How is Brexit uncertainty disturbing UK-Japan trade relations?

Share this article:

30 April 2019

Dr Minako Morita-Jaeger is an international trade policy consultant and an Associate Fellow of the UK Trade Policy Observatory.

The UK managed to avoid crashing out of the EU on 12^th April for the second time. But this delay extends uncertainty since the possibility of a No-deal Brexit on 31^st October remains. The UK’s trade partners have been looking at Brexit uncertainty with great dismay. Japan is not an exception. Here, I highlight how this uncertainty is affecting Japanese businesses in Europe and analyse possible future UK-Japan trade relations based on the three scenarios currently in the UK political debate. This provides an update to the UKTPO blog on UK-Japan relations.

UK’s relative market attractiveness declining in Europe

On-going Brexit uncertainty has been diminishing confidence in the UK. According to the JETRO’s (Japan External Trade Organization) annual business survey, Japanese businesses’ evaluation of UK’s political and social stability has been declining since the 2016 Referendum. In the latest survey, conducted in September-October 2018, although political anxiety over Brexit was not as intense as it is now, Japanese companies doing business in Europe regarded the UK as the most politically and socially unstable country in Europe together with Romania. The survey also shows that the UK’s relative market attractiveness in Europe is declining. For example, the UK’s expected change in business profits in comparison with the previous year ranked the 2^nd lowest among European countries both in 2018 and in 2019.[1]  About 70% of Japanese businesses were concerned about economic stagnation in the UK, and 60% were worried about the UK’s post-Brexit policy and regulatory changes, namely tariff rates and regulatory consistency with the EU.

Since the 1980s, the UK has been enjoying its role as a gateway to the EU for Japanese businesses. The UK has established its position as Japan’s second to top FDI destination ($153.6 billion of FDI stock, 2017), after the US ($491.3 billion of FDI stock, 2017).[2] Unfortunately, the continuing uncertainty over Brexit is already driving Japanese business to reconsider or restructure their business model in Europe although the degree of impact differs across business sectors and individual companies.[3] To date, some Japanese financial services companies have already moved their EU headquarters from the UK to Germany, Netherland and Luxemburg in order to acquire financial services passport. According to the JETRO business survey, some Japanese manufacturing companies have decided, or are considering, to move their headquarters from the UK or to redesign sales and production functions.

It is generally understood that the role of an FDI host country is to provide political and institutional certainty and predictability. The Brexit saga is doing the opposite, magnifying risks and imposing unreasonable costs on its foreign investors.

Three scenarios for a future UK-Japan trade deal

In August 2017, Japan and the UK agreed to quickly create a new bilateral economic partnership based on the EU-Japan Economic Partnership Agreement (not a roll-over) when the UK leaves the EU. Since then, Japan has been preparing for the process on the assumption that a withdrawal agreement would provide a legally-binding plan of the future EU-UK trade relationship. Thus, it was a big surprise for Japan when the UK Government suddenly asked Japan to switch to a ‘No deal’ basis for the UK-Japan agreement (a ‘roll-over’) towards the end of March 2019.

Currently, two problems hinder the enactment of a future UK-Japan trade partnership. First, the Political Declaration on the future relationship between the UK and the EU is ambiguous and not legally binding. Second, the UK itself has not yet formed domestic consensus on what it wants in terms of its future relationship with the EU.

The future UK-Japan trade deal entirely depends on the result of the EU-UK future trade relationship. For example, the three likely scenarios in the UK political debate: (1) the Government’s facilitated customs arrangements in the Political Declaration; (2) a permanent customs union with the EU; and (3) Common Market 2.0 would result in a completely different type of UK-Japan trade deal. (Gasiorek and Winters explained the economics of the three options in the UKTPO blog of 3^rd April).

In assessing the options, the Japanese Government would start from its request in September 2016 to maintain the status quo between the EU and the UK. These include: (i) maintaining the current tariff rates and customs clearance procedures; (ii) free movement of capital and unrestricted investment; (iii) continuous access to labour with the necessary skills from across the EU; and (iv) harmonised regulations and standards.

