, leverage and new rules

The TPP played a central role in Japan’s strategy for catching up in terms of globalization. Following the US withdrawal, Japan took a leading role in designing the replacement regional trade body, CPTPP. It left the door open for the US to rejoin, thus offsetting the risk of having to engage with it in bilateral trade negotiations.

Despite concerns over agricultural protectionism, Japan has been a strong advocate of the TPP/CPTPP and understands its economic significance. First, in response to a succession of yen appreciations, Japanese multilateral firms have extended a complex supply chain network across the whole Asia-Pacific region. Since the performance of overseas production and business networks affects the integrated profits of companies, ensuring the network is covered by a single set of rules is essential. For example, the rules of origin109 specification in CPTPP has a strategic significance in that it allows full recognition of values among its members. Therefore, if a Japanese firm assembles an electronic appliance in Vietnam for export to Australia, using parts supplied in Japan, the value originating in Japan can be aggregated with the relatively minor value accrued in Vietnam, enabling the products to enjoy free market access to Australia. For Japan’s extensive supply chains, generous rules of origin are regarded as a significant benefit.

Second, on the basis of profits from the supply chain, Japan has tried to increase membership of the TPP/CPTPP to achieve deeper and broader integration in the region. Again, rules of origin are expected to play an important role; for example, as a result of the wage hike in China, South Korean firms have recently shifted their major assembly lines to Vietnam, a member of CPTPP. However, the value of parts and other necessary input from South Korea, which is not a member, cannot be aggregated with the values in Vietnam when goods are exported to a member country. As a result of this discrimination and competition with Japan, the South Korean government is under pressure to enter into discussions on joining CPTPP. If it joined, this would encourage competition with Taiwan, and if Vietnam continues to attract FDI thanks to CPTPP, this might also lead to competition between Vietnam and other ASEAN members, such as Thailand, the Philippines and Indonesia. Japan hopes that this domino effect might pressure China to become serious about rules-based FTAs that require members to adhere to higher standards.

Originally the TPP had the strategic purpose of creating a group that could collectively bargain with large emerging economies, such as China, which tends to leverage its market power politically. Unlike the WTO, which could not make the necessary changes to its rules to avoid this type of behaviour, the TPP, a plurilateral agreement among like-minded members, was created to initiate new rules with a specific focus on investor protection and the competition environment on a ‘WTO-plus’ basis. For instance, the TPP guaranteed stricter national treatment measures in investment and banned various government interventions into private business such as access to source code, server controls and restrictions on data movement. Under the TPP, intellectual property rights (IPR) protection was substantially enhanced, above the WTO level. It also introduced investor-state dispute settlement (ISDS) measures to better protect investors, and the transparency principle to ensure members are accountable for import inspection, sanitary and phytosanitary measures and technical barriers to trade, as well as focusing on competition rules for state enterprises, restricting non-commercial aid and favourable lending by government-controlled financial institutions.

The strategic character of the TPP faded when it became CPTPP, without US market power – especially in terms of IPR protection for pharmaceutical businesses and others – but it retains the original framework. While the Trump administration has stuck to bilateral negotiations, interestingly, the revised North American Free Trade Agreement (NAFTA) and South Korea–US FTA have much in common with the original TPP, indicating that US national interests have not changed. Japan has the largest financial assets and FDI stock in the region, so the alliance and cooperation with the US in creating the original agreement remain an essential part of CPTPP.

The strategic character of the TPP faded when it became CPTPP without US market power, but it retains the original framework

The RCEP: Supply chains, market growth and market-led integration

Expectations regarding the RCEP have been far lower than for CPTPP. Negotiations began in 2012, but progress has been extremely slow. China’s interests have shifted away from FTAs towards a stronger focus on its leadership in regional cooperation, rather than liberalization. This is symbolized by the Belt and Road Initiative and the establishment of the Asian Infrastructure Investment Bank (AIIB). Meanwhile India has remained rather negative about opening its market. The RCEP was originally an initiative by ASEAN, which coordinated FTA agreements with individual members (China, Japan, South Korea, Australia, New Zealand and India). ASEAN continues to try to control the RCEP process. It stresses that these partnerships should be based on common tariffs among members, as is the case in its intraregional ASEAN Free Trade Area. However, while Japan is supportive, both China and South Korea oppose this idea, and this has constrained the pace of negotiations from the start.

