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Australian Government - Department of Foreign Affairs and Trade

Advancing the interests of Australia and Australians internationally

Australian Government - Department of Foreign Affairs and Trade

Advancing the interests of Australia and Australians internationally

Australia and Japan: How distance and complementarity shape a remarkable commercial relationship Chapter 2 - Shaping forces: complementarity and distance

Australian Government Department of Foreign Affairs and Trade, 2008

ISBN: 978 1921244 8 96 (paperback)

Key points

  • The complementarity between the economies of Australia and Japan-each having what the other needs at a price it can afford-continues to be the principal driving force in the expansion of the commercial relationship.
  • That complementarity is constrained by the distance between Australia and Japan, which results not only from geographic separation but also from differences such as in language, business practices and customs, technical standards, legal and political systems, and even relative standards of living.
  • Overcoming the impediments presented by distance requires some effort. Where the complementarity is great, commercial incentives will lead firms to trade and invest despite the challenges. Where the complementarity is less marked, there may be a role for governments and business in working to reduce some of these impediments.
  • As the economies of Australia and Japan evolve, it will increasingly be the effects of non-geographic distance rather than complementarity that shape the development of the bilateral commercial relationship.

Two powerful forces, pulling in different directions, have been instrumental in shaping the commercial relationship between Australia and Japan. On the one hand, the complementarity between the two economies makes them 'natural' trading partners. On the other, distance (in its many dimensions) between Australia and Japan has been, and remains, a significant impediment.

The relationship described in Chapter 1-one of tremendous strengths, but which has proved stubbornly resistant to moving into new areas of endeavour-is the product of the interplay between these two forces. This chapter examines the nature of both the forces and their effects to date, as the backdrop for the discussion of the future of the relationship in subsequent chapters.

The driving force: complementarity

It is the essence of a successful trade transaction that both sides of the bargain feel that they are better off for having made it-or, in other words, each has something that the other values more than what they already have. Things work better still when each side feels an interest in assisting the other to deliver what it needs.

The secret of the success of Australia's trade and investment relationship with Japan is that, from the earliest days, it has been ever thus. Australia had pearls for which there was a market in Japan; Japan had divers to help exploit the resource. Australia had wool to feed the looms of pre-war and early post-war Japan; Japan produced insulators that enabled the spread of electricity through the Australian continent. Australia has coal, LNG and uranium to power Japan's industrial sector- and Japanese buyers helped to finance the development of those resources. Japan has the affordable cars and electronic equipment Australians used to shrink their continent's vast expanse to a manageable size, as well as other consumer goods to make life comfortable. And, as the two countries have become increasingly affluent, and the thoughts of their people have turned to leisure, each has offered attractions not easily found at home-whether the coral of the Great Barrier Reef or the dry powder snow of the Hokkaido ski resorts-to travellers from the other, conveniently within the same time zone.

The strength of the complementarity can be seen in the figures: Australia has been the principal or one of the principal suppliers to Japan of a range of minerals and energy for four decades. Importantly, the strength of the complementarity is underlined by the fact that Japan's domestic production of almost all these commodities-coal, iron ore, uranium, silica, bauxite and alumina, and other minerals and base metals-has been minimal, so that Australia's domination of Japanese imports has effectively meant Australian domination of the supply of these products in Japan.7 Similarly, Japan has been a leading supplier of a number of manufactured goods imported by Australia; the most important of these in recent years have been cars and motorcycles, for which Japan has been the principal source.

To date, these complementarities between the two economies have evolved as the economies themselves have. As we saw in Chapter 1, wool was for a long time the staple of Australia's exports to Japan, but the direct bilateral trade evaporated as Japan's looms moved offshore. However, another substantial agricultural export industry has grown up-considerably funded by Japanese investment-in grain-fed beef, of which Australia is Japan's largest supplier (displacing the United States from its long-held top rank following its problems with bovine spongiform encephalopathy (BSE, or 'mad cow disease')), in addition to the sizeable trade in traditional grass-fed beef. Similarly, as Japan's energy mix has changed, LNG (for which Australia was the third-ranked source of imports in 2007) and uranium have emerged alongside coal as highly significant imports from Australia. Australia's imports from Japan-while still concentrated in the manufacturing sector-have, likewise, shifted away from consumer electronics and electrical goods and textiles as Japan's own industry has become more capital intensive. Japan has long since ceded its place as the source of low-cost, labour-intensive light manufactures to others, and become viewed as a cutting-edge provider of top-quality, high-technology consumer and capital goods.

The constraining force: distance

If having what the other needed were all that mattered, the bilateral commercial relationship might be even larger and have been so for longer. However, concurrent with the story of complementarity has been a story of fluctuations in what we describe as 'distance' between the two countries. This concept encompasses the many potential impediments resulting from differences between Australia and Japan across a range of factors. These factors include commonality (or lack thereof) of elements such as language, business practices and customs, technical standards, legal and political systems, and even relative standards of living, as well as the traditional geographic definition of distance in terms of physical separation between the two countries. Ghemawat (2007) provides a useful framework for analysing what he characterises as the four dimensions of distance: cultural, administrative, geographic and economic (the 'CAGE' framework, set out in Table 2.1).

Focusing on this multidimensional concept of distance in analysing the Australia- Japan commercial relationship is of interest for a number of reasons. It can help us to explain what has not happened, as well as what has; and-through a look at how bilateral distance has been diminished throughout the history of the relationship, and where it still exists-it may provide clues to business as to how to open up opportunities for successful bilateral dealings, and to governments as to how they might go about ensuring that the conditions are right for the relationship to continue to flourish.

