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Policy Issues Regarding the Promotion of FTA Utilization in Japan.

Byline: Arata Kuno

When pursuing economic gains from free trade agreements (FTAs) we must always bear in mind at a minimum whether the following three conditions are met.The first is whether a country's FTAs offer sufficient coverage in terms of the number of partner countries as well as trade values. If the number of partners is insufficient or if the FTAs are not concluded with countries that have strong business needs their trade expansion effects are likely to be limited. The second is whether a sufficient level of trade liberalization is committed to under the agreements. No matter how many partners a country enters into FTAs with if the ratio of liberalized items is limited or if important trade items are excluded from liberalization then the economic gains from FTAs are likely to fall short of expectations. The third is whether firms will actually utilize FTA preferential tariffs when trading with FTA partner countries. No matter how ambitious the liberalization achieved through FTA negotiations if potential users are unaware that FTAs can be utilized as a corporate strategic tool or if they face significant transaction costs when utilizing FTAs an expansion of users is unlikely.What policy issues are revealed by looking at these three conditions together in a Japanese context To date there has been active discussion in Japan about the first and second conditions that is which countries Japan should negotiate FTAs with and which items should be subject to liberalization. On the other hand once FTA negotiations have been settled the attention of the media and the people tends to turn toward the next FTA negotiations; there has not necessarily been sufficient discussion either of the state of utilization of existing FTAs or of obstacles to utilization. Needless to say the conclusion of FTAs alone does not automatically bring the economic benefits to firms and consumers. In order to maximize the economic benefits of FTAs it is necessary to ensure that the agreements are actually utilized by as many firms as possible through increased awareness of agreements and improved usability.This paper is organized as follows. First I will briefly describe Japan's current situation with regard to the first and second conditions. Second I will discuss the third condition which has also been taken up in the White Paper on International Economy and Trade 2014. That is I will focus on the difficulties that firms are facing when utilizing FTAs. Finally some policy implications will be addressed.1st Condition: Coverage of FTA PartnersAmong the three conditions mentioned above improvement in the near future is assured for the first that is we can expect broader coverage of FTA partner countries. Until now Japan has been said to be relatively reluctant to negotiate FTAs with economic superpowers. Indeed according to trade statistics in 2013 Japan's export dependence ratio with respect to its 15 FTA partner countries was only 18.9% with import dependence ratio at 17.6% and total trade dependence ratio (exports and imports) at 18.2% - in all cases below 20% (Chart 1).This situation however is expected to improve drastically in the not-so-distant future. The reason is that Japan is now actively engaged in negotiating gmega FTAsh with countries and regions upon which Japanese trade depends heavily including the China Japan and South Korea FTA (CJK FTA) and the Regional Comprehensive Economic Partnership (RCEP) both of which include China Japan's largest trading partner; the Trans-Pacific Partnership (TPP) which includes the United States Japan's second-largest trading partner; and an Economic Partnership Agreement (EPA) with the European Union Japan's third-largest trading partner. Including trade data from the 42 countries with which Japan is already negotiating and the one country with which it has agreed to initiate negotiations the above figures rise to 81.0% for export dependence 87.4% for import dependence and 84.4% for total trade dependence. The issue of entering into FTAs with other important trading partners such as Taiwan Russia and the Mercosur countries remains but if agreements are reached in all of the negotiations currently underway it will enormously improve the situation with respect to the first condition.2nd Condition: Level of Liberalization under FTAsDespite the name it is very unusual for gfreeh trade agreement negotiations to result in the complete elimination of tariffs. Japan is certainly no exception and the FTAs it has entered into so far have exempted many items from liberalization primarily gsacred groundh items (568 on a tariff line basis) related to rice wheat dairy products sugar and beef and pork. Chart 2 indicates