U.S. – Japan Trade Agreement: A Relief or Prolonged Tariff Battle?

While the recent trade agreement between the U.S. and Japan comes as a relief, it is so primarily because the alternative would be far worse. This arrangement, announced by President Trump earlier this week, successfully averts a prolonged tariff battle with Japan, a key U.S. ally in Asia. However, the resemblance of this agremeent to a victory in a trade war is dubious at best. Despite the president’s enthusiastic description of the arrangement as possibly ‘the largest Deal ever made,’ the details that have surfaced seem rather less extraordinary.

The deal’s main provisions appear to involve a pledge from Japan to invest $550 billion in the U.S. Japan also commitments to reduce restrictions on American imports, like rice. In return, President Trump will lower his ‘reciprocal’ tariffs on Japan from 25% down to 15%, seemingly including cars. While lower tariffs are always welcome, it is worth noting that they remain a 15% tax hike on Japanese imports.

Deflecting prevailing narratives, it is a mistake to think that Japanese exporters will fully shoulder this tax hike. Often depending on the item and market competition conditions, some costs may certainly be absorbed by these exporters. Yet the reality is that both American businesses and consumers will likely have to cope with increased costs. This, in turn, can negatively impact their competitiveness and, ultimately, their living standards.

Doubts also linger about the heralded $550 billion Japanese investment in the U.S. During discussions, Japanese Prime Minister Shigeru Ishiba hinted at the possibility of government loans and guarantees to back these promising ‘investments.’ The goal, he stated, is to build stable supply chains in key sectors. This raises concerns about potential entanglement with Japanese and, indeed, American industrial strategies, especially given Trump’s assertion that these investments are at his direction and that the U.S. is set to receive 90% of the profits.

However, it is crucial to understand that increased investment inflows inherently mean a larger trade deficit in the U.S. balance of payments. One might wonder if President Trump is aware of this. More Japanese investment in the U.S. could have been secured earlier, had it not been for certain actions on the part of Mr. Trump which may have deterred such investments.

For instance, both the current president and President Biden previously hindered a $14.9 billion purchase of U.S. Steel by Nippon Steel, a deal that came to fruition only in June last year. Perhaps Japanese firms would be more inclined to invest in the U.S. without the need for loan guarantees or trade agreements, if only they were more assured of fair treatment and a welcoming environment for their capital.

One encouraging outcome of this deal, however, is the seeming reduction in auto tariffs in the U.S. from 25% to 15%. Nevertheless, this rate still represents a significant hike from the 2.5% applied to passenger cars prior to Trump taking office. In a 25% tariff world for imported trucks, this deal brings in its wake a complicated economic situation which requires careful navigation.

U.S. car manufacturers are apprehensive that Japanese firms may enjoy preferential tariff rates. Contrastingly, manufacturers in Detroit could end up paying 25% on imports of cars and parts sourced from Mexico and Canada. This exemplifies the consequential economic mess that can result from an aggressive ‘tariffs-first, negotiate-later’ stance.

But is this trade war truly being won as Mr. Trump claims? The answer depends on one’s definition of victory. Mr. Trump has indisputably demonstrated his ability to intimidate numerous countries into accepting higher tariffs, no doubt powered by the significant bargaining chip that is the size of the U.S. market. The unexpected boon is that many countries have refrained from retaliation, hence sparing the world from a catastrophic downward spiral reminiscent of the 1930s.

But there’s another side to Trump’s strategy of changing market access whimsically – it sends a message to the world about the U.S.’s negotiating style. As a response, countries may seek to diversify their trade partnerships, and are already forming new bilateral and multilateral deals that exclude the U.S. Consequently, this could also provide an opening for China to broaden its commercial influence at the U.S.’s expense.

China too has exhibited its capacity to engage in trade intimidation. The country’s retaliation against Trump’s 145% tariffs, by imposing export restrictions on vital minerals, proves that it can play the trade game just as fiercely. If this trade dispute ever concludes, the average U.S. tariff could still end up close to 15% from its starting point of 2.4% in January, reflecting a growth-impeding tax hike.

Now, Trumponomics is at a crossroads. The question is whether the growth-encouraging aspects of Trump’s tax and deregulation policies will offset the negative impact of raised tariffs. The Japan deal at least offers an initial step towards reducing the damaging uncertainty surrounding trade.

Now, what does this suggest for other trade discussions, particularly those involving the European Union? The Japan negotiation, despite its complexity, appears relatively straightforward, especially since Tokyo’s agricultural protectionism could be negotiated into concessions. However, discussions with Brussels promise to be riddled with more prickly issues, such as tech and pharma taxes and complaints about U.S. financial regulations.