Table 2.1: The generic, country-level CAGE framework for distance
  Cultural distance Administrative distance Geographic distance Economic distance
Country-pairs (bilateral) Different languages Different ethnicities; lack of connective ethnic or social networks Different religions Lack of trust Different values, norms, and dispositions Lack of colonial ties Lack of shared regional trading bloc Lack of common currency Political hostility
Physical distance Lack of land border Differences in time zones Differences in climates and disease environments

Rich-poor differences Other differences in cost or quality of

  • natural resources
  • inancial resources
  • human resources
  • infrastructure
  • information of knowledge
Countries (unilateral or multilateral) Insularity Traditionalism Nonmarket or closed economy Extent of home bias Lack of membership in international organisations Weak institutions, corruption Landlocked geography Lack of internal navigability Geographic size Geographic remoteness Weak transportation or communication links Economic size Low per-capita income

Source: Ghemawat (2007: 41).

Ghemawat's work, among others', highlights the continuing impact of distance, in these many dimensions, on the likely success or otherwise of the trade and investment decisions of corporations. Notwithstanding the effects of globalisation-especially the impact of technological developments (in particular in information and communications), the decline in transport costs (although these are under pressure now) and the improvements in speed, efficiency and reliability (which permit companies to source inputs from foreign rather than local sources, for example), and the growth of international trade and investment-the majority of the world's economic activity is local or regional.

All other things being equal, the level of trade and investment varies with proximity. The tools economists use to measure this effect-fitted gravity models-show that the further two countries are from each other the smaller their trade: in general, these models predict that an increase in physical distance is associated with a similar reduction in the volume of trade-that is, countries that are 5,000 kilometres apart would be expected to do only one-fifth of the trade that they would do if the distance between them were 1,000 kilometres (Ghemawat 2007: 37).8 Most of the largest bilateral commercial relationships have been and still are between countries that share a border (such as Canada and the United States, and France and

Germany or, more recently, Mexico and the United States) or are near neighbours (such as China and Japan). This geographic proximity is often accompanied by cultural, administrative, political and/or economic similarities (frequently embodied in a preferential trade agreement between the countries, as in the case of Australia and New Zealand).

As the Australia-Japan relationship demonstrates, this does not mean that countries that are distant on one or more of these dimensions cannot trade with or invest in one another. However, these different elements of distance are likely to act as impediments to the development of a close and substantial commercial relationship. Research by Ghemawat and Mallick (cited in Ghemawat 2007) estimated that trade was greater by 42 per cent if the two countries used a common language, by 47 per cent if they were both members of a preferential trade agreement, by 114 per cent if they used a common currency, by 125 per cent if they shared a land border, and by 188 per cent if they had a colonial relationship.

Distance in the bilateral relationship

How, then, might we characterise the degree of distance, in all its dimensions, with which the bilateral relationship between Australia and Japan must contend? How have the various elements affected the relationship? And how has it evolved over time (see Box 2.1 for a summary of key developments)?

Box 2.1 Some milestones in Australia–Japan commercial relations

  • 1853 Arrival of Commodore Perry signals opening of Japan to the outside world
  • 1865 First recorded import of Australian coal by Japan
  • 1868 Meiji Restoration in Japan sees Tokugawa Shogunate overthrown. Last ship carrying convicts from Britain arrives in Australia
  • 1888 First recorded Japanese imports of Australian wool
  • 1889 Fusajiro Kanematsu establishes the first Japanese trading house to develop and expand the wool trade; Sydney branch set up in the following year
  • 1890s Efforts made by Japan and some of the Australian colonies to establish trading links
  • 1897 Queensland adheres to the Great Britain–Japan Treaty of Navigation and Commerce. Japan opens a consulate in Sydney
  • 1900 Japan imports wheat from Australian colonies
  • 1901 Japan is the 13th-largest trading partner of the newly federated Australia
  • 1902 New South Wales appoints a commercial agent in Japan
  • 1905 Jo Takasuka and his wife Ichiko travel to Australia and make the first sustained attempt to grow rice in Australia, on the Murray River, near Swan Hill, in the north-west of Victoria
  • 1909 Mitsui is the first of the major Japanese trading houses to establish an office in Australia
  • 1914–18 World War I—Australia and Japan allies
  • 1915 Japan seeks a trade agreement with Australia
  • 1930–31 Japan is Australia’s third most important trading partner
  • 1935 Australian Government appoints a trade commissioner to Japan
  • 1936 Australia implements a trade diversion policy (which limits imports from Japan) as part of western sanctions in response to Japanese abrogation of the naval arms control treaty. Japan’s retaliation (restricting imports from Australia) leads to an uneasy
    settlement
  • 1938 Concerned about security, the Australian Government bans iron ore exports after Japanese companies had secured the rights from the West Australian Government to mine and export iron ore from Yampi Sound
  • 1941 Trade suspended when Japan enters the Pacific War
  • 1947 Australian companies are allowed to trade with Japan under controlled arrangements
  • 1950 In response to balance of payments problems, Australia imposes import restrictions on imports from all countries, but the tighter controls imposed on Japanese goods cause a dramatic reduction in imports
  • 1951 Signing of the San Francisco peace treaty, which formally ended World War II
  • 1953 Japan seeks trade talks with Australia
  • 1955 Japan joins the General Agreement on Tariffs and Trade; Australia (like 13 other GATT Contracting Parties) invokes Article XXXV to allow continued discrimination against Japan
  • 1956 Australia and Japan sign the first post-war bilateral, intergovernmental agreement (on aviation) and commence negotiations on an intergovernmental trade agreement Australia lifts all Japan-specific visa restrictions imposed during and after
    World War II
  • 1956–57 Japanese trading companies (re)open offices in Australia to take advantage of the changed trading environment
  • 1957 Agreement on Commerce between the Commonwealth of Australia and Japan signed
  • 1960 Australia lifts many restrictions on exports of iron ore
  • 1963 Renegotiation of the Agreement on Commerce: Australia agrees to give up the right to impose safeguards in the event of a surge in imports and to accept full GATT obligations towards Japan Western Mining Corporation signs a contract to supply iron ore to Japanese steel mills
  • 1966–67 Japan surpasses the United Kingdom to become the largest market for Australian exports
  • 1973 Abolition of the White Australia policy
  • 1976 Basic Treaty of Friendship and Cooperation (known as the Nara Treaty) signed
  • 1976–77 Japan’s share of Australian exports of goods and services reaches its peak of 31 per cent
  • 1985–86 Imports from Japan peak at 20 per cent of Australian imports of goods and services
  • 1986 Tensions in the trade relationship run high after Japanese buyers force significant price reductions in annual negotiations on coal prices and volumes
  • 1996 Two-way trade declines for the first time in 40 years
  • 2007 Australia’s two-way trade with China exceeds that with Japan for the first time Negotiations commence on a bilateral free trade agreement between Australia and Japan

