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I Recognition of the Current Situation: Fears of a Shift to a Bloc Economy

Since the end of World War II, the world has enjoyed prosperity by promoting trade and investment in a free and open international economic order. In particular, the growth of trade and investment in the 20 years after the establishment of the World Trade Organization (WTO) in 1995 and China's accession to the WTO in 2001 have been remarkable.^#1

In the past few years, however, the two largest economies have entered into a strategic competition,^#2 and COVID-19 has spread since 2020.^#3 Furthermore, Russia's aggression against Ukraine has further heightened concerns about a divided world.^#4

If this situation prevails, the institutional foundations that supported postwar prosperity will inevitably be eroded, bringing about fears that the world will shift towards a bloc economy similar to the one that existed before World War II. If the world shifts in such a way, many developing countries that do not belong to either bloc will lose opportunities for growth. Market fragmentation hinders investment required to address global issues such as climate change. In fact, it is estimated that if the world were divided into two blocs and the international division of labor and technology transfer were disrupted, the world would lose 5% of its GDP in the long run, which is equivalent to the size of the Japanese economy.^#5 This is why reconstruction of the free and open international economic order is urgent.

II Direction the Global Community Should Pursue: Maintaining and Promoting Free Trade and Investment

1. Maintaining and Promoting Free Trade and Investment

As mentioned above, free trade and investment are facing serious challenges. At the same time, quite a few countries, particularly developing nations and small and medium-sized countries, are seeking to integrate into the global economy or regional economies. Although WTO membership has not increased above 164 over the past six years, 24 countries or regions are in the accession process.

Although it has been quite a while since the WTO ceased to function, and the path to WTO reform^#6 is yet to be completed, a Ministerial Conference (MC12) was held in June for the first time in four and a half years, and it adopted a Ministerial Declaration for the first time in six and a half years. Moreover, the Tunis Declaration, an outcome of the 8th Tokyo International Conference on African Development (TICAD8), was made last month, and included the following statement: "We reaffirm our commitment to uphold and strengthen the rules-based multilateral trading system, which is transparent, fair and inclusive, with the WTO at its core." In order to ensure a level playing field for developing countries and thereby realize sustainable development, Members no longer regarded as developing countries should renounce that status and assume reasonable responsibilities.

In addition to the multilateral approaches mentioned above, the plurilateral approach is becoming increasingly important. Efforts should be made starting with interested Members, with a view to reaching agreement with as many Members as possible. Highly anticipated advances include expansion of Information Technology Agreement (ITA) membership, resumption of negotiations on the Environmental Goods Agreement (EGA), and progress under the WTO Joint Statement Initiative (JSI) namely in rulemaking on e-commerce and investment facilitation. With regard to the enforcement of rules, it is necessary to make use of the Multi-Party Interim Appeal Arbitration Arrangement (MPIA),^#7 in the face of the fact that the WTO Appellate Body has ceased to function.

Furthermore, to establish a rules-based trade and investment framework, efforts to conclude regional trade agreements, which currently total 354,^#8 are essential. The African Continental Free Trade Area (AfCFTA) has been in operation since January 2021, and the Regional Comprehensive Economic Partnership (RCEP) agreement entered into force in January this year. Although these efforts are regional, their positive impact is significant.

In order to maintain and promote free trade and investment, it is also necessary to respond to the following requirements.

2. Ensuring Security

Against the background of rapid development of consumer technology, the scope of security is expanding to include daily economic activities. Under these circumstances, even if trade and investment were to be restricted from a security perspective, such restrictions need to be limited to the minimum extent truly necessary (negative list approach). By doing so, free trade and investment could be maintained while meeting security requirements. Moreover, the predictability of business activities would be enhanced. If the supply chain is to be revised in light of geopolitical risks, companies should take the initiative in doing so, because supply chains were originally built by companies based on their business strategies. Even if the government is involved from a security perspective, it should focus on supporting corporate efforts, rather than using regulatory mechanisms.

It should be noted that Article 21 of the General Agreement on Tariffs and Trade (GATT) does not preclude a Party from taking any action which it considers necessary for the protection of its essential security interests, such as those "taken in time of war or other emergency in international relations." However, it should be considered whether such a concept is appropriate in today's era of strong economic and security linkages, including from the perspective of countering acts of economic coercion.

3. Pursuing Sustainability

As symbolized by the United Nations Sustainable Development Goals (SDGs), pursuing sustainability has become an important issue. It is a step forward that MC12 reached a certain level of agreement on fisheries subsidies. The remaining challenge is how to address carbon border adjustment measures (CBAM) to prevent "carbon leakage."

