Thoughts on Future Economic Relations
Between Japan and the European Union

October 18, 1994
(Japan Federation of Economic Organizations)

1) Introduction

Integration of the European community took a new step forward with the creation of a single market in January 1993. The Treaty of the European Union, which took effect in November 1993, aims at even closer integration, with planned negotiations ostensibly leading to an agreement admitting some of the European Free Trade Association (EFTA) member states to the EU and eventually to the formation of a pan-European entity.

In actuality, however, closer integration and expanded membership in the community are contradictory goals -- and have lead, during the ratification process, to efforts to reject the centralization of power. Doubts have also been expressed over the merging of economies and the establishing of a common currency.

At this time it is uncertain whether voters in those nations that have already agreed to membership will actually accept eventual union. Yet in spite of all these unresolved issues, the movement toward European integration cannot be stemmed. As Europe moves closer to the 21st century the process will continue resolutely.

The trend toward "deepening" and "widening" is a matter of great interest to us in Japan. Politically, we have every reason to believe that the creation of a pan-European entity will help to stabilize the international community. All member states would adopt common foreign policies and, in the economic sphere, we can assume that a single market and cohesive industrial policies would invigorate the entire European economy. These developments, in turn, would lead to expanded world trade and balanced development of the world's economy.

Continued close trilateral relations among Japan, the United States and Europe are essential to global stability and economic prosperity. In the past, the Japan-Europe relationship was relatively weak, when compared to the U.S.-Japan or U.S.-Europe relationship. However, economically speaking, the relationship changed radically in the second half of the 1980s when Japanese companies invested heavily in Europe and virtually all EU member states began to view Japan and the Japanese market with a positive and confident attitude.

We in the Japanese private sector intend to promote further Japanese investment in Europe, in keeping with free market principles. We welcome European efforts to increase exports to Japan and will cooperate fully with such efforts. We hope that Europe will be able to maintain its current business climate and open markets -- and will be able to further improve its positive business environment.

Global economic cooperation would benefit greatly from improved economic relations between Japan and Europe. Although substantial agreement was reached in the Uruguay Round of GATT negotiations, there are still many unresolved issues to be addressed, including environmental policies and the coordination of competition policies. Europe's recent experience in the process of integration can surely serve as a guide in seeking solutions to these complex issues. We believe that Japan and Europe should also work together to formulate better assistance policies for developing countries in order to improve market cooperation. We sincerely hope that such cooperative efforts will be productive for both Japan and Europe, leading to a more stable world economic system based on the principles of freedom, peace, democracy and respect for human rights, supported by the ideals of a free market economy and the spirit of competition.

2) The EU:Moving Toward Closer Integration and Expanded Membership

A) Europe's Market Integration and Issues Facing the EU

In a meeting of the Council of the European Union, EU member states agreed to adopt 266 items out of the 282 proposed in the council's white paper on the internal market and in its seventh report. Member states have already brought an average of 85.5 percent of their domestic laws and regulations into conformity with 230 EU-agreed items, and all countries are taking steps to resolve the remaining issues. However, they must still go through the difficult process of coordinating a number of important issues that remain, such as quarantine controls, corporate laws, intellectual property rights and value-added tax.

In October 1992, a committee headed by Mr. Peter Sutherland, presented a 38-point proposal on improving integration measures as part of its report on Europe's Internal Market After "EC '92." While the report on one hand had stressed the need to clarify the process under which EU policies are decided upon, on the other, it urged that administrative efficiency be raised by changing the EU's policy-making power from that of issuing decisions to that of issuing regulations. Thus, the report proposed two contradictory concepts.

In response to proposals made by the Sutherland Report, the European Commission will issue annual reports and announced policies to ensure transparency in the process under which the commission arrives at decisions, and to strengthen cooperation among members. It is clear that Europe has not yet created a single market, but it is also clear, if one looks at economic trends, that internal trade is now much more dynamic than external trade. It is generally assumed that the move toward a single market has contributed to the EU's economic growth.

A single market does provide a sound basis for expanded free market commercial activity. It can be assumed that a more vigorous EU economy will help to prevent the creation of a "Fortress Europe" and will therefore help to stabilize the world economy. What should be kept in mind, however, is the fact that there is a growing tendency in some European quarters to look inward and to move toward isolationist thinking. We fervently hope that the EU will make every effort to ensure that it does not develop into a single market isolated within economic barriers.

