Journal of International Trade, Logistics and Law, Vol. 8, Num. 1, 2022, 28-36 28 MEASURING THE POTENTIAL ECONOMIC IMPACT OF A JAPAN–US FREE TRADE AGREEMENT: CAN IT ENABLE THE US TO ELIMINATE ITS TRADE DEFICIT IN GOODS WITH JAPAN? Shun HASEGAWA Hokkaido University, Japan Hirokazu AKAHORI Akita Prefectural University, Japan Daisuke SAWAUCHI Hokkai School of Commerce, Japan Yasutaka YAMAMOTO Hokkaido University, Japan Received: January 24, 2022 Accepted: March 29, 2022 Published: June 01, 2022 Abstract: Japan and the US are two major global trading partners that have at times been at odds regarding each other’s international trade policies. In particular, the ongoing US trade deficit in goods with Japan has been one of the primary disputes between Japan and the US. However, the recent withdrawal of the US from the Trans-Pacific Partnership (TPP) sent a clear signal that the US would take a new approach to international trade issues and has potentially paved the way for a bilateral free trade agreement (FTA) with the remaining TPP countries, including Japan. This paper contributes to the debate on the potential economic impact of a Japan–US FTA (JUFTA) by evaluating whether it could enable the US to eliminate its trade deficit in goods with Japan. To do this, we measure the potential impact of a JUFTA using a dynamic Global Trade Analysis Project (GTAP) model. We find that a JUFTA is unlikely to enable the US to eliminate its trade deficit in goods with Japan, although the deficit will certainly decrease as a result. Keywords: Free Trade Agreement, Trade Deficit in Goods, GTAP Model JEL Codes: F15, F17 1. Introduction Japan and the US are two major countries in the global trading system, which at times have been at odds regarding each other’s international trade policies. Overall, the US has fears about its ongoing trade deficit, with the trade deficit between it and northeast Asian countries a major concern (Park, 2018). The US trade deficit in goods with Japan has also been one of the major disputes between Japan and the US. Recently, the US withdrawal from the Trans-Pacific Partnership (TPP) sent a clear signal that the US would take a new approach to trade issues and paved the way for a potential bilateral free trade agreement (FTA) with the remaining TPP countries, including Japan (Office of the United States Trade Representative, 2017). Consequently, the so-called Trade Agreement between Japan and the United States of America came into effect in early 2020 (Ministry of Foreign Affairs of Japan, 2020). However, if the US trade deficit were to increase because of this trade agreement, it could become a major flashpoint for future Japan–US relations. Measuring the Potential Economic Impact of a Japan–US Free Trade Agreement: Can It Enable the US to Eliminate its Trade Deficit in Goods with Japan? 29 The purpose of this paper is to contribute to the debate on the potential economic impact of a Japan–US FTA (JUFTA) by questioning whether it would enable the US to eliminate its trade deficit in goods with Japan. To respond to this research question, we measure the potential impact of a JUFTA using a dynamic Global Trade Analysis Project (GTAP) model. A JUFTA is an example of one of the so-called “mega” FTAs, which in addition to the TPP, includes the Regional Comprehensive Economic Partnership and the Japan–China–Korea FTA (Kim et al., 2015). The potential economic impacts of FTAs have been most widely evaluated using numerical simulation with a computable general equilibrium model such as the GTAP model, with several studies quantifying the effects of mega FTAs using both static (e.g., Akahori et al., 2014; Areerat et al., 2012) and dynamic (e.g., Akahori et al., 2021; Bhattacharyay and Mukhopadhyay, 2015; Lee and Itakura, 2016) GTAP models. However, to our knowledge, there is no existing assessment using the dynamic GTAP model to determine the economic impact of an FTA between the US as the world’s largest economy and Japan. In this study, we assume that a JUFTA is implemented from 2017 onwards, with tariffs uniformly reduced over five years and tariffs on all items eliminated by 2021. 