4. Ensuring Regulatory Coherence of Domestic Standards

Due to the growing importance of the environment, labor, health, and security at country level, standards and regulations developed in each country will have a greater impact on trade. Unilateral imposition of standards on specific countries and regions could provoke a backlash against free trade. It is important to promote regulatory cooperation to ensure interoperability of standards.

5. Addressing Digitalizing Economy

As the digitalization of economic activities progresses, it is essential to establish rules for the cross-border transfer of data in order to smoothly develop global business and increase the added value of products and services. At present, discussions on electronic commerce are being held under the WTO Joint Statement Initiative, while bilateral and plurilateral negotiations through economic partnership agreements (EPA) are also progressing. However, these rule-making efforts have not always kept pace with the rapidly digitalizing economy. It is necessary to enable interoperability between various rules based on trust in national privacy and security systems.

III Japan's Role: Towards the G7 Hiroshima Summit

Japan has benefited greatly from a free and open international economic order. Taking into account its assumption of the G7 chair next year, Japan should take the initiative in realizing the following objectives in response to the demands listed in section II above.

1. Maintaining and Promoting Inclusive Free Trade and Investment

Japan, as chair of the G7, needs to take the lead in maintaining and promoting free trade and investment under these extremely challenging international circumstances. With uncertainty mounting over the outlook of the world economy, it is not enough simply to tackle unresolved issues such as WTO reform. Cooperation among Japan, the United States, and the European Union must be strengthened based on the Japan-EU Economic Partnership Agreement (EPA), the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and the Japan-US trade agreement. At the same time, it is necessary to launch a new initiative that encompasses the entire world, including developing countries.

2. Ensuring a Balance between Security and Free Trade and Investment

Japan is located in the Indo-Pacific, a region that harbors high geopolitical risks while also being a global growth center. Japan also has close trade and investment ties with both of the major superpowers, which are becoming increasingly strategically competitive. Therefore, other countries are watching how Japan will balance security with free trade and investment. In this regard, the global community has a high level of interest in the Economic Security Promotion Act^#9 enacted in May this year. The Act aims to secure Japan's strategic autonomy and to acquire, maintain, and strengthen advantages and indispensability. In order to serve as a model for other countries, full consideration should be given to compatibility with free economic activities in implementing economic measures to ensure security.

3. Ensuring a Balance between Tackling Climate Change and Free Trade and Investment

Trade and investment need to be promoted in ways that contribute to decarbonization, taking into account discussions at "the Climate Club," which the G7 Members agreed to establish at the Elmau Summit this year. Countries and regions considering introduction of the CBAM scheme must ensure its compatibility with the WTO agreement in order not to result in a disguised restriction on international trade.

4. Ensuring International Interoperability of Domestic Standards

During the Japan-EU EPA negotiations, Japan endeavored to reduce non-tariff barriers, for example by promoting mutual recognition of standards and regulations in a manner that reflects business views. As a result, the Japan-EU EPA has a chapter on regulatory cooperation, which stipulates that regulatory authorities on both sides shall inform the other Party at an early stage of any trade and investment regulatory measures, provide opportunities for submission of comments, conduct ex-ante and ex-post evaluations, and exchange information on good practices. By utilizing such experience, Japan should endeavor to ensure interoperability of different standards and regulations in each country.

5. Realizing Data Free Flow with Trust (DFFT)

Establishment of rules for free cross-border data flow began in 2019, when former Prime Minister Shinzo Abe proposed the concept of DFFT at the World Economic Forum in Davos. The G20 Osaka Summit, which Japan chaired in June 2019, agreed to "cooperate to encourage the interoperability of different frameworks." Japan is also one of the co-conveners leading ongoing discussions under the WTO Joint Statement Initiative (JSI) on e-commerce. Against this background, Japan should continue to lead discussions at various forums.

IV Strategies Japan Should Adopt

Based on the above, Japan should concentrate its policy resources on the following points.