Cultural distance

Cultural distance encompasses the many factors-including language, shared ethnic networks, the impact of values (especially trust) and religion-that arise from the interaction of people. The patterns of investment and services trade that exist between Australia and the world suggest that cultural distance is a particularly important factor in these areas. Australia's largest investment relationships-in both directions-are with the relatively culturally proximate United States and Great Britain-despite the geographic distance.

The transformation in bilateral cultural distance over the 150 years since the first export of coal from Australia to Japan could hardly be more remarkable. Mutual understanding has gone from an initial zero (reflecting the sakoku or 'closed country' policies of Japan during the Tokugawa era) through the awakening in the early years of the 20th century of a realisation in each country that goods from the other might be welcome even if migrants (courtesy of Australia's own partial sakoku, the White Australia policy) were not; via pre-World War II suspicion, wartime enmity and residual hostility in the immediate post-war era; by way of caution as bilateral trade and later investment started to increase with Japan's emergence as a major economic power; through increasing people-to-people contact as more young Australians studied Japanese language and culture and brought this knowledge to their careers, and as more Japanese people visited Australia for business or as tourists; to arrive at a current relationship of significant friendship and familiarity in which repeated surveys rank each country as among those most liked and trusted by the people of the other, and which, increasingly, is being reflected in the growth of intimacy and cooperation beyond the commercial arena.

Examples of institutionalised efforts to reduce cultural distance include the Australia-Japan Business Cooperation Committee and its Japanese counterpart, the Japan-Australia Business Cooperation Committee, some of the early leaders of which made considerable efforts to understand Japanese (and Australian) language and culture, as well as business practices; programs of Australia's (now-defunct) Asian Studies Council; the Australian National University's Australia- Japan Research Centre, which specialises in enhanced understanding of the two countries and their relationship; the Australian government-funded Australia-Japan Foundation; and the annual Australia-Japan Council, which brings together high-level business and government representatives from both countries. The Australian Government provided support for the development and operation of Australian studies programs in Japanese universities, and, at the more popular level, for a significant Australian presence at international expositions in Japan, most recently the Aichi Expo of 2005 (see Box 2.2). Australia has been one of the targets for Japanese Government-funded programs such as the Japan Foundation, which has promoted Japanese language and culture in Australia, and the Japan Exchange and Teaching (JET) program through which many young Australians have experienced Japan as teachers, leading to longstanding personal and professional connections. As well, there is a network of 45 Japan-Australia societies in Japan and 15 counterpart Australia-Japan societies active in Australia. Another non-government initiative is the number of exchange programs organised by groups such as Rotary that enable young people to spend time in the other country.

Box 2.2 Australia at Aichi-Australia's Japan savvy

Australia's popular pavilion at the 2005 Aichi World Expo in Nagoya (capital of Aichi prefecture) was a snapshot of change in the relationship between Australia and Japan.

Thousands of young Australians applied for the 60 positions as pavilion attendants, despite the high language proficiency requirements. As a result, the Australian pavilion stood out among the 120 countries represented at the Expo for its Japanese-speaking staff, and was consistently rated in the top five national attractions at the Expo.

Moreover, most of the Australian attendants had studied Japanese culture, had already experienced living in Japan and wanted to use their skills in an environment such as the Expo, resulting in an outwardly friendly and hospitable atmosphere that attracted Japanese people visiting the Expo. The evident skill of the staff was, of itself, a profound advertisement for the pavilion's promotion of Australian education services.

Other advantages of the Australian Government's growing engagement with Japan and the rest of Asia over more than 50 years were also evident, particularly in the cultural and business aspects of the pavilion's operations. Organisers were able to call on a large pool of entertainers who had experience touring Japan and other parts of Asia, which enabled audiences to readily identify and appreciate the performances. Strong existing business links between Australia and Japan laid the foundation for more than 200 functions, including 43 business events that strengthened existing business links in the Chubu region (the region of nine prefectures in central western Honshu, including the Aichi prefecture) as well as sowing the seeds for greenfield projects.