For Japan, it does not matter that progress on the RCEP is slow or that the standard may end up lower than what was outlined in the original TPP. Emerging economies are growing at a much faster rate than developed ones, and as the markets change, opportunities for renegotiation remain. In fact, RCEP members have agreed to the liberalization of ‘substantially all trade within a certain period’ (GATT Article 24, and GATS Article 5)110 and have committed to ‘substantially improved, wider, and deeper integration than in the ASEAN plus ones’ individual agreements. RCEP members have also agreed on a comprehensive pact, which includes services, investment and trade enhancement, among other considerations. Through its global supply chains, Japan has experienced benefits from the process of integration – including through tourism and business exchanges – and hopes to realize the potential of these emerging markets gradually.

It is worth highlighting that the RCEP framework is essentially the closest possible framework to a Japan–China FTA for which bilateral negotiations are politically too difficult. Like CPTPP, the RCEP also may provide a platform for competitive liberalization in Japan, South Korea and China. Once the RCEP is agreed, any future Japan–China agreement will theoretically be more liberal than the 2015 China–South Korea FTA. This may create an incentive for South Korea to upgrade its pact with China, at least to the level of the Japan–China concession. On the other hand, if South Korea joins CPTPP, it will effectively constitute a virtual FTA between Japan and South Korea in the plurilateral framework.111 Since achieving an FTA with China is politically the most challenging of all, Japan has taken a detour by pursuing the two plurilateral approaches, CPTPP and the RCEP. It has also taken a similar approach with India; the Japan–India FTA was established in 2011 but needs substantial review. Japan has encouraged positive relations between ASEAN and India through the former’s supply chain, and in this context the ASEAN-led RCEP has the potential to improve relations between Japan and India. Thus, while committed to CPTPP’s rule-based institutional approach, Japan has tried to take a more realistic and flexible approach to the emerging economies through the RCEP. This may be at a lower institutional level than CPTPP, but as the growth potential is far higher and economic impact is greater for Japan, an early agreement to the RCEP negotiations is necessary, especially since this will also help to counterbalance the Trump administration’s unilateral trade policies.

China–Japan–South Korea (CJK) FTA: Competition policy, innovation and IPR

At present, progress in negotiating a China–Japan–South Korea (CJK) FTA has been slow. This can primarily be attributed to a lack of political will among the three countries, but the process has also stalled due to a loss of vision,112 which reflects market changes since talks began. When negotiations started in 2012, there was an established division of labour among the three countries, mainly in hardware manufacture. In electronics, vertical integration was common: Japan focused mostly on value-added materials and parts, which it exported to South Korea or Taiwan, where various devices were processed, with China assembling them into the final products such as home appliances, audio-visual devices and mobile phones. However, in the past decade this vertical division of labour has changed. China has tried to gain a larger part of the process to reflect the increase in its value-added production. The Chinese government has also encouraged outward FDI through M&As in order to acquire advanced technologies.

As the division of labour increasingly shifts from vertical to horizontal, and the structure of trade becomes more competitive than complementary, competitive tension among CJK has increased. Unlike the EU integration process, the cross-border M&A market in CJK is far from developed and is often affected by industrial nationalism113 rather than governed by rules. As industrial structures converge and competition intensifies, the CJK business sectors need a comprehensive competition policy.114 Both the US and the EU have recently started to tighten scrutiny of China’s M&As, and these trends tend to justify the industrial nationalism in CJK. At the same time, there has been a lack of research and discussion on competition policy coordination, which may diminish the potential for integration. A further impediment to advancing strategic competition policy is the fact that Japan and other Western economies have yet to acknowledge China as a genuine market economy within the WTO regime.115 Competition policy requires serious dialogue and greater efforts to achieve mutual understanding.

Prior to the trilateral negotiations, the shared vision for CJK integration focused solely on hardware manufacturing,116 but China’s industrial restructuring over the last decade has changed this vision. China has tried to lead the new industrial paradigm, including the ‘internet of things’, fintech and AI-applied IT platforms. These new economies do not necessarily need inward FDI or a traditional market-opening framework and are based heavily on the Chinese market with its unique regulatory context. At the same time, China has tried to lead the technology shift to electric cars. While petrol-based engines require complicated and subtle connections among the components – an area where China has found it difficult to catch up – the development of electric cars may be an opportunity for Chinese companies to be more competitive.

