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Mixed messages for Japan in Trump's NAFTA revamp

Tokyo will worry about US right to veto pacts with nonmarket economies, such as China

| Japan
The United States-Mexico-Canada Agreement shows Washington is ready to compromise.   © Reuters

When the text of the United States-Mexico-Canada Agreement was released last month trade ministries around the world worked through the night as officials pored over the details to see what the trilateral deal might mean for them, as well for the global trading system.

As the Trump administration's first wholesale rewrite of an existing trade agreement, the USMCA, which replaces the North American Free Trade Agreement, is likely to serve as the model for future U.S. trade pacts.

Probably no capital was as busy as Tokyo. Less than a week prior to the USMCA breakthrough, President Donald Trump and Prime Minister Shinzo Abe agreed to pursue bilateral trade negotiations. In a joint announcement, the leaders laid out a two-staged process, with the first phase focused on manufactured and agricultural goods. Negotiations are expected to start early next year.

As Japan prepares for these talks, the USMCA will prove instructive. The first important take-away for Japan and other trading partners is that despite a lot of drama, at the end of the day the U.S. compromised throughout the agreement, a necessary aspect of any trade negotiation.

The outcome of the USMCA is a far cry from the nonconventional ideas that the U.S. administration floated at the outset. Trade deficit reduction targets, tax equalization measures and U.S. automotive production requirements do not appear in the final deal. The administration dropped the extreme elements of many of its initial proposals, including the sunset provision.

Second, as the leader of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP, commonly referred to as the TPP 11), Japan was probably relieved to see that many of its provisions found their way into USMCA. One doesn't need to do a deep dive to see CPTPP rules in chapters ranging from intellectual property protection to digital trade to labor and the environment. Some important updates to these rules have been added, which is natural given that many CPTPP provisions were negotiated several years ago. The last thing the global trading system needs are competing rules across trading blocs, making it difficult for businesses to navigate complex terrain. With many CPTPP rules in USMCA, this regulatory "spaghetti bowl" was avoided, and Japan can hang on to hopes that the U.S. will return to this agreement.

So, that's the good news for Japan. However, there are other aspects of the USMCA that should set off alarm bells in Tokyo.

The USMCA automotive provisions top the list. In side letters to the agreement, the U.S. granted both Mexico and Canada guaranteed tariff-free access on autos and auto parts, up to a fixed quantitative limit, above which tariffs on national security grounds could be applied. This poses problems for Japan on two fronts. First, such quantitative restrictions have been a source of tension between the two countries, with Japan having its auto exports to the U.S. capped in the 1980s under so-called voluntary export restraints. Since then, Japan has strongly resisted quotas. Secondly, Mexico and Canada have granted legitimacy to the U.S. using national security to justify imposing tariffs. While Japan has gained a temporary reprieve from such tariffs in the Joint Announcement, it should prepare itself for a similar U.S. requests for quotas. While most Japanese cars sold in the U.S. are produced locally, Japanese auto exports are still significant.

Automotive rules of origin are also of potential concern. This issue threatened to bring down the entire USMCA. Ultimately the three parties agreed to 75% North American automotive content requirements, the highest of any recent trade agreement. This was also one of thorniest issues in the TPP negotiations with an outcome of 45% content. This gap will need to be narrowed in bilateral negotiations with the United States, which won't be easy for Japan given Japanese automakers` diverse supply chains.

Linked to the automotive issue is currency. U.S. automakers have long complained that their most formidable barrier to the Japanese market has been currency manipulation by Tokyo. For the first time in a U.S. trade agreement, currency provisions are embedded in the USMCA text, with procedural obligations subject to dispute settlement. It didn't take much time for a difference of views on this issue to surface, with Treasury Secretary Steven Mnuchin suggesting that the USMCA approach could be a model for Japan, and Minister for Economic Revitalization Toshimitsu Motegi questioning whether it was appropriate to take up currency in the talks.

Another important aspect of the USMCA which likely surprised Japan and other trading partners relates to trade agreements that Mexico or Canada may pursue with nonmarket economies. While China is not named, it is the obvious target.

This provision allows the United States to review such agreements before signature, and withdraw from the trilateral USMCA if it chooses to. While Tokyo is not likely to enter into a bilateral FTA negotiation with Beijing anytime soon, it is negotiating with China and 14 other Asian partners in the Regional Comprehensive Economic Partnership talks. It's unclear how RCEP would be treated if the U.S. asked Japan to include a similar provision.

Finally, what wasn't in the USMCA surely also disappointed Japan, namely no mention of the steel and aluminum tariffs imposed on national security grounds on most countries.

At the time of this writing, these metal tariffs remain in place for Mexico and Canada. Japan likely viewed the initiation of bilateral talks as an opportunity to gain U.S. agreement to eliminate these tariffs, particularly for steel where Japan is the sixth largest source of U.S. imports. The continued imposition of tariffs on Mexico and Canada casts serious doubt on whether the U.S. would lift them as part of a bilateral deal with Japan.

Of course, each negotiation is different with its own unique trade-offs. Nevertheless, Japan would benefit from closely studying the USMCA and developing strategies on how it would address similar U.S. requests that were made to Mexico and Canada.

Wendy Cutler is vice president of Asia Society Policy Institute in New York and former acting deputy U.S. trade representative.

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