Despite these efforts, and the success that has been achieved, bilateral cultural distance remains significant. Most critically-given the interest in overcoming the apparent difficulties experienced in expanding the relationship beyond areas of clear complementarity-there are some crucial areas in which, relative to the relationships both Australia and Japan have with other major commercial partners, bilateral cultural distance seems to be increasing markedly.

Migration appears to be a particularly important factor in determining flows of both trade and investment, in large part, apparently, because of its capacity to enhance information flows between the countries concerned (Dolman 2008). In this area, it is clear that considerable distance remains. The numbers of Japanese living in Australia and Australians living in Japan are extremely low compared to the incidence of migration in Australia's relations with most other major and emerging trading partners. Japan is not a significant source of migrants to Australia, either overall or recently in either the skilled or business migration categories, despite the size of the bilateral commercial relationship. It was the fifth-largest source of working holiday visa holders in 2006-07-behind the United Kingdom, the Republic of Korea (which had more than two and a half times as many working holiday-makers visiting Australia as Japan), Germany and the Republic of Ireland.

The education relationship, too, is critical, given the strength and depth of the links that arise from long-term study. Japan has retained a significant position as the eighth-largest source of foreign students in Australia, but numbers are broadly steady (see Box 2.3) and have been falling slightly in the past two to three years (although official figures do not pick up when visitors from Japan are (legitimately) undertaking short-term studies while on working holiday or tourist visas). For its part, Australia has maintained its interest in study in and of Japan at a level that is relatively high by western standards-Japan is the third-largest destination for Australians studying overseas and the largest foreign-language destination; but numbers are dwarfed by the huge numbers of students from other regional countries undertaking studies in Japan. Moreover, whereas students from China, the Republic of Korea, India and other major trading partners of both countries have tended to travel to Australia or Japan for the study of disciplines such as engineering or management, the principal focus of students travelling in both directions bilaterally has tended to be on the language or the culture of the other- something arguably less likely to lead directly to business links since it provides students with less direct exposure to the business strengths of the other country.

Box 2.3 The importance of education in breaking down distance barriers

Education is one of the keys to bridging cultural and political distance— particularly in the case of a bilateral relationship such as that between Australia and Japan, where language, history and culture differ significantly. Since the late 1980s, when the boom in Japanese language education occurred, Australia has been relatively well served for expertise in this area. However, although
Australia remains the home to a number of tertiary institutions regarded as centres of excellence for Japanese studies, this situation may be changing both in relative and absolute terms. Among Year 12 students the recent trend has been for enrolments in Japanese courses to be relatively static, notwithstanding continuing government support (including through the National Asian Languages
and Studies in Schools Program), while an increase in Chinese studies mirroring that in Japanese in the early 1990s has occurred (see Figure 2.1).

Figure 2.1

Year 12 school numbers studying Japanese hold steady

Total Year 12 enrolments in language courses in Australian schools, 1991–2006

Figure 2.1. See explanation on text.

Source: Schools Group, Department of Education, Employment and Workplace Relations.

A similar trend is noticeable at the university level. A 2003 survey of 33 Australian universities found that there had been a huge rise in demand for Japanese studies before 1989 as evidenced by a rapid rate of increase in enrolments. This was followed by slower but continued growth until 1996. Between 1996 and 2003 (the latest data recorded in the joint Australian–Japanese study), enrolment
numbers generally showed a declining trend across the 33 universities surveyed (JF and AJRC 2004).

Again highlighting the erosion of any advantage Australia might have had in this area in relative terms, Figure 2.2 shows that the total number of overseas student enrolments in Japan has increased rapidly in the past ten years. Numbers of Australian students in Japan, however, have remained relatively static at around 350 since the early 2000s—and in 2007 comprised only 0.28 per cent of total overseas enrolments.

Interestingly, while traditionally not a major provider of international education, Japan is emerging as increasingly attractive to students from many of the markets to which Australia is providing education. Japanese development assistance programs that have been targeted at developing countries in the region are part of the reason for this, but it is evident that Japan is also attracting
substantially more privately funded students.

Figure 2.2

More and more foreign students study in Japan, especially privately
funded ones

International students in Japan, total and by source of funds, 1983–2007 (as of each May 1)

Figure 2.2. See explanation on text.

Source: Japan Student Services Organization, <www.jasso.go.jp/index_e.html>.

For its part, Japan has traditionally not been a major source of overseas students for Australia (unsurprisingly, given the highly developed nature of its education system, and the relative prestige attached to attendance at major Japanese, rather than overseas, institutions in the Japanese employment market), but it has been a significant one. From a Japanese perspective, Australia remains a popular choice: in 2006 and 2007 it was the second-ranked destination for higher education behind the United States. That said, it has declined markedly in relative importance in the past ten years. Since 1997, total foreign student numbers in Australia have more than tripled, and enrolments from some emerging economies, especially China, India and Brazil, have grown phenomenally while
those from Japan have grown only slowly (by a total of 32 per cent) over the whole period, and have been declining in absolute terms since 2004 (Figure 2.3). The decline has been particularly pronounced in the ELICOS (English Language Intensive Courses for Overseas Students) sector (Figure 2.4), which is particularly price-sensitive, suggesting that exchange rate movements might have been influential.

Figure 2.3

Japanese student numbers fall slightly while those from selected developing countries grow rapidly

Numbers of students from Japan, China, India and Brazil studying in Australia (all sectors), 1997–2007

Figure 2.3. See description on text.

Figure 2.4

Fewer Japanese come to Australia to study, especially ELICOS

Japanese international student enrolments in Australia by sector, 2002–07

Figure 2.4. See description on text.