Elsewhere in China’s economy, the pace of restructuring in heavy industries such as steel or cement tends to be far slower, and there are now fewer incentives for liberalization in hardware manufacturing in the country. CJK need to reconsider the strategic and specific gains of integration. For China, with its lead in the AI and IT platform-based industries, IPR and data-related regulations should be a priority to protect its own development. With Japanese companies lagging behind Chinese companies in this sector, there is increasing pressure on Japan to forge better, cooperative relations with its neighbours.

At this stage, it remains to be seen whether the CJK countries will be able to finalize an independent agreement. It is possible that developments may occur on the sidelines of plurilateral frameworks such as CPTPP or RCEP, but these will not necessarily fit unique CJK economic structures. The question then remains whether CJK should base integration on existing frameworks, or proactively revise their trilateral engagement to match their own specific circumstances. Future trilateral negotiations could be based on the vision and recommendations laid out in the China–Japan–Korea Joint Study Group (2011),117 which wrapped up discussions on cooperation potential from 2003 to 2011. However, since then the industrial structure has converged rapidly, and the 2011 report ignores items such as competition policy coordination, deregulation in FDI and services, IPR and trade-enhancing measures. As in Japan, the rate of ageing in the populations of South Korea and China is accelerating. This means healthcare and elderly care, as well as innovative technology and services in these sectors, have become significant focus areas. CJK are not only hardware manufacturers, but also the leading markets for next-generation services, including 5G mobile communications. Based on these development and market changes, CJK have the highest use of robotics in industry, and their future supply chains will be fully integrated with the internet. These developments show that Japan has shared interests with South Korea and China, and future trilateral integration should focus more on innovation and the service sector, rather than hardware manufacturing and other ICT businesses found in conventional FTA packages.

Prospects for cooperation between Japan and the UK

As outlined above, economic integration within Asia has been perceived as a specific growth strategy in Japan, which has been driven by the need to catch up on globalization and the conscious use of market pressures for reform. As Table 4.3 shows, the major growth strategies and integration packages are interlinked. With regard to political stability, there is a high expectation that Japan will continue to promote integration with the UK, although the prospects for this post-Brexit (in whatever form) remain very uncertain. However, both countries can benefit, if they use the changes associated with Brexit as an opportunity, not a misfortune. Since the Japan–EU EPA was implemented in 2019, Japan and the UK will need to agree on a new bilateral integration package immediately after Brexit.

Traditionally, the two countries’ mutual economic relations have been at a relatively minor level, with the exception of Japan’s FDI into the UK. Japan’s exports to the UK were worth $13.7 billon (2 per cent of all trade exports) in 2017 and its imports from the UK only $7 billion (1.1 per cent of all imports). In the same year, Japan accounted for only 1.6 per cent of UK trade exports and 2.1 per cent of imports. However, its FDI into the UK reached $152.6 billion, or 9.8 per cent of its whole portfolio, in 2017, making Japan the UK’s second largest investor after the US. Through this investment, approximately 1,000 Japanese firms created around 160,000 jobs in the UK.118 Japan has invested not only in the financial sector, but also in the automotive, electronics and other manufacturing and services sectors. The main attraction being the UK’s business-friendly climate before Brexit and the English-speaking environment.

It is clear that bilateral UK–Japan FDI is underperforming. The major reason for this asymmetric relationship is that while the UK has been the main gateway to the EU for Japan, for the UK, Japan represents just one independent market, which has not experienced much growth and is not very well integrated with the rest of Asia. Japan’s poor return on inward FDI has also been a major contributory factor.

Reflecting upon these asymmetric relations, it is natural for both parties to talk about the priority of minimizing the negative shock of Brexit. From Japan’s point of view, a soft Brexit may allow more time for discussion to establish a free-trade area for goods with the EU, ‘based on the common rulebook for all goods’, as suggested by the UK government in its Chequers statement.119 In the case of a hard Brexit, if ‘a highly streamlined customs arrangement’ and ‘a new customs partnership’120 are established, Japan may cooperate with the UK, for instance, by coordinating the Japan–EU EPA and a future Japan–UK FTA in terms of rules of origin and trade facilitation measures. For practical purposes, it may be beneficial to enable broad rules of origin to cover the supply chains among the three parties, as in CPTPP. Especially if the UK leaves the EU customs union, determining the extent to which rules of origin cover supply chains and trade facilitation is essential for economic efficiency.