2. Methodology 2.1. The Dynamic GTAP Model The dynamic GTAP model is a recursively dynamic computable general equilibrium model of the world economy that extends the standard static GTAP model to improve the treatment of the long run but retains all other features of the model (Ianchovichina and Walmsley, 2012). Within a recursively solvable discrete-time framework, a given database refers to a given period. A simulation then takes the database to the next period, with simulation results representing changes between the initial period and the next (Ianchovichina and Walmsley, 2012). To understand policy effects using the dynamic GTAP model, two types of simulation are possible. The first is a baseline simulation, which assumes an economy in which the policy is not implemented. The second is a policy simulation, which assumes an economy in which the policy is implemented. We compare the results of these simulations to evaluate the effects of the policy (Itakura, 2012). The baseline scenario contains information on macroeconomic variables. These variables include projections of real GDP, gross investment, capital stock, population, and the total labor force (Lee and Itakura, 2016). Ianchovichina and Walmsley (2012) provide additional details on the key features of the dynamic GTAP model. 2.2. Data and Scenario In this study, we employ GTAP Database Version 9a, which covers 140 countries/regions and 57 sectors with 2011 as the base year. For the present analysis, we aggregate the data into nine countries/regions and 25 sectors (see Appendix-1 and Appendix-2). This regional aggregation highlights the importance of the major trading partners of Japan and the US. The sector aggregation framework was designed to distinguish between the agricultural sectors that are important for the present analysis. The farm sector comprises 12 sectors, ranging from No. 1 (paddy rice) to No. 12 (wool, silkworm cocoons), and the food sector includes eight sectors, ranging from No. 13 (meat: cattle, sheep, goats, horses) to No. 20 (beverages and tobacco products). In this paper, we define the agricultural sector as including all farm and food sectors (Nos. 1–20). We define the goods sector as comprising sectors Nos. 1–23 (the manufacturing industry) and the service sector as including No. 24 (transport) and No. 25 (services). Table 1 provides details on the initial bilateral tariffs between Japan and the US. As shown, Japan’s highest tariff on US imports is levied on paddy rice (410.0%), while the US’s highest tariff on Japanese imports is levied on sugar (26.5%). To evaluate the effects of a JUFTA using the dynamic GTAP model, the baseline scenario was first established, showing the path of each of the nine countries/regions over the period 2011–2021. Real GDP projections and capital stocks were obtained from Fouré et al. (2010). Projections for the population were taken from the United Nations (2015), whereas those for labor are based on the working-age population (14–65-year-olds). Labor is divided into skilled and unskilled labor. In the base case scenario, tertiary education is used to estimate the amount of skilled labor (Walmsley et al., 2000). For the dynamic GTAP model, we applied the same scenario, which assumes the complete removal of all import tariffs, not only those on the agricultural sector but also those applying in the nonagricultural sector. Although it is Shun HASEGAWA, Hirokazu AKAHORI, Daisuke SAWAUCHI & Yasutaka YAMAMOTO 30 unlikely that the JUFTA would remove all import tariffs across all sectors between the two countries, this scenario provides an upper bound of the economic impact of the import tariff reduction only. For the dynamic GTAP simulation, we assume that the JUFTA is implemented from 2017, tariffs are uniformly reduced over a five-year period, and tariffs on all items are eliminated by 2021. We assume that there is no productivity change in each sector resulting from the JUFTA. Although a JUFTA will likely affect productivity in some sectors, it is extremely