On the UK’s Trade Deal With Japan

So much for the UK ruining its international reputation and reliability as a treaty partner. When rumblings arose throughout the international political community early last week of Prime Minister Boris Johnson’s government potentially violating international law by reneging on part of the Brexit Withdrawal Agreement, some politicians declared the UK’s reputation tarnished—allegedly near-guaranteeing no country would sign a free-trade agreement with them and that Brexit would be disastrous for trade. Yet last Friday, the UK turned this narrative on its head, agreeing in principle to a free-trade deal—its first as an independent country in nearly 50 years—with Japan, the world’s third-largest economy. In our view, this is further evidence Brexit just isn’t the isolationist, protectionist nightmare headlines frequently portray.

According to the Department for International Trade, the agreement will boost annual trade between the UK and Japan by £15.2 billion—with 99% of exports to Japan tariff-free.^[i] For reference, the UK’s total trade (exports plus imports) with Japan amounted to £29.1 billion in 2018.^[ii] The deal will liberalise rules of origin, allowing more products (e.g., UK biscuits and some types of clothing) to qualify for tariff-free trade. Some digital provisions—notably, data localisation—mean companies won’t have to set up offshore servers to continue doing business, which we think is likely to benefit British financial services companies and Japanese videogame makers. Moreover, Japanese automakers will see tariff reductions for 92% of automotive parts, whilst UK dairy farmers will get tariff-free access to Japan for some of their cheeses—a notable compromise given the issue nearly derailed negotiations.^[iii]

Whilst some financial commentators we follow are highlighting the big-sounding headline numbers, reality suggests the economic benefits are modest given each country sends only about 2% of its total goods exports to each other.^[iv] Yet the UK-Japan agreement is more significant for what it symbolises, in our view. Namely, all the hubbub about an inward-turning, unreliable, backtracking UK isn’t dissuading other countries from signing deals. The UK and Japan are even treating their deal as the next step for the UK to eventually join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)—an 11-member free-trade agreement spanning the Pacific.^[v] Tied to that, Trade Secretary Liz Truss confirmed publicly last week trade talks were back on with Canada.

We think one helpful factor is that the UK isn’t starting these deals from scratch. As a former EU member, the UK already has an existing framework to work off of for countries with EU trade agreements. The UK and potential deal partners can tweak certain provisions as both parties see fit—which could theoretically end up benefitting both sides. According to some Japanese experts, the new Japan-UK deal is essentially the Japan-EU deal with some minor improvements.^[vi] For example, tariff rates for certain automotive parts will decrease more quickly in the UK deal than in the EU deal. We think this experience and knowledge could help the UK reach FTAs with countries with EU deals much more quickly than they might if starting from scratch—which could then allow the UK to pursue free-trade pacts with countries the EU couldn’t reach (e.g., Australia or the US). Despite all the warnings, these developments don’t indicate a more protectionist or outcast post-Brexit UK, in our view.

We also think they bode well for UK-EU trade talks. Many commentators continue warning about the seemingly dwindling prospects of a UK-EU trade agreement—a much larger economic relationship—especially after Johnson’s Internal Market Bill stirred up a bunch of political drama. Yet the UK and EU already share a lot of common ground, and reports indicate both sides are hung up on only a handful of points, albeit contentious ones. We think that could make it easier than headlines portray to sign an agreement in October to enable year-end ratification, although we can’t (and won’t) predict if this will happen—political decisions can’t be forecast, in our view. However, we don’t see a “no-deal” scenario ending the world. Yes, tariffs will go into effect in that scenario—but based on the government’s previously announced tariff schedule, they are neither particularly high nor onerous. We think they also likely won’t prevent the UK and EU from continuing to negotiate and reach a future deal—perhaps one that ends up better suited for both sides.

For all the ink spilled over UK turning inward in a post-Brexit world, reality appears to be shaping up to be better than many first thought—an underappreciated positive, in our view.