While the UK has been the main gateway to the EU for Japan, for the UK, Japan represents just one independent market, which has not experienced much growth and is not very well integrated with the rest of Asia

After any post-Brexit ‘interim period’, another challenge for Japan will be to ensure that the relationship with the UK becomes more interactive and balanced. This can be approached from two angles. Since Japan is expected to pursue integration as its growth strategy, through mega-FTAs like CPTPP, the RCEP and CJK, the UK could, in principle, enjoy increased access to the Asia-Pacific market by using Japan as its gateway, much as Japan has used the UK to access the EU market in the past. Though it is not certain at this stage whether the UK will pursue its ‘Global Britain’ strategy, assuming it is no longer in a customs union with the EU after Brexit, joining CPTPP actually would offer it the first group of candidates for FTAs: Japan, Australia, New Zealand and Canada. Were the US to return to CPTPP (although this is unlikely), CPTPP’s economic coverage would be almost identical to the whole of the UK’s non-EU trade. Even without the US, it would still cover more than 30 per cent of non-EU trade, which is growing rapidly. Since CPTPP requires newcomers to accept the whole pact as it stands, bargaining for special treatment would not be easy. However, it is essentially a business-oriented FTA, not a customs union binding the external trade policies of its members. It has no common immigration policies, no common safety standards or beyond-the-border regulations, and the sovereignty of members is tactfully observed. There is no equivalent to the EU Commission, and without the US, the controversial ISDS has become more restricted. Other rules such as expanded IPR, server controls or data movement rules would generally fit the UK’s service- and IT-driven economy, especially in trying to cultivate and compete fairly in the emerging Asia-Pacific markets. Within CPTPP, the UK may be able to bargain more efficiently bilaterally with China and India, on the basis of their own particular interests. However, given that the unilateral trade policy of the US has shaken the WTO, the larger the market, the faster it grows, the stronger its bargaining power. If CPTPP or any kind of plurilateral pact offers a better bargaining position for ‘Global Britain’ vis-à-vis the US, it may be worth discussion.

Finally, there may be questions about how to promote ‘bilateral’ Japan–UK cooperation independently from the context of economic integration. Japan has borrowed many ideas from the UK in trying to benefit from globalization. The reform of corporate governance through the introduction of a stewardship code originated in the UK, and open innovation in Japan needs many market-enhancing services, including corporate venture capital, accelerators for venture firms, business matching services, application program interface (API) services, and various kinds of technology consulting where the UK has experience. Since the UK has been competitive in business services, seeking out the market potential in Japan should create a positive agenda for the bilateral relationship. Both parties may be able to share knowledge and experience in cultivating the market not only through their successes but also through sharing lessons learned from failures.

With regard to public–private partnership (PPP) and private finance initiatives (PFI), Japan is in a totally different position to the UK. PPP/PFI has been severely criticized in the UK, even after the introduction of the new approach to PPP in the form of Private Finance 2 (PF2) to allow minor equity holding by government, exclusions for ‘soft services’ (like cleaning), limitations on risk transfer to the private sector, transparency rules, and diversified capital allocation, which led to the failure of Carillion in 2018. On the other hand, Japan lags far behind in terms of PPP/PFI, and through Abenomics the government is now trying to double the total size of such projects to JPY 21 trillion (£141.8 billion) by 2022, from the current level of JPY 10–12 trillion,121 expanding the coverage to schemes ranging from airports, waterworks, sewerage and roads to housing and schools. In Japan, there is no criticism of the excessive profits or windfall gains in the private sector, but it has the opposite kind of problem in that the private sector lacks adequate incentives for participation, typically because of regulations on equity transactions. Major projects have still been limited to infrastructure building only, and service-purchasing-type PFIs are regarded by firms as merely ‘low-risk, low-return’ projects. For Japan, learning how to share the risk burden between the government and the private sector flexibly and reasonably in changing market conditions remains a major challenge, and if Japan and the UK can together successfully shape reasonable PPP/PFI standards in Japan for the Asia-Pacific market, this may promote more fruitful investment in the emerging markets.

Moreover, as a mature economy and mid-sized country with an ageing demographic, Japan has come to see social innovation as a potential resource for growth. Abenomics has shown the country that, no matter how desperately the government may seek success from sandbox deregulation, entrepreneurship motivated by social purpose is desperately required to realize it. In general, Japan has been slow to develop IT-based services, but this is because Japanese users have been fairly satisfied with existing ones. For instance, public services in Japan never became too costly or degraded, even after the global financial crisis, but examined in detail there are many potential opportunities for innovation as the labour shortage has started to threaten service provision.