B) The Maastricht Treaty

It was assumed that the agreements reached in Maastricht in December 1991 would become decisive in setting Europe on the road to complete integration. The agreements envisioned the creation of two unions: one monetary, based on uniform fiscal policies and a common European currency; and one political, based on common policies in the areas of foreign affairs, defense and trade. However, this move to integration suffered two major setbacks in June 1992, when the Danish people opposed ratification of the treaty through a referendum, and later when confusion in the currency markets gave rise to doubts about the very aim of the treaty. The Danish referendum indicated how difficult it would be to gain grass-roots support for this "supra-national" experiment, while the currency market crisis demonstrated the complexity of achieving a monetary union among countries whose economic policies varied greatly.

During a summit meeting in Edinburgh in December 1992, it was agreed that Denmark could opt out of participation in common policies on currency, defense, citizenship and the judicial system. The European Commission indicated its intention to revise existing decisions relating to subsidiary. These compromises resulted in the Danes approving ratification of the treaty in a second referendum in May 1993. At this time, the United Kingdom, where parliamentary debate on the treaty had been contentious all along, finally decided to participate.

Although the provisions of the treaty are now in effect and have been ratified by all member states, EU integration is by no means complete. In fact, treaty ratification and implementation are just the beginning of the process, and some extremely difficult tasks must still be tackled. With regard to monetary union, a matter of great interest to us in Japan, not one country has met the requirement of adoption of economic convergence indicators, which is essential for progressing to the third stage of union. Conversely, there has been movement away from integration in major countries, with the United Kingdom and Italy having left the Exchange Rate Mechanism.

Therefore, factors imply that it is practically impossible for all member states to move simultaneously to the third stage of union envisioned during 1997-99. It is now highly probable that the most realistic path is a two-track approach. Even German Chancellor Helmut Kohl, whose role as president of the Council of Ministers during the second half of 1994 is to promote EU integration, will probably have to propose the two-track approach.

C) Widening

Expansion of membership in what is now the EU, has continued for some years, with the United Kingdom, Ireland and Denmark joining in 1973, Greece in 1981 and Spain and Portugal in 1986. By forming a single Europe under the Maastricht Treaty, the EU has become more attractive to other nations. In fact, EFTA member states, Turkey, Malta, Cyprus, etc., have followed each other in applying for EU membership. Austria, Sweden and Finland began negotiations with this aim in February 1993 and reached agreement in March 1994, joined subsequently by Norway. These countries are all expected to become EU members in 1995 after holding national referenda.

Expansion of the EU membership means a union of countries with very different ways of thinking and very different economic performance levels -- and such expansion inherently serves as an impediment to close integration. It would appear that closer integration and expanded membership are mutually exclusive goals that contradict each other at a time when the EU's structure needs to be maintained by delicately balancing national differences.

In the movement toward expansion, the EU asks that when EFTA countries join, they accept the terms of the Maastricht Treaty -- and this could be thought of as one way to maintain the balance between closer integration and expanded membership. However, in the current round of expansion discussions, the question of voting rights has come up and this clearly indicates how expansion brings with it very difficult challenges.

Another issue facing the EU is the question of including those countries that are tied by regional alliances as EU member states, such as those in Central and Eastern Europe, and those of the former Soviet Union. This question is presently the cause of disagreement between France and other nations in the "closer integration camp," who are pressing for stronger bonds with the EU, and the United Kingdom and other nations in the "expanded membership camp," who are urging wider acceptance because of security considerations. Here too, the argument urging a two-track approach can be heard. We will have to wait to see which camp is successful in the mid to long term -- the side urging closer integration or that endorsing expanded membership.

Japanese companies in general would find it more advantageous if there were an expansion of EU membership over a wider geographic area, within which business activities were subject to the same basic policies. For their part, European companies look forward to the same greater opportunities in the large potential market that could be created within the EU. However, we must remain aware of the risk that liberalized trade, within a union that maintains economic barriers, could strengthen the inward-looking orientation of European businesses and lead to regionalism and protectionism.

3) Japan and EU:Trade and Investment

A) Trade

If one looks at trade statistics for the most recent 10-year period, one can see that Japan's trade surplus with the EU over this period has risen constantly, with the exception of a decline in the periods from 1989 to 1990 and during 1993. Japan's trade surplus grew from $10.4 billion in 1983 to $31.2 billion in 1992, although it did decline to $26.3 billion in 1993. Trade imbalance is equal to the imbalance between savings rates and investments, and should be addressed by coordinated macroeconomic policies among all relevant countries. Within the framework of trade, Japan has had a comparative advantage by virtue of its products that have a large market share, such as motor vehicles and electronic goods, while the EU enjoys a comparative advantage in specialty goods with relatively small market shares, such as machine tools, chemical products and luxury items.