Note: ELICOS = English Language Intensive Courses for Overseas Students.

Source: Australian Education International Statistics, Department of Education, Employment and Workplace Relations.

These numbers do not present the complete picture, as there have been positive developments at the secondary school level. Australia has become the most popular destination for Japanese 'school visits’ (either shugaku ryoko (school excursions) or kenshu ryoko (school study tours)), with almost 50,000 primary and secondary school students travelling to Australia in 2006 as members of
school parties. The challenge will be converting the interest resulting from this relatively superficial contact into return visits that lead to the development of deeper relationships.

One factor in the number of Japanese students studying in Australia, and vice versa, is the formal links between Australian and Japanese institutions (even though many of these agreements were more about opportunities for staff sabbaticals than student exchanges (Pokarier 2006)). In 1994, there were 133 such agreements; by 2002 the number had increased to 513, of which 299 were
with private institutions (Pokarier 2006). Governments, too, have recognised the importance of cooperation and, in 2007, Australia and Japan signed the Memorandum on Cooperation in Education, which formalised a framework for new cooperative activities at both the governmental and institutional levels.

Administrative and political distance

The administrative-political dimension of distance includes the laws, policies and institutions by which a country is governed and its economy operates. While there are significant similarities between Australia and Japan-both stable democracies with well-established legal systems-for most Australian businesses seeking to do business with Japan, the devil is in the detail. The very different histories of the two countries and the absence of a shared political, legal or administrative heritage mean that many of the ways that laws are made and enforced and the administrative practices-most notably the use of administrative guidance by powerful Japanese government ministries to 'encourage' (or 'discourage') certain activities by companies-are different and can affect perceptions about opportunities for commerce. So, too, can the different approaches to corporate law and corporate governance, which, in practice, limit the managerial oversight of shareholders, together with policies that have traditionally discouraged inward foreign direct investment.

Despite these many differences between the two countries, there are some administrative commonalities that have had the effect of diminishing distance. For example, one consequence of both Australia and Japan driving on the left-hand side of the road is that Australia became the third-largest export market for motor vehicles produced in Japan. (Japanese motor vehicle companies with plants in North America and Europe often source cars for their local markets from those plants rather than from factories in Japan.)

While trade and investment can (and often does) take place in their absence, intergovernmental agreements and institutions can facilitate commerce. As the membership and influence of the World Trade Organization (and before it the General Agreement on Tariffs and Trade) grew, the multilateral framework provided a set of rules designed to engender security and predictability in trade, making traditional bilateral agreements less important than they once were. However, the recent proliferation of preferential agreements-free trade agreements in Australian parlance, economic partnership agreements in Japanese terminology-has added another dimension to intergovernmental frameworks.

The Agreement on Commerce between the Commonwealth of Australia and Japan, signed in 1957, was a successful example of a traditional bilateral agreement. Such traditional agreements focused on reducing the impact of or removing the administrative barriers that made commerce expensive and/or difficult, or even prohibited it.

The Agreement on Commerce did just that: it led to the removal of the restrictions that had disrupted trade since the 1930s. It provided a more certain and secure framework for firms to do business, and began a new phase in commercial links. It increased the pace at which commercial ties developed. The changes in rules, together with the public signal in both countries that such ties were welcome, both contributed to this expansion.

Box 2.4 Why the 1957 Agreement on Commerce was so significant

The Agreement on Commerce removed most trade restrictions between Australia and Japan in 1957. Principal among these restrictions on the Australian side were import licences, used extensively to protect domestic industry, support trade with the United Kingdom and ration the use of foreign exchange (in an era of fixed exchange rates and a shortage of US dollars in sterling-bloc countries). Foreign exchange was also an issue in Japan, and the Agreed Minutes attached to the Agreement on Commerce recorded Japan's commitment to ensuring foreign exchange limitations and other non-tariff measures were not used to constrain imports of wool.

Tariffs were also a key area of concern for both countries. The Agreement on Commerce provided for tariffs to be levied on the basis of MFN (most-favourednation, i.e. non-discriminatory) treatment. When Japan joined the GATT in 1955, 14 Contracting Parties invoked Article XXXV, which allowed them not to extend MFN treatment to Japan. Australia was the first of those 14 to commit to revoking its use of Article XXXV and treating Japan as it did other parties to GATT.

Both countries saw benefits from the trade relationship. Japan sought such an agreement because of its interest in Australian raw materials, and as a promising developed country market for its manufactures. While strong foreign exchange and cultural pressures in Australia favoured trade with the United Kingdom, even in the early post-war period Australia sought to source many of its specialised needs (such as insulators for the electricity grid) from Japan.

The Agreement proved successful. While trade had expanded significantly in the 1950s before the Agreement was negotiated, it both provided a more secure and predictable legal basis for commercial ties and highlighted, in Australia, that Japan was once again a respectable trading partner. The Agreement came about despite some strong opposition within Australia at bureaucratic and political levels and from Australian manufacturers.

The Agreement on Commerce was only the first step in removing restrictions on bilateral commercial ties. In 1960 the Australian Government relaxed many of the restrictions on exports of iron ore, and in 1963 removed the embargo. The Agreement itself was renegotiated and amended in 1963 after the intervening years had seen continued growth in two-way trade and a diminution of many of the concerns (for example, on exchange rates) that had been reflected in the original text. The 1963 changes removed the remaining discriminatory treatment by Australia (Article V, which provided a broad right to impose safeguards, was deleted; this right applied to both parties but had been included at Australia's request). As well, the exchange of notes between the Australian and Japanese ministers confirmed that Australia would no longer invoke GATT Article XXXV- although Australia had levied the same tariffs on Japanese imports as those from other countries since 1957, it had retained the right on other issues to treat Japan differently from other GATT Contracting Parties.

