EU-Japan FTA carries political weight though trade gains are more modest and longer term

The EU-Japan free trade agreement sends a political message amid heightened global trade tensions, transcending its limited near-term economic impact. Long term, the FTA will provide a modest GDP boost and may shift the trade balance in Europe’s favour.

Scope Ratings believes the EU-Japan Economic Partnership Agreement signed on Tuesday underscores the commitment of both parties not just to the liberalisation of trade but also to data protection, intellectual property rights, corporate governance, and sustainable development.

“The EU and Japan (A+/Stable) are sending a strong signal to advocates of protectionism and critics of the world’s rules-based trading system, including in the current US administration but also within some European countries,” says Scope analyst John F. Opie.

Overall, the EU and Japan already have low tariffs on goods, with average most-favoured-nation tariff rates of 3.8% in the case of both partners. The trade-weighted average tariff rate in Japan for EU exports is 1.7%, while the reverse for Japanese exports to the EU is 3.4%. The impact of the new FTA will depend on how the tariff phase-out affects market size and the number of markets, as well as price elasticities.

These tariffs will be phased out over 15 years. The FTA also includes trade in services, in which the EU exports around EUR 28bn to Japan each year, with a surplus in services trade with Japan of EUR 13bn in 2017. Under the FTA, 99% of remaining tariffs on traded goods will eventually be eliminated between the partners, with the European Commission expecting EU exporters to save around EUR 1bn in custom duties per annum.

The European Commission estimates that reducing levies and other barriers over the long term could boost the EU’s GDP by 0.8% and Japan’s by 0.3%. Europe’s food sector will benefit the most, with easier access to Japanese markets, while Japanese car and car part makers will have easier access to European markets, where their sales have been weaker than European rivals.

The agreement comes into force in 2019 after ratification from the European and Japanese parliaments. Scope does not anticipate political barriers to ratification, but equally does not expect the agreement to have a significant near-term impact on relevant sovereign ratings.

“Furthermore, the longer-term impact of the FTA shouldn’t be exaggerated”, adds Opie.

The pact foresees a lengthy 15-year phase-out period while large surpluses in favour of Japan have long characterised the EU-Japan goods trade, even if they have recently narrowed. From a European perspective, the Japanese domestic market remains challenging due to local societal and economic preferences for local products and services. EU companies may now compete for public procurement tenders in 48 core cities in Japan, as well as in the Japanese public railway sector, but it remains to be seen how many new trade opportunities this may open.

“There is a fundamental asymmetry in trade relations between a culturally homogenous, island country and a multicultural bloc of sovereign nations.”

Scope believes that the EU-Japanese trade balance could shift in Europe’s favour if only because there is more room for Japan’s markets to open versus vice versa, due to greater non-tariff barriers and depending on import-export elasticities. Sectors with high non-tariff barriers are a case in point: reducing bureaucratic entanglements, a key element of the FTA, will aid EU exporters, who have faced difficulties in the past in meeting high Japanese standards. Under the FTA, Japan agrees to use international standards and will cooperate with the EU in setting new international technical standards.

The EU-Japan free trade agreement sends a political message amid heightened global trade tensions, transcending its limited near-term economic impact. Long term, the FTA will provide a modest GDP boost and may shift the trade balance in Europe’s favour.

Scope Ratings believes the EU-Japan Economic Partnership Agreement signed on Tuesday underscores the commitment of both parties not just to the liberalisation of trade but also to data protection, intellectual property rights, corporate governance, and sustainable development.

“The EU and Japan (A+/Stable) are sending a strong signal to advocates of protectionism and critics of the world’s rules-based trading system, including in the current US administration but also within some European countries,” says Scope analyst John F. Opie.

Overall, the EU and Japan already have low tariffs on goods, with average most-favoured-nation tariff rates of 3.8% in the case of both partners. The trade-weighted average tariff rate in Japan for EU exports is 1.7%, while the reverse for Japanese exports to the EU is 3.4%. The impact of the new FTA will depend on how the tariff phase-out affects market size and the number of markets, as well as price elasticities.

These tariffs will be phased out over 15 years. The FTA also includes trade in services, in which the EU exports around EUR 28bn to Japan each year, with a surplus in services trade with Japan of EUR 13bn in 2017. Under the FTA, 99% of remaining tariffs on traded goods will eventually be eliminated between the partners, with the European Commission expecting EU exporters to save around EUR 1bn in custom duties per annum.

The European Commission estimates that reducing levies and other barriers over the long term could boost the EU’s GDP by 0.8% and Japan’s by 0.3%. Europe’s food sector will benefit the most, with easier access to Japanese markets, while Japanese car and car part makers will have easier access to European markets, where their sales have been weaker than European rivals.

The agreement comes into force in 2019 after ratification from the European and Japanese parliaments. Scope does not anticipate political barriers to ratification, but equally does not expect the agreement to have a significant near-term impact on relevant sovereign ratings.

“Furthermore, the longer-term impact of the FTA shouldn’t be exaggerated”, adds Opie.

The pact foresees a lengthy 15-year phase-out period while large surpluses in favour of Japan have long characterised the EU-Japan goods trade, even if they have recently narrowed. From a European perspective, the Japanese domestic market remains challenging due to local societal and economic preferences for local products and services. EU companies may now compete for public procurement tenders in 48 core cities in Japan, as well as in the Japanese public railway sector, but it remains to be seen how many new trade opportunities this may open.

“There is a fundamental asymmetry in trade relations between a culturally homogenous, island country and a multicultural bloc of sovereign nations.”

Scope believes that the EU-Japanese trade balance could shift in Europe’s favour if only because there is more room for Japan’s markets to open versus vice versa, due to greater non-tariff barriers and depending on import-export elasticities. Sectors with high non-tariff barriers are a case in point: reducing bureaucratic entanglements, a key element of the FTA, will aid EU exporters, who have faced difficulties in the past in meeting high Japanese standards. Under the FTA, Japan agrees to use international standards and will cooperate with the EU in setting new international technical standards.