Mature economies may be destined to decline in size relative to emerging economies, but both Japan and the UK need to find a way to survive globally, while maintaining their rich local traditions and realizing their business and innovative strengths

Sharing knowledge and expertise in social innovation may become a strategic area for cooperation between the UK and Japan, partly because of their similar situations. In democratic states with local authorities, neither central government nor national parties can implement the sort of radical deregulation that is possible in emerging economies. Ageing is slower in the UK than in Japan but remains an inevitable conundrum given progress in medical innovations. Issues such as how to sustain social welfare services therefore need intensive discussions. Both countries wish to have an arm’s-length form of economic integration with their immediate regions. As recent reflections over PPP/PFI have suggested, the generation of new ideas for project efficiency may benefit from the active participation of the public, local communities and NGOs in similar settings, as well as cultivating strategic and practical discussions on social innovation markets. Mature economies may be destined to decline in size relative to emerging economies, but both Japan and the UK need to find a way to survive globally, while maintaining their rich local traditions and realizing their business and innovative strengths.

Conclusion

Under Abenomics, Japan has focused on economic integration as a part of its growth strategy. Labour shortages that have not been met by a rise in foreign workers have been somewhat mitigated by the increasing participation of women and older people, and the application of AI and other new technologies has started to replace human labour, though at a slower rate than in other Asian countries. Meanwhile, the pace of wage rises has remained slow and the government has committed to increasing productivity and innovation in an attempt to address this. It is difficult to encourage private consumption in Japan without higher wages as would normally be expected if there is a shortage of labour.

On the other hand, while trying to control or even to utilize industrial nationalism in competition with South Korea and China, the government has succeeded in convincing the Japanese public that economic integration is a necessary and proactive policy to compete with Japan’s neighbours and improve living standards through market growth. An example of this is the resulting rise in tourists visiting Japan, which has contributed to boosting small businesses and in some cases increased property prices. In addition to CPTPP and the Japan–EU EPA, Japan is likely to continue its integration efforts, for example by signing up to the RCEP or by concluding FTAs with China, South Korea, and probably with the UK after Brexit.

Assuming that the Japanese commitment to globalization lasts for at least another decade, while the UK tries to muddle through the Brexit aftermath, Japan–UK cooperation on more balanced development may be discussed in three areas. First, Japan’s FDI into the UK may be significantly undermined, depending on what kind of Brexit occurs. Brexit may influence Japan’s supply chains and its assets in the City of London. If a post-Brexit UK seeks to promote a ‘Global Britain’, Japan may be happy to discuss the coordination of practical rules of origin and other trade enhancement measures to link both the Japan–EU EPA and any future Japan–UK FTA.

Second, if the UK were to participate in CPTPP it may bolster Britain’s preparation for talks with the larger emerging economies including China and India. In addition, Japan is negotiating the RCEP and a CJK FTA. Considering the high level of liberalization and comprehensiveness of all these agreements, ‘Global Britain’ may therefore be able to enjoy access to the Asia-Pacific market by making Japan its gateway to the region. Japan has become far more serious about attracting inward FDI under Abenomics, and promoting FDI with service sector cooperation in an interactive way will help make any future UK–Japan relationship more balanced.

Finally, even in a bilateral context, both markets may reveal opportunities that are as yet untapped. Japan’s efforts to take advantage of globalization have often been influenced by the UK, including corporate governance reform, sandbox deregulation, start-up environmental reform and PPP/PFI. UK investors may occupy an advantageous position in various business services such as marketing, consultancy or information transmission, and thus be good advocates for service-sector growth strategies in Japan, while learning from Japan’s economic progress and how it has dealt with low growth, a potential long-term outcome for the UK given the turbulence of Brexit. While enjoying a third boom in start-ups, though modest both in volume and in pace compared with China, Japan has steadily shifted its focus to types of business that focus on social innovation, including fintech, healthcare, more varied and value-added tourism and smart cities, all of which are based on AI/IT technologies. As mature economies, Japan and the UK share many similarities in their market environments. Redefining each other’s potential in both global and bilateral contexts may lead to successful outcomes for both post-Abenomics Japan and post-Brexit Britain, while also enabling a better balance and a deepening of the bilateral relationship that has lasted for more than a century.