difficult to determine such effects, and thus there is little basis for estimating specific values for productivity change (such as a 1% increase in a year) in each sector resulting from the JUFTA. Table 1: Initial Bilateral Tariffs on Different Sectors Source: Version 9a of the GTAP Database. nec – not elsewhere classified. In addition to measuring the impact on the economy, the JUFTA simulations in this analysis particularly focus on the economic impacts on agricultural sector output. Changes in real GDP are used as the indicator of the impact on the entire economy and these are then compared with the changes in agricultural sector output. Sector Japanese tariffs on imports from the US (%) US tariffs on imports from Japan (%) Paddy rice 410.0 1.3 Wheat 18.6 1.6 Cereal grains nec 7.6 0.1 Vegetables, fruit and nuts 9.9 7.6 Oil seeds 2.8 0.0 Sugar cane, sugar beets 0.0 0.1 Plant-based fibers 0.0 0.3 Crops nec 0.1 1.5 Bovine cattle, sheep, goats, horses 11.0 2.8 Animal products nec 4.3 1.0 Raw milk 0.0 0.0 Wool, silkworm cocoons 27.9 2.1 Bovine cattle meat products 38.4 2.2 Meat products nec 56.5 3.0 Vegetable oils and fats 1.7 0.3 Dairy products 88.8 19.6 Processed rice 241.0 3.2 Sugar 23.1 26.5 Food products nec 11.0 3.6 Beverages and tobacco products 2.6 3.3 Forestry, fishing 0.6 0.5 Natural resources 0.0 0.1 Manufacturing 0.7 1.2 Transport 0.0 0.0 Services 0.0 0.0 Measuring the Potential Economic Impact of a Japan–US Free Trade Agreement: Can It Enable the US to Eliminate its Trade Deficit in Goods with Japan? 31 Note that an FTA may result not only in a trade creation effect but also in a trade diversion effect. This trade diversion effect may discriminate against non-FTA member economies. The inefficiencies resulting from the trade diversion effect may mean that the benefits accrued from the trade creation effect are overestimated. To shed light on this, we estimate movements in bilateral trade flows under the JUFTA in terms of both trade creation and trade diversion effects (Siriwardana, 2007). 3. Results The impact of the JUFTA on the GDP of the two countries is less than one percentage point when compared with their baselines. However, Japan is likely to experience a more substantial gain in real GDP than is the US (Table 2). As a result of the JUFTA, the real GDP of Japan in 2021 will be 0.14 percentage points higher than its baseline. In contrast, the real GDP of the US in 2021 will be 0.01 percentage points higher than its baseline. Table 2: Impact of the JUFTA on Real GDP (percentage point differences from baseline). Year 2017 2018 2019 2020 2021 Japan 0.02 0.04 0.07 0.11 0.14 US 0.00 0.00 0.00 0.01 0.01 The impact on the agricultural output of the two countries in 2021 is more than one percentage point compared with the baseline (Table 3). The impact of full trade liberalization is more observable in terms of agricultural output, as shown in Table 3, than in terms of real GDP, as shown in Table 2. Indeed, the agricultural sector output of Japan in 2021 is predicted to decline by 5.22 percentage points compared with the baseline because of the JUFTA. In contrast, the agricultural sector output of the US in 2021 is predicted to increase by 2.44 percentage points compared with the baseline. Table 3: Impact of the JUFTA on Agricultural Outputs (percentage point differences from baseline). Year 2017 2018 2019 2020 2021 Japan –0.40 –1.02 –1.93 –3.26 –5.22 US 0.30 0.69 1.17 1.74 2.44 Table 4 provides details of the impact of the sectoral output changes in 2021 in percentage point terms. As shown, output from the agricultural sector tends to decline in Japan, whereas that from the agricultural sector in the US tends to increase because of the JUFTA. In percentage point terms, the largest decline in sectoral outputs in Japan occurs in the paddy rice sector (–30.49 percentage points from the baseline). Correspondingly, in the US, the largest increase in sectoral outputs occurs in the processed rice sector (61.11 percentage points from the baseline), with the second-largest increase in the paddy rice sector (18.91 percentage