1. Launch of a Trade and Investment Framework with the G7 Members at its Core

In order to avoid splintering of the world economy and maintain and promote free trade and investment, in preparation for the G7 Hiroshima Summit next year Japan should advocate for the establishment of a high-level trade and investment framework, namely a "Free Trade and Investment Club" with G7 Members at its core. It is crucial that the framework is inclusive, allowing participation of all countries and regions committed to meeting several criteria within a certain period of time. Examples of criteria can be described as follows:

• Elimination of tariffs on substantially all industrial products
• Prohibition of performance requirements for inward direct investment and ensuring freedom of remittance, etc.
• Restrictions on compulsory enforcement of intellectual property rights
• Ensuring free cross-border data transfer, prohibition of data localization requirements, and prohibition of requirements for disclosure of source code and algorithms

2. Expanding and Enhancing Economic Partnership Networks

Japan should return to its fundamental principles for EPAs and select negotiating partners with a view to forming an international environment that helps to secure Japan's economic interests.^#10 By doing so, Japan can further expand and deepen EPA networks, which have grown to cover about 80% of Japan's total trade, while increasing the number of investment treaties, which currently cover approximately 80 countries and regions. (See Annex I, 1-3)

3. Securing a Stable Supply of Energy and Food

In selecting partners for EPAs and investment agreements, it is necessary to pay particular attention to energy and food security, the importance of which has been reaffirmed by Russia's aggression against Ukraine. Japan's primary self-sufficiency rate for energy is 11.2% (FY2020) and 37% for food (calorie-based/FY2020). These rates are extremely low compared to other countries. Since complete self-sufficiency is far from realistic, it is essential to build stable and close relations with energy- and food-exporting countries. (See Annex I 4)

4. Establishing Rules for DFFT

In addition to establishing rules on free cross-border data flow, including the permanent moratorium on imposing tariffs on electronic transmissions in the ongoing discussions under the WTO Joint Statement Initiative on e-commerce, efforts should be made through the Indo-Pacific Economic Framework (IPEF), in which the major ASEAN countries and India participate. (See Annex II)

I Expanding and Enhancing Economic Partnership Networks

1. Promoting High-Level Trade and Investment

(1) The United States' Return to the TPP

In parallel with the concretization of IPEF, Japan should persist in urging the United States to return to the TPP over the medium to long term, to engage the United States in the creation of an economic order in the Indo-Pacific region.

(2) CPTPP Accession

Countries and regions applying for CPTPP accession must comply with the high standards set by the current CPTPP agreement in terms of both market access and rules. Applicants' performance and intentions will be tested.

Under RCEP, for example, major industrial goods such as automobiles, electrical appliances, and some steel products are not subject to tariff elimination. Goods such as auto parts are subject to different milestones for tariff elimination ranging from 10 to 20 years. In contrast, CPTPP calls for the elimination of almost 100% of tariffs on industrial goods. Therefore, when RCEP Members apply for CPTPP accession, they must not only steadily implement RCEP, but also be ready to eliminate tariffs ahead of schedule.

The Electronic Commerce chapter of RCEP stipulates free cross-border data transfer and prohibition of data localization requirements.^#11 CPTPP includes prohibition of requirements for disclosure of source code and non-discriminatory treatment of digital products in addition to these principles. When RCEP Members apply for CPTPP accession, they are required to comply with the provisions of the former agreement as well as those of the latter. Moreover, RCEP Members must never misuse, or be suspected of misusing, the Electronic Commerce chapter, even though it allows for restrictions based on public policy objectives^#12 and is not subject to dispute settlement procedures.^#13

Furthermore, CPTPP prohibits performance requirements targeting inward direct investment. Therefore, countries and regions seeking to join CPTPP must not enforce measures such as requirements for domestic production of certain products or technology transfer requirements.

(3) Effective Use of the Japan-EU EPA Chapter on Regulatory Cooperation

The Japan-EU EPA chapter on regulatory cooperation should be utilized to promote dialogue aimed at ensuring interoperability of standards and regulations, mainly in the areas of climate change and digitalization.^#14 It is also important that Japan and the EU cooperate to ensure interoperability of standards and regulations in third countries in Asia and elsewhere.

2. Early Conclusion of EPAs Currently under Negotiation

(1) Japan-Turkey EPA

Located at the crossroads of Europe, Asia, the Middle East, and North Africa, Turkey, with a population of nearly 85 million, is becoming increasingly important as a production base and consumer market. In addition, it has high potential as a partner for African businesses of Japanese companies. It is therefore vital to conclude a Japan-Turkey EPA as soon as possible. In addition to tariff elimination, the EPA should address prohibition of local content requirements and abolition of the obligation to employ local personnel with a view to lowering investment and business barriers.

(2) Japan-Colombia EPA

Colombia is rich in natural resources such as oil, coal, and ferronickel, which are becoming increasingly important from the perspective of Japan's energy and resource security. Colombia is also attractive in terms of market size, as it has the third largest population in Latin America after Brazil and Mexico. Economic partnership among Chile, Mexico, and Peru as Members of the Pacific Alliance^#15 also makes the Colombian market significant. Japan-Colombia EPA negotiations that began in December 2012 must achieve a prompt conclusion, regardless of the change of administration in Colombia.