In 2007, 50 years after the Agreement on Commerce helped expand trade and investment ties, negotiations began on a free trade agreement/economic partnership agreement between Australia and Japan, which both governments hope will provide further assistance for business so that trade and investment will continue to flourish in the future.

While the Agreement on Commerce was not the first intergovernmental agreement between Australia and Japan after the Peace Treaty of 1951-an air services agreement was signed in 1956-it heralded an increase in governmental efforts to expand the relationship. The two countries negotiated agreements covering issues as diverse as fisheries, double taxation, culture and the peaceful uses of nuclear energy. Many of these agreements were intended to facilitate the development of commercial relations, often in particular sectors. These issue-specific agreements complemented the all-encompassing Basic Treaty of Friendship and Cooperation (commonly known as the Nara Treaty) of 1976. New agreements continue to be negotiated as needed: in January 2008 the two governments signed the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, an update of the 1969 double taxation treaty that addresses issues affecting business today and reflects the current tax treaty policies and practices of the two countries.

Political distance has also diminished significantly, particularly if one considers starting points of almost complete mutual isolation and ignorance (1865 when the first trade was recorded) or absolute hostility (the immediate aftermath of World War II). Intergovernmental relations have progressed particularly rapidly in the past ten years, with Australia and Japan seeing each other as natural partners on a range of issues that extends well beyond the commercial-for example, cooperation between defence forces in Iraq and a trilateral security dialogue with the United States, as well as commitment to the Asia-Pacific Economic Cooperation forum (APEC) and cooperation on a range of regional architecture proposals. The Japan-Australia Conferences, of which four have been held since April 2001, also provide key participants in the relationship from government, business, the media, academia and the broader community with additional, less formal opportunities to share perspectives and make recommendations to ministers on issues of importance for bilateral relations. The current negotiations on a free trade agreement have the potential to culminate in extra institutional support to further reduce political distance. Governments at lower levels have also sought to build closer links: by 2008 there were 85 sister-city affiliations, six sister-port relationships and six sister-state relationships, as well as 11 sister relationships between broadcast stations.

Geographic distance

Geographic distance is important, particularly in the case of merchandise trade and especially when higher fuel prices lead to increased transport costs; and obviously presents a considerable potential impediment to trade between Australia and Japan. The two are a substantial distance apart. However, the negative effects of the 5,000-plus kilometres between them are offset by some countervailing factors; distance is relative as well as absolute. Iron ore imports to Japan from Australia have to travel less than one-third of the 18,000-odd kilometres from the other key supplier, Brazil, for example; and Japan, though distant, is still nearer than some of Australia's other major sources of supply of motor vehicles, such as Europe. Shipping routes are relatively direct, and the distance is short enough to permit direct flights (which encourages both tourism and air freight). The lack of a significant time difference is an important benefit to services trade in particular. For agricultural trade, the northern/southern hemisphere difference in seasons has provided opportunities for Australian producers, often in conjunction with Japanese investors, to grow varieties of fruit and vegetables favoured in Japan for sale during the months when local produce is not available.

Geographic distance is more than just the proximity or lack thereof between Australia and Japan: it also reflects the transport and communications infrastructure as well as the ease and cost with which they can be used. Here again, there does appear to be some evidence that developments in other commercial relationships are having some impact on Australia-Japan relations through the economics of air services. The phenomenal increase in business travel-passenger airlines' largest profit driver-from both countries to India and China appears to be resulting in a decline in the relative profitability of airline services between Australia and Japan (where business travel is relatively low and not increasing). Unsurprisingly, given the highly competitive nature of the airline industry internationally, this is leading carriers to redirect planes away from Australia-Japan routes to more lucrative destinations, with consequent negative effects for other bilateral industries such as tourism.

Economic distance

Economic distance between Australia and Japan is relatively small. Both are wealthy economies with per capita incomes of a similar order of magnitude. Although Australia is a much smaller economy than Japan, it has, as we have seen, had a high propensity to consume Japanese products, and Japan's absolute size, in particular, is an important factor encouraging exports from Australia. Even in the past, the complementarities between the economic structures of the two meant that differences of wealth had little impact on the ease of commerce between Australia and Japan. While there was a widespread perception in Australia of a lower standard of living in Japan in the early 20th century and when Japan was recovering from the devastation of war, the Japanese 'economic miracle' led fairly rapidly to production that relied on low labour costs (such as in textiles and clothing) moving offshore from Japan, thus diminishing opportunities for arbitrage based on cost differences between the two countries in that area.

An important economic factor is the current size of the bilateral trade and investment relationship itself. It is generally the case that significant economic interaction in certain sectors will create the links that lead to an expansion of economic relations into other fields. As we saw in Chapter 1 and as we discuss further in Chapter 4, this has perhaps been a weaker factor in some sectors than might have been expected.

Differences of economic structure, and the political consequences of this, continue to have some impact on economic and trade policy measures affecting bilateral trade. Australia and Japan have both opened their economies significantly to the world in the past 30 years, and tariffs in general are at very low levels, befitting developed economies. However, Japan's low level of comparative advantage in agriculture, combined with a strong political imperative to preserve the sector despite its poor productivity, has resulted in ongoing high levels of protection, both through border measures such as tariffs and quotas, and through large subsidies, directly affecting the prospects for increased trade in an area of clear complementarity.