points from the baseline), followed by the meat products sector (9.61 percentage points from the baseline). Table 5 displays the movements in bilateral trade flows under the JUFTA. The results show that the JUFTA not only has huge impacts on the trading relationships between Japan and the US but also has adverse impacts on the trading relationships with third-party countries that trade with Japan and the US because of trade diversion effects. Japan experiences a substantial increase in imports from the US (27.72 percentage points from the baseline), indicating a trade creation effect. However, Japan experiences trade diversion from non-FTA member economies toward the US. These trade diversions are most significant for the Rest of North America, followed by Australia and New Zealand. In 2021, Japan’s imports from the Rest of North America (Australia and New Zealand) decline 11.11 (4.21) percentage points from the baseline. The US experiences trade creation effects with Japan as well as with all other non-FTA member economies, except for the Rest of the World category. In addition, the trade diversion that seems to occur with the Rest of the World is almost negligible. Shun HASEGAWA, Hirokazu AKAHORI, Daisuke SAWAUCHI & Yasutaka YAMAMOTO 32 Table 4: Impacts of the JUFTA on Sectoral Outputs in 2021 (percentage point differences from baseline). Sector Japan US Paddy rice –30.49 18.91 Wheat –22.50 –0.62 Cereal grains nec –4.84 1.87 Vegetables, fruit and nuts 0.28 –0.34 Oil seeds 2.88 –1.37 Sugar cane, sugar beets –0.91 0.27 Plant-based fibers 3.38 –1.91 Crops nec –2.76 –2.08 Bovine cattle, sheep, goats, horses –11.94 3.73 Animal products nec –19.40 5.63 Raw milk –12.71 3.71 Wool, silkworm cocoons –0.55 –4.84 Bovine cattle meat products –13.87 3.86 Meat products nec –25.44 9.61 Vegetable oils and fats 1.20 –0.45 Dairy products –15.77 4.43 Processed rice –26.58 61.11 Sugar –0.99 0.18 Food products nec 0.83 0.66 Beverages and tobacco products 0.46 0.01 Forestry, fishing 0.36 –0.12 Natural resources 0.02 –0.06 Manufacturing 0.69 –0.39 Transport –0.08 –0.03 Services 0.09 0.02 nec –not elsewhere classified. Table 5: Movements in Bilateral Trade Flows under the JUFTA in 2021 (percentage point differences from baseline). Country/Region Japan US Trade creation Trade diversion Trade creation Trade diversion Japan 8.32 US 27.72 China –1.79 0.37 Korea –0.61 0.23 ASEAN –1.54 0.38 Australia and New Zealand –4.21 1.54 Rest of North America –11.11 0.23 EU27 –1.90 0.23 Rest of World –0.51 –0.03 Total (World) 2.10 0.64 Measuring the Potential Economic Impact of a Japan–US Free Trade Agreement: Can It Enable the US to Eliminate its Trade Deficit in Goods with Japan? 33 Finally, to answer our main research question, the JUFTA is unlikely to eliminate the US’s trade deficit in goods with Japan, although the deficit will decrease (Figure 1). More precisely, the trade deficit in goods will decrease from – 40,088 million USD for the 2021 baseline scenario to –20,251 million USD for the full trade liberalization scenario. This result occurs because of the increase in the trade surplus for agricultural goods (rising from 23,514 million USD in the baseline 2021 scenario to 53,525 million USD for the 2021 full trade liberalization scenario), which exceeds the increase in the trade deficit for nonagricultural goods (which increases from –63,602 million USD for the 2021 baseline scenario to –73,776 million USD for the 2021 full trade liberalization scenario). Figure 1: US Trade Balance with Japan (USD Millions). 