94 ‘Abenomics’, the policy package launched in 2013, is now well known for its ‘three arrows’, the first being quantitative easing, the second agile fiscal spending and the third private-sector-led growth strategies.

95 The TPP originated in the P4 Agreement signed in 2006 by Singapore, Chile, New Zealand and Brunei. In 2010, the US, Australia, Peru, Vietnam and Malaysia joined, followed by Canada, Mexico and Japan, to form the TPP-12.

96 A Japanese government policy that seeks to harness technologies, such as AI and the ‘internet of things’, in response to social challenges in sectors including healthcare, mobility and infrastructure.

97 Abenomics shares some elements of policies implemented by the Trump administration including cutting corporate tax, claiming there is ‘unfair’ competition from China and other emerging economies with state enterprises and exchange rate intervention, and reducing the commitment to environmental protection. The only notable difference, albeit a fundamental one, is the Abe administration’s commitment to globalization and maintenance of the rule of law – an issue that presumably requires a reinforcement of a free and open international trade regime.

98 Japan’s tariffs on manufactured goods are the lowest in the world, leaving the agricultural sector as the focus in every FTA negotiation.

99 Japan is the largest importer of meat, and in the original TPP, the US, Australia, New Zealand and Mexico competed with each other to mitigate the speed of liberalization for Japan.

100 Ministry of Finance (2018), ‘法人実効税率の国際比較’ [International Comparison of Effective Corporate Tax Rates], https://www.mof.go.jp/tax_policy/summary/corporation/084.pdf (accessed 25. Jan. 2019).

101 This refers to project-based deregulation, where the government creates a special deregulatory environment to enable businesses to test new products, services or business models.

102 Prime Minister of Japan and His Cabinet (2016), ‘日本再興戦略2016’ [Japan Revitalization Plan 2016], https://www.kantei.go.jp/jp/singi/keizaisaisei/miraitoshikaigi/dai13/siryou2-2.pdf (accessed 11 Feb. 2019).

103 For the well-researched role of gaiatsu in the Japan–US political economy, see, for example, Calder, K. (1988), ‘Japanese Foreign Policy Formation: Explaining the Reactive States’, World Politics, 40(4), pp. 517–41; Rosenbluth, F. M. (1989), Financial Politics in Contemporary Japan, Cornell University Press; Schoppa, L. J. (1997), Bargaining with Japan: What American Pressure Can and Cannot Do, Columbia University Press; Suzuki, K. (2013), Political Process of Japan-U.S. Structural Impediments Initiative, Kyoto: Minerva Shobo.

104 In the TPP, Japan agreed to abolish tariffs on 81 per cent of all agricultural trade, while in the 13 other FTAs before the TPP, including with Australia, the average was only 56 per cent. However, in TPP, Japan tried to exclude rice, wheat, beef, pork and dairy goods but even among these, 30 per cent of tariff lines were eventually lifted.

105 Ministry of Health, Labour and Welfare (2017), ‘Report on Foreign Worker Employment’, https://www.mhlw.go.jp/stf/houdou/0000192073.html (accessed 3 Jan. 2018).

106 Since the Japanese labour market had relied on the long-term employment system for decades, which did not promote mobility, the largest wage gap is between regular workers and irregular (temporary) and part-time workers. This reflects working experience rather than productivity itself. Labour shortages have encouraged the participation of women and seniors in the labour force, but their working style cannot converge with that of male workers fully committed to their traditional working style with long working hours.

107 Cabinet Office (2017), ‘National Accounts for 2017 (2008SNA, benchmark year = 2011)’, https://www.esri.cao.go.jp/en/sna/data/kakuhou/files/2017/2017annual_report_e.html (accessed 3 Jan. 2019).

108 Before the standard changes in the SNA, the Cabinet Office revised its estimation of the potential growth rate and published the results. The latest estimate from 2016 is used here. See ‘Monthly Economic Development’ for figures, http://www5.cao.go.jp/keizai3/getsurei-e/index-e.html (accessed 3 Apr. 2019).

109 As an exclusive trade pact, an FTA usually needs specific rules of origin. In determining these rules, one typical standard is to aggregate the value produced among the member countries, but CPTPP generously allows full aggregation in order to promote free trade among the members.