the level of liberalization in Japan's existing FTAs for both Japan and its partners. Two points in this regard bear further comment.First as a result of maintaining a policy of not liberalizing sacred ground items the Japan-side level of liberalization is below 95% on a tariff line basis for every FTA except that with Singapore. This is relatively low compared to the FTAs entered into by other advanced nations. For example the FTA between the EU and South Korea achieves a 99.5% level of liberalization for both countries that between the US and Australia more than 98% for both countries and that between Australia and Thailand 100% for both countries (WTO World Tariff Profiles 2013 pp.184-188). Second for the majority of Japan's FTAs the level of liberalization for the partner country is also below 95%. The low level of liberalization among partner countries can be seen as the price paid for the low level of liberalization on the Japan side. The more stubbornly Japan refuses to liberalize certain agricultural products the lower its bargaining power when seeking to open markets in the partner country.Will Japan pursue a more ambitious opening of its markets than it has to date The answer to this question lies in the course of the mega-FTA negotiations currently underway. In terms of the magnitude of outside pressure to open Japanese markets and the magnitude of the economic interests to Japanese exporters of opening up partner country markets these mega-FTA negotiations are clearly of a different order from what has come before. If the Japanese government is unable to achieve open markets even when faced with such an opportunity it will likely be a long time before we can hope to see qualitative improvement in Japan's FTAs. On the other hand if it can achieve an ambitious liberalization through a series of mega FTAs it will not only provide hope that the negotiation of any new FTAs in the future would lead to a high level of liberalization but also provide momentum for members of Japan's existing FTAs to seek additional liberalization through renegotiation.3rd Condition: Utilization of FTA Preferential TariffsHow much are FTA preferential tariffs actually being used in the course of trade with Japan's FTA partners Looking at the issuance of certificates of origin - which are necessary when utilizing preferential tariffs for exports their number increased four-fold during the five-year period between January 2009 and January 2014 from 3373 to 14892 (Chart 3). Considering that Japan entered into a growing number of FTAs over this period we can also look to the average number of issuances per FTA over time which shows a 2.9-fold rise over the same period from 422 to 1241. Seen in terms of the number of certificate of origin issuances then the use of FTA preferential tariffs in exports has increased. If we look at the distribution of issuances by partner country more than 80% of issuances are related to exports to just four countries: Thailand (5435) Indonesia (3293) India (2351) and Malaysia (1041) (Chart 4).Next let's look at the utilization ratio of FTAs in terms of the number of firms using FTAs. According to the results of an annual survey conducted by the Japan External Trade Organization (JETRO) among firms engaged in trade with FTA partner countries the utilization ratio of FTA preferential tariffs rose 6.7 percentage points from 36.2% to 42.9% between 2009 and 2013 (Chart 5). This growth however is relatively slow compared to the rise in issuance of certificates of origin suggesting that there remains room to expand the pool of users.There are a number of reasons why a company might not utilize an FTA that has been entered into with a given country. One such case is when the tariffs on the items a firm trades have already been eliminated prior to the conclusion of the FTA. When past GATT/WTO negotiations have already eliminated the most-favored-nation (MFN) tariff on a given item there is no need for a firm to go out of its way to conduct trade using FTA preferential tariffs. A second reason as described already is when the items a firm trades have still not been liberalized even after the FTA has been negotiated. A third is when tariffs have been eliminated as a result of FTA negotiations but prohibitively high compliance costs must be borne in order to meet restrictive rules of origin (ROOs) requirements. A fourth is when there are transaction costs associated with determining whether to use the FTA or with its actual utilization. Specifically the use of FTAs is hindered by the fact that searching for and fully understanding information about the tariff-saving effects ROOs and other administrative procedures involved in using an FTA and then making a management decision to do so requires a not insignificant amount of management resources.