4. Conclusion We aimed to contribute to the debate on the potential economic impact of a JUFTA by asking the following question: can a JUFTA enable the US to eliminate its trade deficit in goods with Japan? To address this question, we measured the potential impact of a JUFTA using a dynamic GTAP model. We assumed that the JUFTA is implemented from 2017, tariffs are uniformly reduced over five years, and tariffs on all items are eliminated by 2021. The main results are as follows. First, Japan is likely to experience a more substantial gain in real GDP than is the US because of the JUFTA. Second, the impact of the JUFTA is more observable in terms of agricultural output than in terms of real GDP in both Japan and the US. Third, the JUFTA not only has large impacts on the trading relationship between Japan and the US but also adverse impacts, resulting from trade diversion effects, on trading relationships with third-party countries that trade with Japan and the US. Finally, to answer our main research question, the JUFTA is unlikely to enable the US to eliminate its trade deficit in goods with Japan, although the deficit will decrease because of the JUFTA. These results should be treated as preliminary because of the inevitable limitations associated with this type of simulation research task. For example, future research should consider simulations of other trade liberalization scenarios, such as a scenario excluding sensitive products, and the effect of nontariff barriers. 18.520 23.514 53.525 –75.546 –63.602 –73.776 –57.026 –40.088 –20.251 -100.000 -80.000 -60.000 -40.000 -20.000 0 20.000 40.000 60.000 2011 Base Year 2021 Baseline 2021 JUFTA Agricultural Goods Nonagricultural Goods Goods (Total) Shun HASEGAWA, Hirokazu AKAHORI, Daisuke SAWAUCHI & Yasutaka YAMAMOTO 34 Acknowledgments This work was supported by JSPS KAKENHI Grant Numbers JP20K06261 and JP21K14927. References Akahori, H., Hasegawa, S., Sawauchi, D., & Yamamoto, Y. (2021), “Economic impact of the Japan–China–USA free trade agreement on Japan using both static and dynamic GTAP models”, Journal of International Trade, Logistics and Law, 7(2), 59–66. Akahori, H., Masuda, K., Yoshida, Y., & Yamamoto, Y. 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Measuring the Potential Economic Impact of a Japan–US Free Trade Agreement: Can It Enable the US to Eliminate its Trade Deficit in Goods with Japan? 35 Appendix–1: Regional Aggregation No. Aggregated country/region GTAP country/region 1 Japan Japan 2 US United States 3 China China 4 Korea Korea 5 ASEAN Indonesia, Singapore, Malaysia, Philippines, Thailand, Vietnam, Cambodia, Lao People's Democratic Republic, Brunei Darussalam, Rest of Southeast Asia 6 Australia and New Zealand Australia, New Zealand 7 Rest of North America Canada, Mexico 8 EU27 Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, United Kingdom 9 Rest of the world All other economies/regions Source: GTAP Database Version 9a. Shun HASEGAWA, Hirokazu AKAHORI, Daisuke SAWAUCHI & Yasutaka YAMAMOTO 36 Appendix–2: Sector Aggregation No. Aggregated sector GTAP sector 1 Paddy rice Paddy rice 2 Wheat Wheat 3 Cereal grains nec Cereal grains nec 4 Vegetables, fruit and nuts Vegetables, fruit and nuts 5 Oil seeds Oil seeds 6 Sugar cane, sugar beets Sugar cane, sugar beets 7 Plant-based fibers Plant-based fibers 8 Crops nec Crops nec 9 Bovine cattle, sheep, goats, horses Bovine cattle, sheep, goats, horses 10 Animal products nec Animal products nec 11 Raw milk Raw milk 12 Wool, silkworm cocoons Wool, silkworm cocoons 13 Bovine cattle meat products Bovine cattle meat products 14 Meat products nec Meat products 15 Vegetable oils and fats Vegetable oils and fats 16 Dairy products Dairy products 17 Processed rice Processed rice 18 Sugar Sugar 19 Food products nec Food products nec 20 Beverages and tobacco products Beverages and tobacco products 21 Forestry, fishing Forestry, Fishing 22 Natural resources Coal, Oil, Gas, Mineral nec 23 Manufacturing Textiles, Wearing apparel, Leather products, Wood products, Paper products, publishing, Petroleum, coal products, Chemical, rubber, plastic products, Mineral products nec, Ferrous metals, Metal nec, Metal products, Motor vehicles and parts, Transport equipment nec, Electronic equipment, Machinery and equipment nec, Manufactures nec 24 Transport Transport nec, Water transport, Air transport 25 Services Electricity, Gas manufacture, distribution, Water, Construction, Trade, Communication, Financial services nec, Insurance, Business services nec, Public administration, Defense, Education, Health, Dwellings Source: GTAP Database Version 9a. nec – not elsewhere classified.