Unilateral and multilateral factors

There are also a number of other factors-some specific to an individual country, others consequent upon the nature of international interaction-that can affect the distance between two countries. Some of these are obvious, observable realities: for example, research shows that land-locked countries typically trade less than their counterparts with direct port access. For Australia, geographic remoteness- both of settlements within the country from one another, and of Australia from the rest of the world-has long been noted as an impediment to economic and other integration. Some characteristics of Japan are often identified as potentially affecting the extent to which it will develop commercial ties internationally. These include the relatively small percentage of Japanese who have emigrated or live overseas, especially by contrast with the larger (in both absolute and percentage terms) diasporas from India and China which have played significant roles in developing those countries' trade and investment links with the world. Another is the longstanding cultural and other traditions associated with agricultural production and lifestyle.

Some such factors are clearly relatively immutable-location is obviously a historical and political reality about which countries can generally do little. Others, however, may be subject to change-for example, Japan's post-Meiji development was generally based on a firm policy stance resisting dependency on inbound foreign direct investment, a stance that continued in the post-war era (LaFeber 1997) and continues to confound a number of would-be investors, but recent Japanese government policy documents have emphasised the importance of foreign direct investment.

The interaction between complementarity and distance

The idea that patterns of trade and investment between Australia and Japan can be analysed in terms of the interaction between complementarity and distance is not, of course, a new one. Drysdale and others have done much research in this area which posits that the intensity of trade (that is, the extent to which trade patterns between two countries correlate with their overall importance in world trade) could be explained as the product of two variables: complementarity and 'bias'-a variable equivalent in many respects to the concept of 'distance' that we have used in this report.

Broadly speaking, Drysdale's conclusions (Drysdale 2006, reproduced in Tables 2.2 and 2.3) demonstrated that the intensity of overall trade between Australia and Japan has consistently been far larger than would be predicted purely by the relative size of the Japanese and Australian contribution to world trade (a larger size than expected is shown by figures over 100); that complementarity-the degree to which each exports goods that the other imports in large quantities-has played a major role (again, figures over 100 show a positive contribution); and that bias-which correlates broadly with what we have called distance-has also played a substantial and almost always positive role (again, figures over 100). The notable and predictable exceptions to this were the immediate pre-war period through to 1954 for Australian exports to Japan, and the whole of the pre-war period in respect of Japanese exports to Australia, when the strength of former colonial ties with the United Kingdom was overriding.

The bias indexes for Japan's imports from Australia and Australia's imports from Japan also show that government actions can and do make a difference: the decline between 1935 and 1937 highlights the effect of the trade restrictions introduced by Australia and Japan's retaliatory measures. The much greater increase between 1954 and 1965 demonstrates that the 1957 Agreement on Commerce had a major effect as a policy and institutional change. Note that the bias and complementarity components of the index have fallen from highs in the late 1970s, reflecting economic restructuring in both Australia and Japan, with consequent changes in both countries' trade patterns and composition of trade.

Table 2.2: Distance matters, and so does government policy, for both Japan's imports from Australia… Complementarity (C), bias (B) and intensity (I) indexes for Japan's imports from Australia, 1913-2000
  1913 1929 1935 1937 1954 1960 1965 1970 1975 1980 1985 1990 1995 2000
C 57 139 147 183 190 198 204 194 217 216 186 194 151 156
B 170 171 203 82 151 233 240 157 158 138 166 148 148 140
I 97 238 298 150 286 462 490 316 348 300 310 295 229 219

Source: Drysdale (2006).

Table 2.3: …and Australia's imports from Japan. Complementarity (C), bias (B) and intensity (I) indexes for Australia's imports from Japan, 1913-2000
  1913 1929 1935 1937 1954 1960 1965 1970 1975 1980 1985 1990 1995 2000
C 113 112 170 159 172 146 110 118 125 129 130 114 113 101
B 64 95 98 73 79 134 172 164 201 189 181 171 132 153
I 72 106 168 116 136 196 190 193 252 244 235 195 150 155

Source: Drysdale (2006).

Drysdale's complementarity, bias and trade intensity indexes essentially represent aggregated measurements of the relationship as a whole. In that sense, his approach provides us with a useful baseline. But to address the question in which we are most interested-the divergence between the fortunes of the very clearly complementary primary sector and tourism and those of elaborately transformed manufacturing and services sectors highlighted in Chapter 1-we need to consider how distance and complementarity interact in relation to specific sectors of the trade and investment relationship.

Areas of high complementarity

As noted above, the areas of the relationship-particularly Japanese imports from Australia-in which complementarity is clearly the driving force comprise largely primary products, in which it can be said both that Australia's revealed comparative advantage is strongest, and that Japan's is weakest. It can also be argued that, at least in relative terms, 'distance' is evolving in a way that generally favours Australia as an ongoing supplier.

Intuitively, geographic distance and ease of transport are significant issues in relation to transport of bulk resources; and Australia, as noted previously, is not close. However, absolute distance is less important in this context than relative distance. As a source of LNG, Australia has played second fiddle to the more proximate Indonesia and Malaysia for many years; but the dwindling of these countries' easily exploitable reserves and new Japanese contracts with North West Shelf suppliers has Australia poised to become Japan's largest supplier after 2015. And as a source of food and many other raw materials, the calculus is shifting in Australia's favour as China's own internal demand reduces or eliminates the surpluses it once exported.

