New US President Donald Trump has announced the country’s withdrawal from the Trans-Pacific Partnership (TPP), and his intention to impose a heavy tariff on imports from Mexico. A wave of protectionist policies is rising around the world, as evidenced by Britain's decision to leave the EU and Indonesia's imposition of export restrictions on raw mining resources. Against this background, at the Asia-Pacific Economic Cooperation (APEC) meeting held on 20 November 2016, Japan's Prime Minister Shinzo Abe stressed that free trade is the wellspring of growth in the world economy, and expressed his opinion that protectionism should be opposed by economic policies that promote inclusive growth.
A great deal of empirical research supports Abe's contention that free trade promotes economic growth. This is not merely because free trade leads industries with a comparative advantage to efficient production, as David Ricardo claimed. Engaging with overseas ‘outsiders’ via trade enables domestic businesses to absorb new knowledge, which promotes innovation.
The development of Silicon Valley is a good example showing the role of ‘outsiders’, or immigrants, most notably Indians and Chinese, in innovation (Saxenian 2002). Keller and Yeaple (2009) shows that the US firms' productivity improves substantially due to knowledge spillovers from inflows of foreign direct investment and imports. My own estimates, taking into consideration the effect of knowledge diffusion from abroad on innovation, indicate that the TPP had the potential to boost Japan's per capita GDP by 1.5% (Todo 2013).
But because establishing and sustaining ties with outsiders entails costs, individuals and corporate networks tend to remain closed. New knowledge does not flow into a closed economy, and the economy becomes stagnant. Then, it can be the case that people seek the cause of this situation in outsiders, for example, in imports or capital flows from overseas, with the result that the economy becomes even more closed. If this situation of network closure and economic stagnation sparks a vicious cycle, it will be difficult to correct the increasing depth of economic insularity. History shows us that this situation on a global scale led to the formation of economic blocs in the 1930s, eventually triggering the start of WWII.
It is essential that both President Trump's protectionism policies and Brexit do not initiate a vicious cycle that leads to this type of chaos. As Japan is still the third largest economy in the world, it is expected to play the vital role of preventing this direction.
To do so, however, Japan itself must become more open. During the presidential campaign, Trump declared that the TPP was unfair because it would lower US tariffs on Japanese automobiles, while Japan's tariffs on US beef would remain in place (Tanaka 2016). This is not a wholly misguided argument. As a result of Japan's establishment of ‘sanctuaries’ during the TPP negotiations, import barriers for products including rice, dairy products and meat were to remain.
In fact, the benefits of the TPP to the US were not particularly large. According to Gilbert et al. (2016), US GDP would only increase by 0.02% as a result of the TPP as it was agreed upon. Compared to estimated increases of 0.3% for Japan and 1.6% for Malaysia, the benefits to be reaped by the US were very small.
This is because while US agricultural production would increase, production in industries like textiles and automobiles would decline. The widespread support for Trump, an opponent of the TPP, can be understood as the result of dissatisfaction with the idea that the agreement would take jobs from US manufacturers, and that the majority of US citizens would not adequately benefit from it.
Thus, to convince President Trump of the benefits from free trade agreements, Japan must liberalise trade in agriculture more (and at the same time, the US must liberalise trade in manufacturing more to create win-win situations). Politically speaking, the liberalisation of the industries that have been protected so far as sanctuaries will not be an easy matter. Naturally, the people involved in the protected industries are opposed to liberalisation. But as already noted, the liberalisation of trade and investment between Japan and the US will considerably boost Japanese and US GDP as a whole. Therefore, if liberalisation of trade and investment is associated with inclusive policies such as redistribution of income, it would be more than possible for all Japanese and US citizens to enjoy these benefits brought by the liberalisation.
But these inclusive policies must not involve protectionism. Protectionist policies, such as those to protect particular industries like agriculture in Japan and the automobile sector in the US, could dampen incentives for producers and cause economic stagnation, cancelling out the benefits of trade and investment liberalisation. For example, because the Japanese government currently restricts transactions in and entries to agriculture, Japanese agriculture is extremely unproductive (Fukao and Miyagawa 2007). Instead, the provision of a fixed amount of subsidies to farmers for specific periods would enable the redistribution of income in a manner that would not rob farmers of the incentive to engage in productivity improvements, making Japanese agriculture internationally competitive in the medium term.
Policies that support the establishment of a diverse range of ties are also inclusive. Small and medium-sized enterprises (SMEs) and micro-enterprises lack the manpower and the information required to establish connections with outsiders including foreign partners. Support from the government for the provision of information, or for business networking in order to assist SMEs in expanding sales channels overseas, and engaging in innovation can ensure that the benefits of liberalisation extend to every area of the economy.
The combination of trade and investment liberalisation and inclusive policies will enable all citizens to enjoy the fruits of growth under globalisation. Hopefully, Japan and the Abe administration will take a lead in implementing such policies in order to prevent the destruction of the world economy due to protectionism.
Editor’s note: This is the updated version of a column which first appeared on RIETI's website in November 2016.
Fukao, K, and T Miyagawa (2007), “Productivity in Japan, the US, and the Major EU Economies: Is Japan Falling Behind?”, RIETI Discussion Paper Series, 07-E-046.
Gilbert, J, T Furusawa, and R Scollay (2016), “The economic impact of Trans-Pacific partnership: What have we learned from CGE simulation?”, Asia-Pacific Research and Training Network on Trade, Working Paper no. 157.
Keller, W, and S R Yeaple (2009), “Multinational Enterprises, International Trade, and Productivity Growth: Firm-Level Evidence from the United States”, The Review of Economics and Statistics, (91) 4, 821-831.
Saxenian, A-L (2002), “Silicon Valley’s New Immigrant High-Growth Entrepreneurs”, Economic Development Quarterly, 16 (1).
Tanaka, H (2016), “Trump and the future of the US–Japan alliance”, East Asia Insights, 11 (2), July.
Todo, Y (2013), “Estimating the TPP's Expected Growth Effects”, RIETI Policy Update, no. 048, April.