As the EU and Japan work to diversify their investments and find growth overseas, the economic partnership agreement that was signed in Tokyo yesterday is a step in that process, writes Hosuk Lee-Makiyama.
The speaking points often mention that the newly signed EU-Japan economic partnership agreement is the largest bilateral trade deal ever completed, covering nearly a third of global gross domestic product. What is mentioned less, but is of importance nonetheless, is the trade pact’s role in fueling foreign direct investment.
Despite its early misfortunes, the EPA became a reality yesterday. Thanks to an overlap of common interests, the accord sets forth a new standard for a Euro-Pacific market space in areas such as motor vehicles, food products and consumer goods. Parallel agreements covering privacy adequacy decisions to support the digital economy and prior reforms on pharmaceuticals were made in preparation for the trade deal.
Japan was already open and void of any regulatory investment barriers or equity caps, and a separate investment treaty is expected to follow in due course.
Yet, traditional trade liberalisation alone could generate foreign direct investment as well as mergers and acquisitions. Empirical studies by prominent economists such as Christopher Findlay in the Asia-Pacific and Jacques Sapir in Europe support the link between trade liberalisation improving the business environment, thereby expanding corporate profits – which in turn attract new foreign investments in both directions.
The lowering of trade costs for European business will further improve the return on investments, nearly doubling the profit margins in sectors like retail. Even the critics – this author included – of Abenomics must admit that Japan has defeated core deflation and restored corporate earnings and dividends. Such opportunities may be timely; the International Monetary Fund projects that the world economy could slow by 0.5% due to new political uncertainties.
Investment diversification for EU firms
For the EU, the agreement delivers a much-needed strategy shift on overseas investments. European multinationals are overexposed to macropolitical risks in the emerging markets, where they must compete on low prices and with yesteryear technologies. China alone accounts for 12% of Germany’s foreign investments – compared to just 1.7% for the US – and is operating at a loss.
In contrast, the returns on EU investments in Japan are nearly double the average made outside the bloc.
Such indicators seem to show that European businesses undervalue Japanese demand, which – at nearly €4 trillion – is still the largest in Asia. Japan’s $4.9 trillion GDP is also growing by €700 a person each year, most of which goes towards consumption, rather than savings or exports. And it is spent by households and businesses, not government agencies or state-owned enterprises – and on high-quality goods and services, and not just industrial equipment.
As Brussels and Tokyo look to find growth overseas and diversify their investments, the EU-Japan EPA is a step in that process.
Unlike investments coming from emerging markets, cross-investments between economies such as the EU and Japan bring capital as well as market know-how and R&D. European and Japanese businesses are highly specialised and complementary, with considerable synergies in new areas, such as electric vehicles, life sciences, digital economy and artificial intelligence – sectors where Japanese R&D spending so far outperforms the rest of Asia combined.
Hosuk Lee-Makiyama (@leemakiyama) is a senior fellow at the London School of Economics.
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