Scenario 1: Facilitated customs arrangements

The facilitated customs arrangements option excludes the single market. In this case, Japanese businesses’ requests on the free movement of services, capital and people are completely neglected. Because the UK Government retains its red line of independent trade policy, this gives way for the future UK-Japan trade deal. However, the inclusion of terms such as ‘ambitious free trade agreement between the EU and the UK’ and ‘ambitious customs arrangements’ in the Political Declaration are far too ambiguous to form the basis of a Free Trade Agreement (FTA) with a third country. For example, it is not clear at all to what extent ‘free movement of goods’ with the EU would be maintained in terms of customs duties and procedures, or what kind of rules of origin would govern EU-UK trade. As for non-tariff barriers, Japan has no clue as to what extent the UK will disentangle itself from the EU regulatory framework.

Scenario 2: A permanent customs union with the EU

From a manufacturer’s perspective, a permanent customs union with the EU would be a slightly better option than the ‘facilitated customs arrangements’. It enables the status quo of current tariff rates against non-EU countries and duty-free trade between the UK and the EU. However, Japanese businesses’ concerns on non-tariff issues, such as unified regulations and standards on goods, are completely neglected. Also, neither a single market for services nor labour mobility within the EU are included in this scenario. While the new agreement may require rolling over the tariff schedule and rules of origin part of the EU-Japan Economic Partnership Agreement, other parts of the Agreement, such as services, intellectual property rights, TBT/SPS related regulations, and data transfer, would all have to be negotiated between the UK and Japan. Like scenario 1, a degree of the UK’s regulatory alignment with the EU will determine the extent of non-tariff barriers.

Scenario 3: Common Market 2.0.

This option would mean that the UK would re-join the European Free Trade Association, being a part of the EU Single Market. The two major advantages for Japanese businesses are (i) free movement of labour and (ii) unified regulations and standards between the EU and the UK. A downside is that the UK would have independent tariffs and rules of origin, which would surely affect Japanese manufactures’ regional supply chains in Europe. In contrast to scenario 2, under this option, there would be a need for a UK-Japan trade deal on goods. Among Japan’s 18 bilateral and plurilateral FTAs, there is no goods-only FTA. The Japan-US Trade Agreement on Goods (TAG), the negotiation of which starts this month, may become the first case, but this would be a special case to avoid a trade war with the US. It cannot serve as a precedent for the UK-Japan future trade deal.

Last but at least, it should be noted that while Brexit uncertainty is diminishing the UK’s relative market attractiveness in Europe and is preventing the negotiation of future UK-Japan trade relations, the EU-Japan EPA, which entered into force this February, is providing new business opportunities in the EU 27. For the UK Government, rebuilding the confidence of Japanese investors and increasing its market attractiveness relative to Europe would be the key economic issues when it comes to the trade deal with Japan.

Footnotes

[1] UK’s expected business profits in 2019 in comparison with the previous year: While 33.7% answered ‘better’, 66.3% answered ‘the same’ or ‘worse’. For comparison, Italy ranked the top 2^nd, 70% answered ‘better’ and 30% answered ‘the same’. JETRO business surveys, December 2018 (above).

[2] JETRO Japan’s outward FDI statistics.

[3] Japanese business analysts debate about Brexit and the Japanese business model. For example, see ”Nihonkigyou ga eikokutettai wo kentousubeki riyuu”, in Japanese (“The reasons why Japanese companies have to consider disinvesting from the UK”), January 2019.

Disclaimer:
The opinions expressed in this blog are those of the author alone and do not necessarily represent the opinions of the University of Sussex or UK Trade Policy Observatory.

Republishing guidelines:
The UK Trade Policy Observatory believes in the free flow of information and encourages readers to cite our materials, providing due acknowledgement. For online use, this should be a link to the original resource on our website. We do not publish under a Creative Commons license. This means you CANNOT republish our articles online or in print for free.