110 World Trade Organization (1994), ‘Article XXIV of the General Agreement on Tariffs and Trade’, https://www.wto.org/english/tratop_e/region_e/region_art24_e.htm (accessed 2 May 2019); World Trade Organization (2018), ‘GATS – Article V (Jurisprudence)’, December 2018, https://www.wto.org/english/res_e/publications_e/ai17_e/gats_art5_jur.pdf (accessed 2 May 2019).

111 As CPTPP does not allow newcomers to renegotiate and requires that they simply accept the liberalization programme, there will be no negotiation between Japan and South Korea.

112 CJK had spent more than seven years of joint research on a shared vision for integration before negotiations started in 2012. See the various reports on CJK integration by the National Institute for Research Advancement (NIRA) from 2003 to 2009, Abe, K. and Urata, S. (eds.) (2008), Japan-China-Korea FTA: The Significance and Challenges, http://www.nira.or.jp/outgoing/report/entry/n080206_146.html (accessed 21 May 2019).

113 Examples of large electronics manufacturers that lost competitiveness include Sharp, which was acquired by the Foxconn group, based in Taiwan, and Toshiba, which sold its home appliances section to the Midea group, based in China. However, the number of large-scale M&As is still limited in Japan.

114 In Toshiba’s restructuring, China intervened in the semiconductor M&A by a US and South Korea-based fund in 2018, on the basis of Chinese anti-monopoly law.

115 China has pushed market economy status almost as the precondition for FTA negotiations, but the only major countries in the region that have accepted China’s market economy status are Australia and South Korea.

116 At the time of the joint research process, published by NIRA, China strongly rejected trade issues related to the exchange rate regime, and the IPR protection agenda, trying instead to limit the focus to hardware manufacturers and their tariffs. See National Institute for Research Advancement (NIRA), China Development Research Center (DRC), and Korea Institute of International Economic Policy (KIEP) (2008), ‘日中韓共同研究中国・日本・韓国間の経済協力強化に関する共同研究報告書及び政策提言’ [Joint Report and Policy Proposal on Economic Cooperation among China, Japan and Korea] http://www.nira.or.jp/outgoing/report/entry/n080206_146.html (accessed 4 Apr. 2019).

117 Ministry of Foreign Affairs of Japan (2011), ‘Joint Study Report for an FTA among, China Japan and Korea’, 16 December 2011, https://www.mofa.go.jp/mofaj/press/release/24/3/pdfs/0330_10_01.pdf (accessed 3 Jan. 2018).

118 JETRO (2018), 世界貿易投資報告 [Global Trade and Investment Report], https://www.jetro.go.jp/world/gtir/2018.html (accessed 3 Jan. 2019); Ministry of Foreign Affairs (2018), 英国基礎データ[Basic Data, United Kingdom of Great Britain and Northern Ireland], https://www.mofa.go.jp/mofaj/area/uk/data.html (accessed 30 Jan. 2019).

119 HM Government (2018), ‘Statement from HM Government’, 6 July 2018, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/723460/CHEQUERS_STATEMENT_-_FINAL.PDF (accessed 3 Oct. 2018).

120 HM Government (2017), ‘Future customs arrangements: A future partnership paper’, 15 August 2017, https://www.gov.uk/government/publications/future-customs-arrangements-a-future-partnership-paper (accessed 3 Oct. 2018).

121 Prime Minister of Japan and His Cabinet (2016), 日本再興戦略 2016 [Japan Revitalization Plan 2016], https://www.kantei.go.jp/jp/singi/keizaisaisei/pdf/2016_zentaihombun.pdf (accessed 30 Jan. 2019).

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The UK and Japan

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Japan’s Response to Globalization and the Prospects for Closer Cooperation with the UK

Yukiko Fukagawa

Introduction

Lessons from the ‘two lost decades’ and catching up with globalization

Table 4.1: The changing focus of growth strategies – JRS, FIS and NEPP

Lesson 1: Business environment reform matters

Table 4.2: Progress of Japan’s FTA/EPA* negotiations (as of April 2019)

Table 4.3: Japan’s growth strategies and their interface with prospective mega-FTAs

Lesson 2: Open innovation matters

Lesson 3: Market pressure matters

Integration as a strategy for growth

The TPP: Supply chains, leverage and new rules

The RCEP: Supply chains, market growth and market-led integration

China–Japan–South Korea (CJK) FTA: Competition policy, innovation and IPR

Prospects for cooperation between Japan and the UK

Conclusion