Australia's developed-country status and the inherent similarity of expectations between Australia and Japan about product quality is another economic distance factor that works in its favour. Both countries have (at times to the despair of their trading partners) stringent quality control and quarantine requirements for food safety, which help to underpin shared understandings about acceptable quality of food exports. The fact that Australia was able to step into the breach created when US exports of beef to Japan ceased as a result of the outbreak of bovine spongiform encephalopathy in the United States in December 2003 underlines the importance of these shared understandings and the high standards of food safety that result from them.

It is not yet clear, however, to what extent the economic distance represented by tariffs and other protective measures in agriculture, as noted above, will be susceptible to early reduction.

Manufactures and services

If geographic distance-relative to rivals and taking account of time zone and seasonal factors-favours Australia's exports of primary products to Japan, the reverse is often true for elaborately transformed manufactures. While there are strong international performers in these fields in Australia, it is certainly also the case both that Australia is less well known overseas for this type of activity, and that Japan is better served for domestic supply, than is the case with primary sector products; and that Australia's relative merits across the board stand out far less from those of international competitors. Australian businesses interviewed for this report repeatedly stressed that lack of name recognition for Australia as a whole in this field in Japan required prospective entrants to the market, in making their case to potential buyers, to be far more persistent than their competitors from countries better known for manufacturing or services products. Complementarity, if it exists, is much more likely to be between individual buyers' products and individual sellers' needs.

Similar considerations apply to exports of services by Japanese service providers: language barriers have contributed to a low propensity of Japanese companies to export services to all countries, not just Australia. And, while a high-income market, Australia is still far smaller than others such as the United States and European Union, deterring service providers and manufacturers from developing products specifically for the Australian market. On the other hand, Japanese manufacturers continue to have advantages, including well-known brand names and a strong association in consumers' minds with high quality and high technology. However, many of the rivals to factories in Japan are now found in other East Asian countries like China, Korea and Thailand, all of which are as close or closer, rather than the more distant Europe or North America.

As will be seen in Chapter 3 in relation to the growth of production networks (encompassing both good and services) in East Asia, this of itself need not mean that trade cannot flourish. Production networking has arisen as a result of ever higher degrees of specialisation according to very fine gradations of comparative advantage, dependent upon relative levels of skills, technology and capital intensity in different countries. Collectively, the sum of large numbers of individual complementarities between buyers and sellers can constitute strong and important bilateral economic relationships between countries. What this suggests, however, is that significant people-to-people contact is needed to build the relationships, trust and mutual knowledge of capability that are required to identify and exploit opportunities. Accordingly, the aspects of distance that affect the degree of human contact in the relationship are likely to be significant in determining its success.

Close examination of statistics that might be expected to provide proxies for measurement of distance in this regard suggests that bilateral distance-principally around the cultural and economic elements of the CAGE framework-appears, if anything, to be growing, rather than diminishing, at least in relative terms.

As noted in Chapter 1, for the past 40 years, Japan has been Australia's largest export market; for more than 35 of those, it was also Australia's largest trading partner. It is the third-largest source of foreign investment in Australia, and the fourth-largest destination for Australian investment overseas. It has also been a major source of tourism to Australia.

Against the background of these figures, the data that describe human contact in the business relationship between the two countries are somewhat disappointing. According to the Australian Bureau of Statistics, Japan is only the sixth-largest source of business visitors to Australia-behind the United States, United Kingdom, New Zealand, China and Singapore. It is the seventh-largest destination for Australian business travel overseas-behind the same five countries plus Hong Kong. Reflecting this, while overall Australian investment in Japan increased significantly between 2002 and 2007, official figures show that the growth has been in portfolio investment (where the requirement for people-to-people contact is significantly less) while direct investment (which requires closer personal engagement) has actually diminished. As we have seen above, other indicators of human contact-migration and student numbers-tend to reinforce the conclusion that, for both countries, other relationships are taking precedence.

Conclusions and implications

The history of commercial relations clearly demonstrates what a powerful force complementarity is. Notwithstanding a wide range of potential and actual barriers, trade and investment between Australia and Japan has flourished, to the advantage of both countries. Many of these barriers have been the result of the distance, in its many forms, between the two countries. As a result, a succession of reports, from Garnaut's Australia and the Northeast Asian Ascendancy in 1989 to de Brouwer and Warren's Strengthening Australia-Japan Economic Relations in 2001, have highlighted the importance of knowing more about each other, including knowledge of business regulations.

One lesson we can draw from the successes, and from the limited nature of commercial ties that have obvious potential to become broader (such as in the services sector), is that overcoming the impediments thrown up by distance requires some effort. Where the complementarity is great, commercial incentives will lead firms to trade and invest. Where the complementarity is less marked, there may be roles for governments and business to play in working to reduce some of these impediments. The history of success of the Agreement on Commerce and the valuable facilitative role played by issue-specific agreements such as those relating to double taxation shows what well-crafted agreements can do. Might the free trade agreement currently under negotiation between Australia and Japan play a similar role in the future?

Before such a question, and others about the future of this remarkable relationship, can be answered we need to consider in more detail some of the other critical forces shaping the economies of Australia and Japan. It is to these issues we now turn.

Footnotes

7 This contrasts with the situation in relation to, for example, China, which imports large quantities of many natural resources and energy but is also a major producer in its own right, so that imports constitute a much smaller share of total consumption.

8 Note that the distance measured here is between the capitals of the countries, although some studies have measured the distance between the economic centres of gravity in partner countries.

Department of Foreign Affairs and Trade