The Japan-EU trade deal recently went into effect after a four year negotiating process with it being signed in the summer of 2018.I want to discuss what we can learn from this deal in other contexts such as post-Brexit UK but to do so we’ll have to discuss how free trade works. Free trade is generally considered good to most economists, based on Ricardo’s work on comparative advantages. Ricardo’s theory is based on the idea of specialisation, that everyone involved in trading would be better off specialising in producing what they’re good at producing and importing the rest. This holds true even if one of the trading partners is better at producing everything than the other as long as it is comparatively better at producing a good.
There is one more thing one has to consider when discussing trade: distance. This may seem obvious but it has been overlooked in many trade discussions I’ve been involved in and heard. Living in the UK during the Brexit process means that trade relations are a much more common topic of discussion than it would otherwise be and I’ve heard several people say that the UK could start to trade with China/the Commonwealth countries instead of the EU. Of course that view doesn’t take distance in mind and it’s not difficult to see the logistical problems which arise with distance. Or what I’ve heard called the “iron law of trade”: as distance doubles trade halves. The law can be explained by transport costs: as distance increases so too does transport costs which makes foreign low price low margin products unable to compete with similar domestic products. This means that only high value products should be profitable to export over large distances which explains why longer transports mean less trade, the low cost products stop being exported as they can’t make a profit.
With this in mind we can start to predict what trading patterns we would expect between the EU and Japan. As mentioned there probably won’t be much trade in things like agricultural goods as they tend to be perishables and generally quite low cost, instead one would expect most of the trade to be in more expensive goods like cars and industrial products. According to the European Commission 99% of EU imports from Japan were industrial products and 89% of EU exports were industrial products in 2017. Industrial products in this case refers to things like machinery, appliances, and chemical products. This means generally high value and often high tech products.
The EU-Japan trade deal is in it self not that interesting, sure it makes up the worlds largest free trade zone and it covers billions of Euros in different products but it isn’t qualitatively different than most trade deals. This is paradoxically what makes it worth analysing as it in some ways show a rather typical free trade deal between two highly advanced economies which are located very far away from one another. Therefore, this example can help to guide our expectations for the kinds of trade deals the UK can expect to make with advanced non-EU economies after Brexit. One conclusion one can draw from this exercise is that the UK will most likely be a net importer should it strike a trade deal with a far away advanced economy like Japan as the UK isn’t very good at producing industrial goods as it is at producing financial services which are much more difficult to export than physical goods.
What do you think about the EU-Japan free trade deal? Are you a supporter of free trade? Please share you thoughts either in the comment section or on Twitter @ipolecoblog. If you enjoyed this blog post you can find our other posts on trade here, and please consider mentioning the blog to your friends who might be interested in the topics we cover.
Photo by Julius Silver from Pexels
Source: European Commission 2017 https://webgate.ec.europa.eu/isdb_results/factsheets/country/details_japan_en.pdf
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