The Japan-EU trade imbalance is not yet, economically speaking, an issue of great importance. However, its continued existence could easily become a political and diplomatic issue, and could provide an excuse for EU protectionism. This is why Japan and each EU member state must make an accurate analysis of their own level of international competitiveness, including the relative strengths enjoyed by their products and services. Then they must implement mutual expansion of their imports and exports through strategic cooperation that would, in-turn, reduce the imbalance.

We must also not waste time in reviewing a variety of factors that may effect the imbalance. We must scrutinize aggressive Japanese business activities that focus on greater market share; we must better understand the strong consumer demand in EU countries for Japanese products; we must examine whether the strong yen will result in reducing Japan's trade imbalances with each EU country; and, we must give careful consideration to the relationship between trade friction and cultural or social friction between Japan and EU countries. Finally, we must continue to seek ways to improve EU access to Japan's markets.

In recent years the European Commission and EU members have approached the Japanese market in a fairly aggressive way. This approach is welcome and in marked contrast to Europe's past attitude, in which the Japanese market was given little attention, and European marketing strategies revolved around expectations of high prices and high returns.

Another issue that must be considered is Europe's concern with what it views as Japan's obsession with U.S.-Japanese relations. A review of the problems Europe has in selling Japan its Airbuses, semiconductors, cellular telephones and automotive parts, shows exactly why Europe feels it has been ignored. Even though Japanese companies have rational economic reasons for buying elsewhere, from the European perspective, Japan focuses on U.S. trade issues to the neglect of European concerns.

We believe that Japan must follow a course of action in which bilateral agreements, such as those it has with the U.S., are made equitably. Actions that appear to favor one country over another will ultimately have a negative impact on Japan. Our trade-related decisions must take into consideration the key issue of long-term economic efficiency as well.

B) Investment

Japanese direct investment in Europe rose rapidly at the time of the initial single market agreement. This investment now measures ten times the total of European direct investment in Japan. Key reasons for this include the yen's appreciation after the Plaza Accord and the increased sophistication of Japanese firms operating overseas, which allowed them to focus at an early stage on the advantages offered by the EU market. They were able to change their strategy from an orientation based on trade, to one promoting investment and production within Europe while awaiting the emergence of a unified market. The result was a significant expansion of Japanese business into the European market.

Japanese companies could benefit from an integrated European market, since it would offer lower business costs due to economies of scale and a lack of trade barriers. Japanese firms have increased their staff and revised their thinking of factory site location: They have established subsidiaries whose operations extend throughout Europe and founded centers for research and development. They have made investments as well in order to remain in compliance with EU anti-dumping regulations, etc.

Previously, the countries now comprising the EU did not necessarily consider the Japanese market to be vital to their interests. Japan's cultural and lifestyle differences presented significant barriers that caused European companies to think carefully before entering the Japanese market. But things have changed -- European businesspeople have a better understanding of the Japanese market. They know that Japan's huge export market consists of consumers who are extremely particular in their demands and who value technological innovation. They also know that success in Japan can lead to success in the global market. As a result, Europeans are revising the way they approach the Japanese market, with many having established their own sales and service centers in Japan.

Working contrary to these trends are two other factors that make Japan a much less attractive place to invest -- the extremely high value of the yen and a market that has traditionally been geared toward low profits. Japan must take steps to expand opportunities for direct investment and offer more incentives than it has previously if it is to attract European business. Unfortunately, Europe itself has lost some of its attraction as a place to invest because of certain decisions taken to address social issues, such as those of the European Works Council issued in September 1994. In future, the European community should make every effort to maintain a business climate that is attractive to foreign investment.

C) Proposals to Reduce Imbalances

From a purely economic point of view, trade and investment imbalances are not inherently problematic and it would be unreasonable to insist that Japan and the EU seek a constant balance. However, long-standing extreme imbalances can become major political and social issues, and can negatively effect bilateral trade, as well as diplomatic relations. If Japan and the EU are to maintain positive economic relations, we cannot ignore the trade imbalance, which is now nearly $30 billion.

As a general rule, it is the country in deficit that should strive to reduce the imbalance -- but in order to maintain the harmony that exists between the EU and Japan, we in Japan must conscientiously undertake the following measures:

D) Ways to Improve Economic Relations Between Japan and the EU

By comparison to the U.S.-Japan relationship and to that of the U.S. and Europe, the economic relationship formed by Japan and the EU is underdeveloped in many ways. The relationship needs to be strengthened by cooperation from both sides so that it can contribute to the expansion of the global economy. This necessitates, among other things, an increased sensitivity on both sides of each partner's needs and action on the following issues along with others already outlined:

4) Coordination Between Japan and the EU

A) Maintaining and Strengthening the Multilateral Free Trade System

Both the economies of Japan and the EU are based on the free trade system, which is the critical element needed for future world economic development -- it must be maintained and strengthened. The North American community of nations, recently prompted by the move toward European integration, entered into the North American Free Trade Agreement and such regional agreements are being considered in the world. If the EU was to become protectionist, these other regions would probably follow suit. The true purpose of integration is to strengthen ties within a region, but we hope that such integration within the EU does not lead toward protectionism.