In Japan a range of FTA-related information is already available through sources such as public agency websites. Previous research however indicates that the FTA-related information provided by public agencies is too technical for most business people to understand correctly and difficult to track tariff rates and other legal provisions in every possible FTA from year to year and notes the need to create manuals that bridge the gap between the legal provisions and actual administrative work (Japan Economic Foundation (2010) Wagakuni ga teiketsu shita EPA riyo no jokyo koka kadai ni kansuru chosa kenkyu hokoku [A Report on Survey Results Concerning the Use of Japan's EPAs their Effectiveness and Related Issues] pp.72-73). The following are examples of the sort of difficulties that company staff who are not experts in FTA-related matters may encounter when trying to determine whether to utilize an FTA.(a) Identifying the correct commodity classification numberThe most important information for all firms considering FTA utilization is whether or not the reduction in tariffs will be sufficient to compensate for the compliance costs of ROOs. The first difficulty a firm faces in trying to identify the amount of tariff reduction is correctly identifying the classification number (HS code) for the items being traded. Without identifying the HS code it is impossible to know what FTA preferential tariff rate will be applied to the item in question so this step is unavoidable.The HS codes used for classifying traded items generally take the form of an eight to 10-digit number. The first six digits are assigned according to international standards but from the seventh digit on each country can independently determine the number of digits and the numbers assigned. As a result when a Japanese company utilizes an FTA for export it must submit to the customs authorities of the importing country not the number as used in Japan but the number determined by the importing country. It is no easy task to access information from overseas and correctly determine which of the many thousands of HS codes applies to the export items. In addition as touched upon in the White Paper on International Economy and Trade 2014 in the event there is a difference of interpretation between the exporting company and the customs authorities in the importing country problems may arise such as preferential tariffs not being applied when passing through customs. One way to avoid such problems is to make use of the importing country's advance rulings system but human resources limitations makes it difficult for small and medium-size enterprises (SMEs) to make full use of such overseas systems.(b) Identifying the preferential tariff rateAfter identifying the HS code for the item to be traded the next challenge faced by company staff is determining the preferential tariff rate that applies to the item in question. Needless to say in order to make a management decision the company needs to grasp not only the tariff rate applied in the current year but also how the preferential tariff rate will change over the phase-out period.Understanding the preferential tariff rate imposed by the partner requires either using the external tariff database under contract to JETRO or referring to the original text of the agreement itself. Because this database provides its services in English however it is not necessarily easily accessible to company staff who lack sufficient English skills. In fact the White Paper suggests that SMEs use the database at only one-third the rate of large corporations.At the same time even though Japanese versions of the texts of agreements are available simply looking through these legal documents is not enough to directly determine preferential tariffs by item over time. To learn the rate one must first understand the meaning of the various codes used to indicate tariff concession status (e.g. A: immediate elimination; B5: eliminate over six years; X: exclude) and then calculate the rate for a given year on one's own. Furthermore the HS code classification method and numbers are revised every five years to ensure they keep up with the times. When HS codes are revised however there is sometimes no effort made to revise the body of the text of the agreement itself to reflect the change. The work of determining the preferential tariff rate therefore becomes more difficult when the most recent code that must be submitted to the customs is not the same as the old code that appears in the agreement.(c) Comparing multiple trade agreementsWhen there are multiple trade agreements that could be used companies must look across all such agreements to determine which one could bring about the largest tariff-saving effects. For example there are two FTAs between Japan and Thailand: the Japan-Thailand Economic Partnership Agreement and the ASEAN-Japan Comprehensive Economic Partnership. In such cases the preferential tariff rates may differ by FTA or by year even for the same item. Furthermore a company that has production facilities in multiple countries may also need to consider not only Japan's FTAs but also those of third countries such as the ASEAN-China FTA or the ASEAN-India FTA. In addition as was the case between Japan and Thailand when a temporary reversal meant that the FTA preferential tariff was actually higher than the MFN tariff utilizing an FTA can sometimes actually be detrimental so companies must also be careful to make comparisons against MFN tariffs. In the event that the RCEP and TPP are successfully negotiated in the future there will be some countries that have concluded three or four FTAs with Japan; this will only increase the difficulty of making a decision to the degree that it increases the number of agreements that must be compared.