3. Launch of Negotiations

(1) Launching EPA Negotiations with Israel

In order to strengthen the strategic partnership with Israel, a democratic country in the Middle East, and to promote cooperation in the development of advanced technologies, a Japan-Israel EPA is needed in addition to the bilateral investment agreement. Since Korea signed a free trade agreement (FTA) with Israel in May 2021, the Japan-Israel EPA is also important from the viewpoint of achieving a level playing field.

(2) Launching EPA Negotiations with Bangladesh

A Japan-Bangladesh EPA is necessary to maintain tariff-free trade, because Bangladesh will graduate from Least Developed Country (LDC) status in 2026 and will no longer be eligible for LDC preferences. Specifically, through a future EPA, it is vital to ensure tariff-free exports from Bangladesh to Japan for goods such as textiles manufactured by Japanese companies operating in Bangladesh. It is also important to ensure market access from Japan to Bangladesh for goods such as materials and equipment related to infrastructure development, manufacturing equipment, steel, motorcycles and associated parts, etc.

(3) Indo-Pacific Economic Framework (IPEF)

The IPEF, which was launched in May this year and includes 14 countries from the Indo-Pacific region, has held a series of discussions on future negotiations. At the Ministerial Meeting held in early September, ministerial statements were released on future negotiations in four areas?trade, supply chains, clean economy, and fair economy?and further progress is expected. Japan needs to contribute to the formation of regional order through rulemaking and by promoting cooperation based on the views of both the United States and Asian countries.

It is anticipated that the outcomes of IPEF will be reflected in discussions at the US-EU Trade and Technology Council (TTC). The Japan-US Economic Policy Consultative Committee Meeting (the Economic "2+2") could serve as a control tower to facilitate discussions at IPEF.

4. Securing a Stable Supply of Energy and Food

(1) Launching EPA Negotiations with Mercosur

Mercosur Members are key exporters of mineral resources, food, and animal feed. Japan must strengthen relations with Mercosur by concluding an EPA, especially from the viewpoint of securing stable imports of these resources.

Liberalization and protection of investment through an EPA are required in order to promote Japanese investment in sectors such as agriculture and natural resource development. Brazil, in particular, places many restrictions on investment, such as restrictions on foreign capital, local content requirements, remittance regulations, and an upper limit on the royalty ratio, and these constraints need to be addressed.

In the face of evolving economic ties with Mercosur, such as the agreement in principle on an EU-Mercosur EPA, the launch of negotiations on a Korea-Mercosur FTA, and the completion of a preliminary study on a Uruguay-China FTA, a Japan-Mercosur EPA is needed to maintain a level playing field with those countries and regions.

(2) Resumption of Japan-Gulf Cooperation Council (GCC) FTA Negotiations

The Japan-GCC FTA negotiations should be resumed so that a future FTA can contribute to the stable supply of energy. This FTA should also address barriers to investment such as restrictions on foreign capital, remittance regulations, excessive obligations regarding establishment of local offices, and the obligation to employ local personnel, from the viewpoint of promoting Japanese investment in the energy field. The business environment, including tax system transparency, should also be improved. Since Korea has agreed to resume FTA negotiations with GCC in November 2021, Japan must also resume its negotiations in order to achieve a level playing field.

(3) Strengthening Cooperation with Indonesia by Reviewing the EPA

It is essential to strengthen relations with Indonesia, a major source of Japan's coal imports and former major source of LNG imports. Earlier this year, Indonesia imposed export restrictions on coal due to tight domestic supply, which were lifted subject to conditions in February. The forum for reviewing the Japan-Indonesia EPA should be utilized to increase the production and stable supply to Japan of energy and natural resources.

In addition, it is necessary to verify whether the value-added mining policy and the fixed royalty under the Mining Law are compatible with RCEP and the Japan-Indonesia EPA, which prohibit performance requirements.

(4) Conclusion of EPAs and Investment Treaties with African Countries

Africa is expected to develop significantly thanks to its abundant natural resources and expanding middle class. As exemplified by the entry into force of AfCFTA in January 2021, African countries are moving toward economic integration, spurring the interest of the global community in strengthening economic partnerships with them. Japan needs to enhance its economic partnership with Africa by taking advantage of the framework of the Tokyo International Conference on African Development (TICAD). Based on the needs of Japanese companies doing business in Africa, conclusion of EPAs and bilateral investment treaties (BIT), including those currently under negotiation, is anticipated. It is essential to ensure that the provisions of such agreements are not inferior to existing agreements that African countries have concluded with European countries, China, Korea, etc.^#16

5. Other

In the face of the situation in Ukraine, the public and private sectors of both Japan and Ukraine shall collaborate with a view to businesses continuity and reconstruction of the country. Based on Ukraine's requests, measures to continue and strengthen bilateral trade and investment in the future, including an EPA, should also be envisaged.

