Life after TPP: Who will be the loser in US-Japan trade talks?

The Trans-Pacific Partnership (TPP) has been a part of the current Japanese government's growth strategy, so the U.S. withdrawal from this trade agreement has been damaging to the country's prime minister, Shinzō Abe, and will pose further problems in the future.

While U.S. President Donald Trump's economic policies remain uncertain, a bilateral agreement between Japan and the U.S. would be the most logical step for the two countries.

Japan's Prime Minister Shinzo Abe and US President Donald Trump wait for a meeting in the Oval Office of the White House on February 10, 2017 in Washington, DC.
Brendan Smilalowski | AFP | Getty Images
Japan's Prime Minister Shinzo Abe and US President Donald Trump wait for a meeting in the Oval Office of the White House on February 10, 2017 in Washington, DC.

However, we can expect tough negotiations with Trump pushing for a deal that favors the U.S. and any new agreement likely to be very different from the TPP.

The question is: Will Japan be forced to sign an agreement much less advantageous than the previous arrangement? There is strong speculation that this will be the case, adding to Prime Minister Abe's current series of headaches.

Since President Trump took office in January, there have been increasing concerns that Japan's continued trade surplus with the U.S. will drive the White House's protectionist outlook. In the fourth quarter of 2016, Japan's economy growth was buoyed by exports of electronic devices and other IT products to China and the rest of Asia, rather than the U.S.. However, should Japanese automobile exports to the U.S. continue to rise and expand Japan's trade surplus with the U.S., we may yet see protectionist pressures grow. This won't be a good position for the Japanese economy to find itself in, given its heavy reliance on exports.

Top level U.S.-Japan talks on economic issues are expected to be held between Deputy Prime Minister Taro Aso and Vice President Mike Pence in April. However, top U.S. trade advisor, Peter Navarro, has already stated that trade between certain nations are not mutually beneficial, mentioning the U.S. trade deficit with Germany, Japan's non-tariff barriers, and the undervalued Chinese yuan as examples. It is not certain which Japanese non-tariff barrier he was referring to, but there is a chance that the U.S. will demand revisions in order to improve the balance of trade.

Currency manipulator?

One possible measure is that the Bank of Japan (BoJ)'s multi-dimensional easing policy may come under criticism for currency manipulation. This sort of criticism - already put forward by President Trump in early February when he claimed yen manipulation by Japan - would put a stop to the BoJ's current yield curve control policy and may lead to higher long-term interest rates. The result? Yet another hit for the Japanese economy with inflation taking a downward slide after only just returning for the first time since 2015.

On the macro economy side, the main focus for Abenomics will be the progress of the government's growth strategies. In particular, it is worth noting the "work style" reforms which Prime Minister Abe stated were his "greatest challenge". Specific measures under these reforms include equalising pay, reducing long working hours, promoting flexible working hours and supporting employment of women and senior citizens. Traditional Japanese employment practices, such as prioritising long-term continuous employment and seniority based wage systems, are seen as hindering the country's economic recovery.

With the potential growth rate declining in Japan due to the falling birth rate and an increasingly aging population, it will be necessary to drive the productivity by investing in IT systems and factory automation, and also alleviate labour shortages by hiring more women and older Japanese who may be already in retirement. In addition, Japan needs to find a way to strengthen its human capital by improving skills and productivity of its workforce.

On the currency side, we expect to see yen depreciation to continue and reach an exchange rate of 117 to the dollar this year on the back of expanding interest rate differentials between Japan and the U.S. This has boosted the stock market and driven the Nikkei 225 to around 21,000 level.

Focus on the fundamentals 

However, we should not forget the risk of hard-line protectionist policies surfacing from the new U.S. administration. In this case, we will need to focus on fundamentals as there is a possibility the yen will strengthen despite depreciation against the dollar.

Although a good relationship between Japan and the U.S. is based on the trustworthy relationship of both leaders, future discussions will nonetheless face difficulties, especially when it comes to trade and currency. With negotiations on the bilateral agreement between the two countries yet to start, only time will tell who will be the winner in a contest that will certainly have implications for both economies.

Katsunori Kitakura is lead strategist at SuMi TRUST, one of the largest asset managers in Japan.

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