We in Japan feel strongly that there is a need for the swift and complete abolition of quotas that discriminate against Japan; we urge the adoption of measures that will prevent the abuse of antidumping regulations; and, we encourage the equitable application of regulations concerning country of origin.

Now that the Uruguay Round of trade negotiations under the GATT has finally been successfully completed, we hope that all participants will respect the spirit of the agreement and put it into effect from January 1995. We believe that both Japan and the EU must contribute to the development of the World Trade Organization as well. They must also demonstrate the joint leadership necessary to deal with post-Uruguay Round issues, including trade, the environment and the establishment of policies governing trade and competition.

B) Coordination of Macroeconomic Policies

If we hope to ensure stable growth of the global economy, it is essential that Japan, the U.S. and the EU coordinate their macroeconomic policies. EU members must comply with the economic convergence indicators set out in the Maastricht Treaty. The U.S. is taking steps to reduce the fiscal deficit and improve the American savings and investment balance. Japan must establish long-term policy commitments after it achieves economic growth driven by domestic demand. If we are to sustain vibrant economic transactions, exchange rate fluctuations must be predictable. When Japan, the U.S. and Europe coordinate macroeconomic management, their economic performances will become balanced, exchange rates will reflect them and will fluctuate with greater predictability.

C) Harmonization of Economic Systems

Companies located in Japan and the EU operate according to market principles but of course they must respect the economic laws of the countries in which they do business. The EU's move toward integration seeks to reconcile the laws governing the operation of all member economies and this effort is supported strongly by the private sector. Both Japan and the U.S. should follow this example and work with their other trading partners in harmonizing economic laws worldwide.

While we are not endorsing a uniform economic system, there is a need to harmonize laws that regulate basic economic activities, such as laws on competition, taxation and corporate law. We should seek a "level playing field" in each country on such issues. To this end, the governments of Japan, the U.S. and Europe should seek to harmonize their economic systems, in careful consultation with the private sector.

D) Development Assistance

Since the end of the Cold War, the countries that comprise the former Soviet Union and those of Central and Eastern Europe have attempted to move toward democratization and the adoption of market economic policies -- but they are finding the process extremely difficult. To a great extent, the success or failure of the reforms being attempted in these nations is related to the success of the industrialized world in establishing a new international order. This is another reason why Japan, as well, is providing significant economic support to these nations, within the international framework. However, because of its proximity, it is the EU that has a clear understanding of the needs of these emerging economies, so it is natural that EU member states are taking the lead, in cooperation with the U.S., in providing the majority of support. The same is true in the private sector -- compared with the business ventures being initiated by European and American firms in this area, the efforts of Japanese firms are very limited.

In Asia as well, economic instability has been growing since the end of the Cold War, yet the positions of Japan and Europe are reversed. As an Asian nation, Japan places great importance on its relations with its Asian neighbors. Japan has an obligation to play a major role in promoting the region's development within an open economic framework in cooperation with the U.S. and Europe. In the case of China, where difficult issues like human rights' abuses complicate international relations, Japan must work to prevent China from being isolated by the world community. We must promote conditions that allow China to develop its own inherent economic strength, which in turn will lead to further growth of the global economy. In addition, the APEC nations need to strengthen market-oriented ties within the region.

We are not saying here that Japan and the EU should limit their international roles to their own regions. Rather, we believe that, although each should concentrate on assisting nations within their own geographical area, they should also play major roles within each other's regions. We know that the EU has shown much interest in the evolution of APEC and we welcome the European community's opinions in this regard.

In conclusion, we in Japan believe that it is possible for Japan and the EU to cooperate in ways that make the best use of the advantages both have to offer in regard to APEC and EU nations, as well as other developing nations, particularly those in Africa, the Middle East and in Central and South America. This link of cooperation would benefit both the EU and Japan, and would contribute to the advancement of developing countries worldwide. Ultimately, it is essential that Japan and the EU work together in building a cooperative relationship that can utilize the strengths of each side's public and private sector institutions and technological expertise to benefit the development of the entire global economy.

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