(d) Understanding ROOsFor a company to engage in exports utilizing FTA preferential tariffs the company must obtain a certificate of origin affirming that the exported item satisfies the ROOs stipulated in the FTA and submit it to customs authorities in the importing country. ROOs however may differ by partner country even for the same item (Table). Furthermore when multiple FTAs have been concluded with a particular country selecting which FTA to utilize requires understanding and comparing all the ROOs requirements for each as well as the steps and procedures needed to obtain and submit certificates of origin.Providing Information to Facilitate FTA UtilizationObtaining further economic gains through FTAs requires expanding the users of the FTAs. Promoting such utilization by as many companies as possible including SMEs with limited management resources requires policy efforts to resolve the various issues mentioned in the previous section. For example it is essential to find user-friendly ways to provide information in order to minimize the company-side cost of searching information. In this section I discuss some policy implications for further supporting and promoting the use of FTAs.First compared to other countries there are a very wide variety of governmental agencies in Japan that provide FTA-related information and much of this information overlaps across the agencies. Moreover it is not uncommon for such agencies to mix the specific detailed information that potential FTA users need with more generic information about the significance and impact of FTAs that targets a broader audience. Going forward information should be consolidated to provide a one-stop portal site where potential FTA users can gather the information they need.Second a system should be built to enable searches in Japanese for HS codes preferential tariff rates and ROO provisions by FTA item and year. Examples of such websites that already exist for other countries include International Enterprise Singapore's Tariff Calculator the New Zealand Ministry of Foreign Affairs and Trade's Tariff Finder and the South Korean Customs Service's FTA Portal.Third from a management strategy perspective the most important information companies want to know is not really a list of tariff rates for each FTA but rather information about tariff savings: how much their tariffs will actually be reduced and when through the use of which FTAs. As it stands now no countries currently provide information that meets all of these conditions but International Enterprise Singapore has incorporated into its website a system by which inputting HS code export trading partner and value of trade produces a list by FTA of expected reductions in tariffs for the current year. Although it is not possible to calculate tariff reductions for a future year of one's choice this is surely a very effective means of encouraging potential FTA users to actually take advantage of FTAs.Fourth it would be desirable to have manuals produced that cover ROOs from the user standpoint. Because so many unfamiliar technical terms appear in discussions of ROOs high-quality manuals written from the user's point of view are essential. For example the US Department of Commerce provides a user's guide outlining ROOs for each FTA. These easy-to-understand guides include examples of how to read ROO provisions explanations of the different types of ROOs information on how to calculate Regional Value Content and glossaries.Fifth success stories and case studies showing how other companies in similar industries have utilized FTAs and how doing so has been beneficial are another valuable form of information for potential FTA users. One such example is the gSuccess Storiesh page on the International Enterprise Singapore website. This page includes examples of how companies have used FTAs successfully complete with the names of the companies and links to related newspaper articles. In the US Industry Opportunity Reports are produced that publicize say what particular companies hope to gain through the US-South Korea Free Trade Agreement and why.ConclusionFinally I would like to touch on recent initiatives in South Korea as an example of a comprehensive effort to increase the FTA utilization rate. In 2010 the South Korean government after conducting a thorough review of the effectiveness of its information provision and support efforts up to that point introduced a new comprehensive package designed to raise the FTA utilization rate to at least 60%. This package launched with the goal of establishing a National FTA Utilization Center and Regional FTA Assistance Centers to implement related measures regularly monitoring utilization rates establishing a portal site for potential FTA users training FTA consultants establishing FTA-related courses at universities and graduate schools opening an FTA call center to answer questions from companies at no charge and offering four years of FTA utilization consulting services to 10000 SMEs engaged in trade with partner countries (gKorea's Policy Package for Enhancing its FTA Utilization and Implications for Korea's Policyh by Inkyo Cheong ERIA-DP-2014-11). Through such efforts the FTA utilization rate which had not exceeded 30% prior to 2010 exceeded 60% by the end of 2013 and reached more than 70% for the US-South Korea FTA and the EU-South Korea FTA.The benefits of promoting FTA utilization through such measures surely go beyond securing short-term economic gains from trade expansion effects. Increasing the number of users means increasing the number of beneficiaries who enjoy the economic benefits of the FTA. Increasing the number of those who benefit from FTAs can be expected to have the politico-economic effect of expanding and strengthening the domestic base of support for future trade policy including trade liberalization and regional economic integration.Arata Kuno is associate professor at the Department of Policy Studies Kyorin University Japan. His specialty is international trade and the trade policy of Japan.
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Publication:Japan Economic Foundation (Tokyo, Japan)
Geographic Code:9JAPA
Date:Aug 31, 2014
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