II Establishment of Rules for DFFT

1. IPEF

Since IPEF does not cover market access for goods, concrete outcomes are required to attract as many countries as possible. From this perspective, rules for free cross-border data flow could be an "early harvest." The rules under CPTPP, RCEP, and the Japan-US Digital Trade Agreement already exist, and rulemaking under IPEF, in which the United States, the major ASEAN countries, Australia, and New Zealand participate, is expected to play a role in incorporating and linking these rules.

2. Japan-US Digital Trade Agreement

In parallel with the discussions under IPEF, it is important to promote bilateral efforts based on the Japan-US Digital Trade Agreement. A mechanism to ensure interoperability between the different regimes for the protection of personal information should be developed (Article 15, Paragraph 3 of the Agreement). Consultation should also be promoted from the security perspective, including responses to cyber-attacks, and reflected in discussions under IPEF.

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1. In 2001, at the beginning of this century, global trade was approx. $6.1 trillion (in terms of exports), but in 2021 it was approx. $22.3 trillion, which is a 3.7-fold increase in 20 years (JETRO World Trade Matrix). In terms of investment, the global stock of FDI stood at $41.8 trillion in 2021, compared with approx. $7.3 trillion in 2001 (UNCTAD World Investment Report 2022).
2. For example, since July 2018, the US has implemented several rounds of tariff increases on China under Section 301 of the Trade Act, and China has responded with countermeasures. Other measures include the tightening of restrictions on inward direct investment and export controls, and exclusion from government procurement, etc.
3. In response to the COVID-19 outbreak, some countries implemented export restrictions for medical supplies and food and raised tariffs on certain items to protect their domestic industries. Strict lockdowns also disrupted global supply chains.
4. Food supply chains have been particularly affected. The decrease in shipments of wheat, etc. from Russia and Ukraine has had a serious impact on the supply to developing countries in Africa and elsewhere, including aid.
5. Mentioned by Dr Ngozi Okonjo-Iweala, Director-General of the WTO, as an estimate by WTO economists at the WTO Ministerial Conference in June 2022.
6. For Keidanren's views on WTO reform, see Towards the 12th WTO Ministerial Conference, September 14, 2021.
7. The Ministry of Economy, Trade and Industry (METI), The Interim Report of the Special Task Force on Policy Response Measures under the Suspension of the Function of the WTO Appellate Body, June 2022.
8. The number of agreements notified to the WTO and currently in force (as of March 2022).
9. Officially called the "Act on the Promotion of National Security through Integrated Economic Measures"
10. According to the "Basic Policy towards further promotion of Economic Partnership Agreements (EPAs), approved by the Council of Ministers on the Promotion of Economic Partnership" (December 21, 2004), in identifying countries or regions to negotiate with, the Government shall take the following perspectives into comprehensive consideration: "Creation of international environment beneficial to our country," "Attainment of economic interests of Japan as a whole," and "Situation of the partner countries/regions and feasibility to realize EPA/FTA."
11. See RCEP Article 12.15.2 for data free flow and Article 12.14.2 for prohibition of data localization requirements.
12. RCEP Articles 12.15.3 and 12.14.3
13. RCEP Article 12.17.3
14. For example, the Climate Club, which was established at the G7 Elmau Summit in June this year, is envisaged to share best practices and work toward a common understanding of assessing ways to reduce emissions, such as through explicit carbon pricing, other carbon mitigation approaches, and carbon intensities (see the G7 Statement on Climate Club, June 28, 2022). In parallel with the Climate Club, the EU and Japan should also work together under the framework of regulatory cooperation, and in doing so it is important to maintain consistency with discussions at the US-EU Trade and Technology Council (TTC).
15. A regional integration initiative established in April 2011 by the leaders of Colombia, Mexico, Peru, and Chile.
16. For example, Algeria, Ghana, Tanzania, Senegal, Nigeria, Zambia, and Ethiopia, with which Japan is negotiating BITs, have already concluded agreements with Europe, China, Korea, and Canada, which include provisions on fair and equitable treatment, prohibition of performance requirements, and investor-state dispute settlement. It is important that the relevant provisions of a future BIT with Japan are not inferior to those of the existing BITs.